Transcript Slide 1

Valuation Opportunities in
Estate & Gift Taxation
Business Valuation Workshop
LCPA-Lafayette
November 6, 2009
Vanessa Claiborne
Chaffe & Associates, Inc.
Miriam Henry
Jones Walker
1
Wealth Transfer Opportunities
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Today’s
Investment
Environment
Background on
Estate Tax
Loans
GRATs
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2
Sale to a Grantor
Trust
Benefits of Gifting
during a Market
Downturn
Qualified Personal
Residence Trust
Charitable Lead
Annuity Trust
Lawyerly
Disclosures
Today’s Investment
Environment
3
Today’s Investment
Environment
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Historically, significant market
declines have been followed by
substantial recoveries
1987 Financial Panic
 1998 Long Term Capital
Management Crisis
 2002 Tech Bubble Bust
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4
Today’s Investment
Environment cont…
5
S&P REIT Index
Action
Buy
Sell
If sold
S&P REIT Index
Date
Price
Gain
10/18/1990 $ 51.71
10/9/1997 $ 113.09 118.70%
2/18/2000 $ 71.81
38.87%
Buy
Sell
If sold
3/12/2003 $ 86.84
2/13/2007 $ 220.56
12/21/2008 $ 65.20
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153.98%
-24.92%
S&P Oil & Gas Equipment Select Industry
Index
S&P Oil & Gas Equipment Select Industry Index
Action
Date
Price
Gain
Buy
6/13/2006 $
2,721.80
Sell
10/3/2006 $
2,500.92
-8.12%
If sold
12/14/2006 $
3,175.25
16.66%
Buy
Sell
If sold
8/16/2007 $
6/30/2008 $
12/5/2008 $
7
3,397.36
5,109.11
1,499.48
50.38%
-55.86%
Background on Estate
Tax
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The U.S. Estate Tax
(as we know it today)
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The estate tax exemption is:
 $3.5 million for 2009
The rate is 45%
The estate tax exemption
amount is reduced by taxable
gifts made during life
You can use $1 million of your
exemption with lifetime gifts
9
What is Subject to U.S. Estate
Tax?
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All property owned at death.
Includes “non-probate” assets like
401(k), IRA, assets held in a
revocable trust (e.g. a “living trust”).
Assets donated during life if
decedent retains control.
Life insurance owned by the
decedent.
QTIP assets from a predeceased
spouse’s estate
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What Deductions are
Available?
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Debts & administrative
expenses.
Charitable gifts at death.
Outright transfers to spouse and
other qualified transfers to
spouse - e.g. “QTIP” trust or
usufruct for life to spouse.
Deductions must be qualified.
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State Inheritance/Estate Tax
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Louisiana has none.
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But, if you own property in other
states, find out if they have a
state death tax and plan to avoid
it (titling asset in an entity or
trust may do it).
12
U.S. Gift Tax
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A tax on lifetime gifts.
You can use up to $1 million of your
exemption during life.
You can make annual exclusion gifts of
$13,000 per year per donee -- without
using exemption.
Tuition payments are excluded and do not
“use up” exemption - but donor must pay
the school directly.
Medical expenses are the same and,
again, donor must pay the health care
provider directly.
Louisiana has no gift tax.
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U.S. Generation-Skipping
Transfer Tax
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An additional tax on top of gift or estate tax
on transfers that “skip” a generation.
Each donor has a GST tax exemption
equal to the estate tax exemption amount but these are separate exemptions.
The GST tax rates is 45%
The rates apply in addition to gift/estate
taxes.
Louisiana does not have a GST tax.
Generally, if a lifetime gift is exempt from
gift tax, it is exempt from GST tax.
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Income Tax
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If you give low basis assets away during
your life, the donee takes your basis and
must pay capital gain upon sale.
Legatees/heir take basis established at
death - often a stepped up basis.
IRD - Income in Respect of Decedent - if
you leave property that includes taxable
(but not yet taxed) income, the legatee will
pay income tax on the income (e.g.
IRA/401(k)).
Think about the income tax impact when
making gift decisions -- income tax can
reduce the value of the gift substantially.
Consider using IRD items to fund
charitable gifts at death -- the charity
doesn’t pay income tax.
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Income Tax Issues
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The income received by the GRAT, even
amounts in excess of the required annuity
payments to the grantor, will all be taxed to
the grantor.
That is, the grantor will have to use a
portion of the annuity payments, or other
funds, to make the necessary income tax
payments.
Being required to pay the income tax on
the entire income of a GRAT can be an
another estate planning advantage.
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These tax payments are essentially tax-free gifts from
the grantor to the beneficiaries of the GRAT.
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The Easy Stuff
