Transcript Risk Management and Holistic Planning

Wealth Transfer Planning
Linda Hayes, JD, LL.M.
What We Will Cover
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Overview of Federal Transfer Tax System
Significance of forms of Title
Gifting
Grantor Retained Interest Trust Strategies
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Non Trust Strategies
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GRATs & QPRTs
SCINs and Private Annuities
Advanced Trust Strategies
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ILITs and Sales to IDGTs
Overview of United States
Transfer Tax System
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Three Types of Transfer Taxes
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Gift Tax
Estate Tax
Generation Skipping Transfer Tax
The type and amount of tax imposed depends on:
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Relationship of transferor to the US Time of the transfer
(lifetime or testamentary)
Type of property
Fair market value of property Identity of transferee/recipient
(e.g. charity, spouse or other related or unrelated person)
Transfer Tax Exclusions &
Deductions
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Gift Tax
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Exclusions
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Lifetime Gifting Exclusion
Annual Exclusion
Tuition and Medical Expenses
Gift Splitting
Deductions
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Marital Deduction
Charitable Deduction
Transfer Tax Exclusions &
Deductions
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Estate Tax
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Exclusions
 Estate Exemption
 Qualified Conservation Easement
Deductions
 Marital Deduction
 Direct to spouse
 In trust for spouse
 QTIP/GPA/Estate Trust/QDOT
 Charitable Deduction
 Administrative Expenses
Tax Rates and Exemption Amounts
Estate &
GST Rate
Estate &
GST Exclusion/
Exemption
Gift Tax Rate
Gift Tax
Exemption
2004
48%
$1,500,000
48%
$1,000,000
2005
47
1,500,000
47
1,000,000
2006
46
2,000,000
46
1,000,000
2007
45
2,000,000
45
1,000,000
2008
45
2,000,000
45
1,000,000
2009
45
3,500,000
45
1,000,000
2010
0
Repealed
35
1,000,000
2011
55
1,000,000
55
1,000,000
Using the Unified Credit Amount
Effectively
Without Credit Trust
Decedent's
Assets $2MM
Not
Taxed
Survivor's
Assets
$2MM
With Credit Trust
Survivor's
Assets
$2MM
Decedent's
Assets $2MM
Not
Taxed
Survivor's Net
Worth at Death
$2MM
Credit Trust
$2MM
Not
Taxed
Survivor's Net
Worth at Death
$4MM
Taxed
$920,000
Net to Heir's:
$3,080,000
Net to Heir's:
$4MM
Gifting
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Forms of Title
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Asset Selection
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Traditional Gifting Strategies
Forms of Title
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Joint Tenancy with Rights of Survivorship
Community Property
Community Property with Rights of Survivorship
Funded Revocable Trust
Custodial Accounts
Asset Selection for Gifting
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Assets to Give
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High growth assets
High income yield assets
High basis assets
Assets Not to Give
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Assets with FMV < Basis
Income from an asset without the principal
Traditional Gifting Strategies
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Outright Gifts
Custodial Accounts – UTMAs and UGMAs
529 Plans
Gifts in Trust
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2503(c) Trusts
Crummey Trusts
GST Trusts
Outright Gifts
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Description
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Advantages
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Property transferred to donee’s own name
Simple
Generally qualifies for annual exclusion
Disadvantages
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Intended donee may be a minor
Subject to claims of donee’s creditors
Custodial Accounts
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Description
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Advantages
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Minor is legal owner but transactions conducted by a
custodian
Simple
Generally qualifies for the annual exclusion
Disadvantages
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Minor receives complete control over the assets at a
certain age (18, 21 or 25 depending on state law)
Subject to claims of donee’s creditors
Assets includible in donor’s estate if donor is custodian and
dies before minor reaches age of majority
529 Accounts
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Description
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Advantages
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Income tax deferred account set up for a beneficiary to pay for the costs
of higher education
Control over assets
Qualifies for the annual exclusion
Can prefund up to five years
Income tax avoidance if funds used for education
Flexibility – can change beneficiary
Asset protection
Disadvantages
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Limited investment options
Gifts in Trust
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Description
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Advantages
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Donor transfers property to a trustee to hold for the benefit
of a another person
Flexibility - can be drafted to meet donor’s goals and
reinforce values
Assets do not have to be distributed at a certain age
Disadvantages
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In general, gifts in trust do not qualify for the annual
exclusion
Irrevocable
Additional costs to administer
2503(c) Trusts
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Description
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Advantages
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Discretionary income and principal distributions until beneficiary
reaches age 21
Trust terminates when beneficiary turns 21 unless extended by
the beneficiary
Qualifies for the annual exclusion
Statutory
Qualifies for annual exclusion
