Estate Planning of SC, LLC

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This is the Perfect Storm of Estate Planning – Get Prepared!

April 16th, 2009

This year, we are in the midst of a “perfect storm” that creates exceptional planning opportunities we are not likely to see again for many years, if ever.  The factors that have come together to create this perfect storm are certainty as to the federal estate tax, significantly reduced asset values, and historically low interest rates.

Take Advantage of Federal Estate Tax Certainty

The prospect for a repeal of the federal estate tax in the foreseeable future is essentially zero and, in South Carolina, there is no state estate tax this year.  Nobody knows whether the Congress and President will agree to a new federal exemption amount or, if they do, what it will be—especially in light of federal spending in the past few months. (Note, however, that if government spending leads to greatly increased inflation, many more individuals will face having taxable estates.)

Because of the virtual certainty that we will continue to have an estate tax, many of us must plan if we wish to avoid paying it.  As the U.S. Supreme Court has said: “Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.  Therefore, if what was done here was what was intended by [the statute], it is of no consequence that it was all an elaborate scheme to get rid of [estate] taxes, as it certainly was.”

Reduced Asset Values Favor Transfer of Wealth

Reduced values for stocks, real estate, and businesses mean that clients can transfer these assets for less today than they could have just a few months ago. For example, if a particular stock declined from $100 per share to $80, now we can transfer 25% more within the $13,000 annual gift tax exclusion (up from $12,000 as of January 1, 2009). In other words, we can now transfer 162.5 shares instead of 130 shares.  Married couples can give twice that amount, or $26,000 per beneficiary, per year (up from $24,000 as of January 1, 2009).  Typically, individuals transfer this amount to children, grandchildren and other close family members.  In addition, reduced real estate and business values mean that we can transfer a larger percentage of these assets now without incurring gift or estate tax by using our $1 million lifetime gift tax exemption.

At the same time, we now have clarity in the law as to the use of the family limited partnership (“FLP”) and family limited liability company (“FLLC”) for asset protection and other purposes. This is a “perfect storm” factor because we can substantially increase the amount of assets we transfer using our annual exclusions and lifetime exemptions by wrapping the assets in an FLP or FLLC and then giving away interests in the FLP or FLLC.  If you are interested in this type of planning, please contact us to discuss it further.

Interest Rates Are At Historic Lows

The March 2009 Applicable Federal Rates (AFRs)—the “safe harbor” interest rates provided by the government for, among other things, intra-family loans—are:

Short-term (not over 3 years) = 0.72%

Mid-term (over 3 but not over 9 years) = 1.94%

Long-term (over 9 years) = 3.52%

These low interest rates make the strategies discussed below even more attractive, particularly if we can transfer interests in an FLP or FLLC that holds depressed value assets.

With these rates, individuals can enter into loans with family members at historically low interest rates (for example, to help start a business, or buy a first or larger home).  Depending upon the amount of the loan and the goals at hand, it may be possible to structure the loan so that annual interest falls within the $13,000 annual gift tax exclusion.  Doing so allows the donor to forgive interest (the beneficiary receives an interest-free loan) such that the donor transfers property to the beneficiary without incurring gift or estate tax.

Over the past 100 years, a U.S. bull market has always followed a bear market.  Selling depressed assets to a trust for a child or grandchild in return for a long-term installment note at today’s historically low interest rates can be an effective way to “freeze” the current asset values in your estate and have the recovery in asset value that comes in the bull market escape exposure to estate taxation for at least a full generation.

How does the trust obtain the ability to purchase the assets?  One common way is by making a gift to the trust followed by the trust purchasing the assets using an interest-bearing promissory note (with terms similar to a financing transaction with a third-party lender) at or above the minimum interest rate established by the IRS: the current AFR.  We are glad to assist the family in making these transactions.

Grantor Trusts

A “grantor” trust contains certain provisions defined by the Internal Revenue Code.  Interestingly, what makes a trust a grantor trust for income taxes is defined by one part of the Internal Revenue Code and what makes a trust a grantor trust for gift and estate taxes is defined by an entirely separate part of the Internal Revenue Code—and the rules don’t match.  Therefore, with careful design, an irrevocable trust can be made to be a grantor trust for income tax purposes yet not be a grantor trust for gift and estate tax purposes. By using this long-standing wrinkle in the Internal Revenue Code, the strategies for transfers of assets by gifts and sales to trusts discussed above can all be virtually “supercharged.”  Making the recipient trust a grantor trust for income tax purposes but not for estate tax purposes produces tax-free compounding of income in the trust and estate depletion for the donor through his paying taxes on that same income.  And paying those taxes is not an additional gift to the trust.

When Is A Sale Not A Sale?