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Don’t die intestate - you can’t get a marital
deduction in Louisiana for the intestate usufruct.
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Make annual exclusion gifts - cash or high basis
securities, other assets with high potential for
appreciation.
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Pay tuitions and medical expenses (and pay the
school/provider directly).
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Consider a power of attorney.
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Make charitable gifts.
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Spend your money!
17
Loans
18
Loans
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The IRS permits relatives to
lend money to one another at
the Applicable Federal Rate,
which the government sets
monthly.
With these, relatives can charge
far less than a bank or other 3rd
party lenders.
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Example
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Loan
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Interest paid over term of loan
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$1 million
30 yr mortgage
Interest 6.5% 3rd party lender or 4.10%
AFR
$1.3 million with 6.5% interest
$756,000 with 4.10% interest
Parents are transferring $544,000
tax free to kids over 30 years
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GRATs
Grantor Retained Annuity Trusts
21
GRATs
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How Does a GRAT Work?
When Would a GRAT be a Good
Strategy?
What Does a GRAT
Accomplish?
GRAT Examples
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How Does a GRAT Work?
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Grantor transfers assets to trust
Grantor receives an annuity stream
for a set term
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Term is chosen by the grantor
Annuity stream is typically either cash or
in kind
Grantor pays little or no gift tax, or
uses gift tax exemption, on present
value of trust remainder
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Gift tax exemption as of 2009
$1,000,000 per grantor
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How Does a GRAT Work?
cont…
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When trust term ends,
remaining trust assets pass to
beneficiaries free of gift tax
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If grantor does not survive the
term, trust assets are included in
the estate and subject to estate
tax
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How Does a GRAT Work?
cont…
Source: J.P. Morgan
25
When Would a GRAT be a
Good Strategy?
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The assets in a portfolio are
appreciating rapidly and/or producing
high income.
The assets transferred can be
discounted pursuant to general
valuation principles.
Grantor wants to retain income
stream from those assets.
Grantor wishes to minimize estate or
gift taxes on the transfer of wealth to
beneficiaries.
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What Does a GRAT
Accomplish?
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A GRAT accomplishes the following:
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“Freezes” the value of gifted assets so
that their future appreciation will not be
subject to transfer tax
Retains the use of the assets for a
period of time.
Discounts the value of the gift for gift tax
purposes.
In a low interest rate environment, a
GRAT provides a great opportunity to
shift future appreciation to
beneficiaries.
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Planning
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Short-term GRATs
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Long-term GRATs
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A short-term GRAT minimizes the
change that a year or two of poor
performance will adversely affect the
overall effectiveness of the GRAT
Allows the annuity payments to be less
each year when designing a zeroed-out
GRAT
Using Increasing Annuity Amounts
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Allows for lower payments in earlier
years and larger payments later.
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GRAT Examples
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Example 1
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The gift element is entirely
eliminated if the gift is “zeroed
out” (i.e. there is no gift if the
actuarial value of the grantor’s
interest equals the full value of
the property transferred to the
trust)
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Example 1 cont…
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Grantor (“G”) transfers property worth $1
million to a GRAT that will pay G $118,430
per year for a term of 10 yrs at the end of
which the GRAT will terminate and the
property will be distributed to G’s children.
If the assumed AFR was 3.2% at the time
the GRAT is created, the value of the
annuity that G retained interest will be
roughly equal to the full value of the
property that G transferred to the GRAT.
(i.e. the GRAT is zeroed out)
For gift tax purposes, the creation of the
GRAT does not involve a gift.
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Example 1 cont…