Disadvantages
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Not as flexible as other trusts
Irrevocable
Crummey Trusts
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Description
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Advantages
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General rule is gifts in trust do not qualify for the annual exclusion
because they are not gifts of a “present interest”
Transfers considered a “present interest” if the beneficiary has
the right to withdraw the contribution (the Crummey withdrawal
power)
Qualifies for the annual exclusion
Flexibility in trust terms
Disadvantages
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Irrevocable
Administrative requirements – Crummey Letters must be sent
Generation Skipping Trusts
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Description
 Trust created for the benefit of grandchildren, designed to use
GST exemption
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Advantages
 Prevents application of estate tax at one generation below donor
 Creditor protection
 Can be drafted as a Crummey Trust to use annual exclusions
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Disadvantages
 Irrevocable
 Flexibility requires careful drafting because of the length of the
trust (e.g., use of trust protector)
Benefits and Role of Trusts
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Revocable Living Trusts - Purposes
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Manage & protect assets
Provide continuity in management at death
Avoid delays and costs of probate
Control how and when assets distributed
Ensure privacy and confidentiality
Irrevocable Trusts - Purposes
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Protect assets through generations
Control how & when assets are distributed
Ensure privacy and confidentiality
Reduce estate and gift taxes through annual and lifetime
exemptions
Transferring appreciation
Basic Estate Plan
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Will
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Durable Power of Attorney (Financial Matters)
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Health Care Power of Attorney (Health Care Proxy)
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Living Will (Optional)
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Revocable Living Trust (Depending on Assets and
Residency)
Grantor Trusts
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Definition
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Income Taxation
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Grantor retained rights or powers over trust sufficient enough to be taxed
on the trust income
FOR INCOME TAX PURPOSES ONLY
Examples: Living Trust, GRAT, IDGT
Grantor subject to tax on all income; receives benefit of all deductions
No separate tax return required
Powers Causing Grantor Status
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Power
Power
Power
Power
of Substitution
to borrow without security
of trustee to distribute to grantor’s spouse
to Revoke
Income Tax Benefit of Grantor Trusts
Non Grantor
Grantor
Trust
Trust
$1,000,000
$1,000,000
$0
$0
$1,000,000
$1,000,000
$50,000
$50,000
Capital Gains Taxed to Trust (15%)
($150,000)
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Ordinary Income Taxed to Trust (35%)
($17,500)
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Capital Gains Taxed to Grantor (15%)
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($150,000)
Ordinary Income Taxed to Grantor (35%)
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($17,500)
$882,500
$1,050,000
Trust Assets at End of Year 1
Basis of Assets
Capital Gains Realized
Ordinary Income Earned
Trust Assets at End of Year 2
Additional Assets to Heirs
$167,500
Estate Tax Savings (46%)
$77,050
Grantor Retained Annuity
Trusts
(GRATs)
Grantor Retained Annuity Trust
(GRAT)
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Description
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Irrevocable trust
Grantor transfers property and retains right to receive a
fixed payment based on initial FMV of property transferred
to trust
Value of remainder interest is a current gift
Can do a “Walton GRAT” making the gift zero
Purpose
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Reduce estate and gift tax
Transfer appreciation over 7520 rate (set each month by
IRS)
Grantor Retained Annuity Trust
(GRAT)
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Advantages
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Disadvantages
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“Zeroed out” GRAT results in no gift
Simple to explain, understand, and execute
Irrevocable
Grantor trust – income taxed to Grantor
GRAT assets must outperform the Section 7520 Rate
Grandchildren cannot be beneficiaries
Timing and amount of annuity payments inflexible
Investment Choices
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Highly appreciating assets are best
Concentrated assets – distributions can be “in kind”
Hard to value assets can be used but need appraisal upon contribution and
distribution
Qualified Personal Residence
Trusts
(QPRTs)
Qualified Personal Residence Trust
(QPRT)
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Description
 Irrevocable trust
 Grantor transfers a personal residence
 Grantor retains the right to use the property for the term
 At end of term, title passes to remainder beneficiary
 Value of remainder interest is a current gift
 Grantor must maintain property
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Purpose
 Reduce estate and gift tax
 Transfer appreciation
 Asset protection
Qualified Personal Residence Trust
(QPRT)
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Advantages
 Effective way to keep trophy house in the family
 May have some asset protection benefits
 Reduction of estate and gift tax
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Disadvantages
 If Grantor dies during the term, included in Grantor’s estate
 Cannot be transferred to grandchildren
 After term, Grantor must pay fair market value rent
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Investment Choices
 None - however, if residence sold during trust term, the QPRT
converts to a GRAT
Non-Traditional Strategies
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Self-Canceling Installment Notes (SCINs)
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Private Annuities
Self-Canceling
Installment Notes
(SCINs)
Self-Canceling Installment Notes
(SCINs)
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Description
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Installment sale of an appreciated asset between family
members or unrelated parties
Recognition of gain is spread out over a term of years
Obligation under the installment note automatically ceases
upon the death of the seller
Cancellation provision must be “bargained for”
Purpose
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Transfer appreciation in an asset
Reduce estate and gift tax
Provide income stream to seller for life
Self-Canceling Installment Notes
(SCINs)
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Advantages
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If seller dies before note is paid off, the unpaid balance is
not subject to estate or gift tax
Seller keeps an income stream for life
Disadvantages
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IRS attack – part sale/part gift
Cancellation provision must be bargained for resulting in
above market sales price or higher rate of interest
Seller cannot keep control over property sold
Private Annuities
(PAs)
Private Annuity
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Description
 Sale of property from one family member to another or unrelated
third parties
 Consideration for sale is purchaser’s (obligor’s) unsecured
promise to payments to seller (annuitant)
 Must make specific, periodic payment to the seller (annuitant) for
the seller’s lifetime
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Purpose
 Transfer of property from one generation to the next without
using lifetime gifting exemption in family context
 Getting income stream from non-income producing asset in thirdparty unrelated context
Private Annuity
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Advantages
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Disadvantages
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Does not use any of seller’s (annuitant’s) lifetime gifting exemption
Provides income stream to annuitant; taxes prorated per payment
Reduces annuitant’s potential estate tax liability
Annuity can be “deferred” or back-loaded
Obligor may not have ability to make payments if annuitant lives long
Must be unsecured
If annuitant dies soon, obligor has negative income tax consequences
On 10/17/06, IRS issued proposed regs that would require immediate recognition
of income! May be the death knell.
Investment Choices
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Real property
Assets expected to appreciate in value
Assets that can be discounted
Irrevocable Life Insurance Trusts
(ILITs)
Irrevocable Life Insurance Trust (ILIT)
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Description
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Irrevocable grantor or non grantor trust designed to
purchase and hold insurance on life of one or more
persons
Purpose
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To exclude life insurance proceeds from insured’s estate
because insured has no “incidents of ownership”
May be used as “wealth replacement” vehicle
Irrevocable Life Insurance Trusts
(ILITs)
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Advantages
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Disadvantages
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Excluded from insured’s estate
Giving Crummey powers to numerous ILIT beneficiaries can absorb
large portion of gift tax
Insured cannot act as trustee
Premium payments made directly by insured are a gift
Payment of Gift Tax can be avoided
Investment Choices
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Trust owns life insurance policy or policies
Policies generally invest in mutual funds
Common Misconceptions
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Creation of Joint Tenancy Account will remove at least a portion
of the account from the estate of individual who creates the
account.
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Once a Revocable Living Trust is created, your estate plan is
complete.
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If primary beneficiary of insurance policy dies, and no secondary
beneficiary is named, proceeds will go directly to insured’s
children or other family members.
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Revocable Living Trusts cannot be named as beneficiary of
employee benefit plans, IRAs or 401(k) plans.
Common Misconceptions
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If two unmarried individuals make unequal contributions to purchase
of real property, there are no gift tax consequences.
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Assets held in joint tenancy form of title can never be divided.
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If the combined estates of husband and wife are less than tax
exempt amount (currently $4,000,000), joint tenancy is an
appropriate method for holding title to assets.
Planning “Landmines”
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Charitable Planning
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Always make sure property held long term (i.e., one year or more)
Is the intended charity is a public charity or private foundation?
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Is the real property being gifted is mortgaged, could have part gift/part sale
Gifts of Stock
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Private foundation – most donations limited to client’s basis in the
gifted property
How, when was stock acquired (beware disqualifying dispositions)?
If property bring gifted is < than FMV, sell the asset, give the cash
Family Dynamics
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Always understand the family dynamics. Some strategies are clearly
inappropriate for families with problematic dynamics (e.g., QPRT)
Understand dynamics not only of client’s lineal descendants, but their
spouses as well.