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Note that if the grantor survives the term of the
zeroed-out GRAT, the GRAT will have property
available for distribution only to the extent the
property in the GRAT appreciates at a rate greater
than the rate (3.4%) that was assumed when the
GRAT was created.
If G survives the retained term, his children will
receive the property (if any) then held in the GRAT.
If the property generates an annual return of at least
15%, G’s children will receive the entire principal of
the trust, which itself may have increased
dramatically in value over the term of the GRAT.
At an 8% growth rate, G. children receive $443,281
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Example 1 cont…
Coupon
118,430
Term
10
Rate
3.2%
PV
($999,999.70)
1
2
3
4
5
6
7
8
9
10
Annual Pmt
PV of an pmt
118,430
115,654
118,430
112,944
118,430
110,297
118,430
107,712
118,430
105,187
118,430
102,722
118,430
100,314
118,430
97,963
118,430
95,667
118,430
93,425
1,184,301
1,041,885
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Example 2
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Interest rate: 3.2%
Term: 10 years
Transfer to Trust: $5 million
Beg. Annuity: $238,722
Annuity Growth Rate: 20%
Assumed Asset Growth Rate: 8%
Value of Annuity: $4,999,985
Taxable Gift: $15.45
Value of Assets at End of GRAT
Term: $2,771,951
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Example 3
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Interest rate: 3.2%
Term: 10 years
Transfer to Trust: $5 million
Beg. Annuity: $238,722
Annuity Growth Rate: 20%
Assumed Asset Growth Rate: 5%
Value of Annuity: $4,999,984
Taxable Gift: $15.45
Value of Assets at End of GRAT
Term: $882,801
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Example 4
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Interest rate: 3.2%
Term: 10 years
Transfer to Trust: $5 million
Beg. Annuity: $238,722
Annuity Growth Rate: 20%
Assumed Asset Growth Rate: 0%
Value of Annuity: $4,999,984
Taxable Gift: $15.45
Value of Assets at End of GRAT
Term: $0.00
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Sale to a Grantor Trust
37
Sale to a Grantor Trust
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Settlor establishes a funded "grantor" trust and sells
assets to the trust for a note.
A "grantor" trust is a trust with a certain tax status
that treats the settlor as the owner for income tax
purposes. Because the grantor is selling the assets
to a grantor trust, there is no income / capital gains
tax on the sale. If the assets are sold during the
term of the trust, the settlor pays the capital gain;
the settlor picks up all the tax on the income during
the term of the trust.
The trust should be funded with sufficient assets to
secure the note and provide economic support for
the loan. Funding usually requires a gift by the
settlor.
Goal: freeze the value of the assets transferred as
of the date of transfer to avoid inclusion of
appreciation in the settlor's estate.
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Illustration of
Sale to a Grantor Trust
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Grantor owns 15,000 shares of stock
valued at $1,000 share
($15,000,000)
Spouse owns 3,000 shares
($3,000,000)
Grantor donates $500,000 of stock
to multigenerational grantor trust
Grantor sells $4.5 million of stock to
grantor trust for a note
October 2009 AFR of 2.66%
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Illustration of
Sale to a Grantor Trust
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Company projects FMV and
Dividends to increase at 15%
per year for 2010, 2011 and
2012
Thereafter, 10% growth is
projected
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Illustration of
Sale to Grantor Trust
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7 years later
FMV of trust assets increase from
$500,000 to $9.67 million as debt is
paid and FMV of stock and dividends
build
$4.1 million of estate taxes saved
Grantor and spouse receive $4.99
million in payments from the trust
Grantor and spouse pay all income
tax on trust dividends (including
upon a sale of the company)
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Benefits of Gifting
During a Market Downturn
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Discounted Assets
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The contribution of discounted
assets to a GRAT may make the
GRAT more effective.
For example, the grantor may
decide to contribute a minority
interest in the grantor’s family
LLC or LP.
Often appraisers value such
interests on a discounted basis.
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Discounted Assets cont…
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The valuation of the interest is
significantly less than such interest’s
pro rata share of the total assets of
such company.
Nevertheless, such a contributed
interest is entitled to a pro rata share
of the earnings and growth of the
company.
This may result in the percentage
“growth” experienced by the GRAT
being significantly greater than that
experienced by the entire company.
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LLC Example 1
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Assume G owns a building with
a FMV of $10 million.
The building generates $1MM/yr
in rent and is expected to
appreciate at 5%/yr
 G transfers the building to an LLC

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LLC Example 1 cont…
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Grantor obtains an appraisal of
a 33% interest in the LLC.

After a 40% discount for lack of
control and marketability, the
value was $2MM ($10MM X
33.33% X 40%)
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LLC Example 1 cont…
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Interest Rate: 3.2%
Term: 10 years
Transferred to Trust: $2 million
Beginning Annuity: $95,489
Annuity Growth Rate: 20%
Assumed Asset Growth Rate: 15%
Value of Annuity: $2 million
Taxable Gift: $1.99
Value of Assets at End of GRAT
Term: $3,992,386
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LLC Example 2
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Interest Rate: 3.2%
Term: 5 years
Transferred to Trust: $2 million
Beginning Annuity: $298,471
Annuity Growth Rate: 20%
Assumed Asset Growth Rate: 25%
Value of Annuity: $1,999,995
Taxable Gift: $5.52
Value of Assets at End of GRAT
Term: $2,740,118
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Operating Company Example

The following is an illustration of
benefits of discounting partial
interests and gifting equity
interests in a private company
during a market downturn
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Operating Company Example
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Dad owns 80% of the business
Junior and Sissy each own 10%
In 2007, business was worth $10
million on a control basis.
Now it is worth $8 million.
Dad donates 20% of the equity to
each child.
No taxes are due because Dad uses
his lifetime exclusion.
50
Operating Company Example

Now, each child owns 30% and
Dad owns 40%, putting all three in
a minority position.
1)
20% interest in the business at control
level in 2007 was $1MM. Gift to each
child in 2009 has a fair market value of
$420K. If value recovers to 2007 level,
in 2011 $580K will have been
transferred to each child tax free. At a
marginal tax rate of 45%, savings are
2 donees x $580K x 45%=$261,000
51
Operating Company Example
2)
Dad’s ownership interest goes
from a control level to a
nonmarketable, minority level. At
a marginal tax rate of 45%,
savings are …
52
Operating Company Example
53
Operating Company Example
54
Qualified Personal
Residence Trust
(QPRT)
55
Qualified Personal Residence
Trust (QPRT)
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Donor transfers personal residence (often
a vacation home) to qualified trust for a
term; at the end of the term the principal
beneficiaries receive the property.
Donor makes a gift of the value of the
remainder interest only -- the actuarial
value of the donor's retained right to use
the property for ten years reduces the
value of the gift.
Goal: transfer asset for a lower transfertax cost; move appreciation out of donor's
estate.
56
QPRT Example

A $1 million vacation home is transferred
 3.2% government interest rate applies
 The trust has a 10-year term and the
donor is 65
 The value of the gift is approximately
$573,020
 At the end of the 10-year term, the
property is worth $3 million, and at the
donor's death 10 years later it is worth
$5 million
57
Charitable Lead Annuity
Trusts
(CLAT)
58
Charitable Lead Annuity Trusts
(CLAT)
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Charity receives an income stream (either
a fixed dollar amount or a fixed percentage
of the value of assets) paid annually for life
or a term.
At the termination of the income interest,
family beneficiary receives the remaining
principal.
CLTs may be established during life or at
death.
The remainder interest is valued
actuarially, as with a GRAT or QPRT.
59
CLAT Example

$2 million is transferred into a CLAT with
PETA (People for the Ethical Treatment of
Attorneys) as the donee
 Interest rate: 3.2%
 Annual Annuity: $140,000 (7%)
 Term is 15 yrs. Total annual return 8%
 PETA receives: $2.1 MM
 Donor uses $352,620 of gift tax
exemption
 Family Beneficiaries receive $2.54 MM
at end of term

Income and capital gain tax advantages
60
Lawyerly Disclaimers
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Don’t try this at home.
We’ve covered the bare basics only.
Every family has a different situation
and needs its own plan.
The numbers I’ve used for examples
are rounded, and will be different
when applied to your family.
Tax laws are always changing.
61
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IRS Circular 230 Disclaimer:
Pursuant to Treasury guidelines, any
tax advice contained in this
communication (or any attachment)
does not constitute a formal opinion.
Accordingly, any tax advice
contained in this communication (or
any attachment) is not intended or
written to be used, and cannot be
used by any taxpayer, for the
purpose of avoiding penalties that
may be asserted by the Internal
Revenue Service.
62
Finally …
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Yes, estate planning is expensive.
But, good planning should bring
great value to your family – in terms
of tax dollars saved and family goals
met.
Sooner is better.
Extremely low market values make
this an opportune time to transfer.
63
Questions?
64
201 St. Charles Ave.
Suite 1410
New Orleans, LA 70170
201 St. Charles Ave.
Suite 5100
New Orleans, LA 70170
(504) 524-1801
www.chaffe-associates.com
[email protected]
(504) 582-8436
www.joneswalker.com
[email protected]