Under the Internal Revenue Code, when an individual sells an asset she must pay income tax on the amount above her “basis” in the property.  In its most simplified sense, basis is the amount the individual paid for an asset when he purchased it; or if she received it by gift, it is her donor’s basis in the property.  A typical sale of appreciated property thus causes imposition of income tax.

However, the IRS treats a grantor trust for income tax purposes as being a mere extension of the donor.  And since one cannot “sell” property to oneself, the IRS ignores (for income tax purposes) a sale to such a grantor trust.  The donor simply continues to report all items of income, realized gain or loss and deduction from income associated with the assets of the grantor trust on his or her individual income tax return.

Grantor Retained Annuity Trusts

Another strategy aided by low interest rates is the Grantor Retained Annuity Trust (“GRAT”). GRATs are a type of irrevocable trust specifically authorized by the IRS regulations interpreting the Internal Revenue Code. They permit you to make a lifetime gift of assets to an irrevocable trust in exchange for a fixed payment stream for a specified term of years.  At the end of the term of years, after making the final payment to the donor, the balance of the GRAT property, if any (the “remainder interest”), transfers to the beneficiaries of your choice—typically children or grandchildren. The IRS published interest rates at the time of the transfer determine the gift for federal gift tax purposes. This “Section 7520 rate” is 120% of the mid-term AFR (2.4% for GRATs established in March 2009). Critically, this rate does not take into consideration any future appreciation in the value of the property, and therefore the trust maker can reduce the value of the gift to as low as zero.

During the term of years the GRAT must pay the donor a set amount at set intervals, which can be no less frequently than annually. The term of years and the amount of the payments are fixed at the time the trust maker establishes the GRAT. During the term of years of the GRAT, the donor can be the GRAT’s sole trustee or a co-trustee with complete control over all decisions of the GRAT and the assets in the GRAT. Alternatively, the GRAT can appoint a financial advisor to manage GRAT assets.

A GRAT is a “heads you win, tails you tie.” win for everyone.   If the performance of the assets in the GRAT exceeds the 7520 rate, the excess value is transferred without estate or gift tax. If the performance of the assets in the GRAT equals or falls below the 7520 rate, the donor gets all the GRAT assets back.

Despite these difficult economic times, there are many reasons why we should plan now rather than wait until we have more economic certainty. Furthermore, for those who may be subject to federal or state estate tax, a “perfect storm” creates a once-in-a-lifetime opportunity to accomplish unique planning goals and objectives.  Please contact us so that we can assist you during this opportunity.

Taxpayer Certainty and Relief Act of 2009 – Estate tax bill proposed

April 3rd, 2009

This just in:

Sen. Max Baucus has introduced a bill in the Senate that would make the 2009 estate tax level permanent and reunify the estate and gift taxes. As you might remember, under current law, the top rate for all three taxes is 45%, and the exemption is $3.5 million for individuals. In 2010, the current law would eliminate the estate tax and the generation-skipping transfer and cut the gift tax rate to 35%, but, in 2011, the estate, generation-skipping transfer, and gift taxes are scheduled to return to pre-2001 levels, with an exemption of $1 million, a 55% top rate, and a 5% surtax on large estates.

In addition to making the 2009 estate tax level of $3.5 million permanent, the new bill, the Taxpayer Certainty and Relief Act of 2009, would allow portability of the exemption for spouses, eliminating the need to segregate assets of a spouse at the first death into a Credit Shelter or Bypass Trust in order to use both spouses exemptions.  It has been said that we can expect a bill to pass by August of this year. 

Another provision would increase the amount available under the special use valuation revaluation to equal the estate tax exemption.

Other provisions in the Baucus bill deal with ordinary income taxes. Under current law, ordinary income tax rates are imposed at 10%, 15%, 25%, 28%, 33% and 35%. These tax rates expire at the end of 2010. The Baucus bill would make permanent the 10%, 25% and 28% tax rates. The 15% tax rate is already permanent law.  It would also make permanent the reduced tax rate on capital gains and dividends for taxpayers in the 10%, 15%, 25% and 28% brackets.  A 2003 tax bill created a new tax rate of 15% (5% for low-and middle-income taxpayers, going to 0% in 2008) for dividends.  Before the passage of the 2003 bill, dividends were taxed at ordinary income rates. The 2003 bill also reduced the capital gains tax rate from 20% (10% for low- and middle-income taxpayers) to 15% (5% for low- and middle-income taxpayers, going to 0% in 2008). These reduced tax rates originally were set to expire at the end of 2008, but they were extended until the end of 2010 in the Tax Increase Prevention and Reconciliation Act of 2005.

Other provisions in the bill deal with ordinary income taxes. Under current law, ordinary income tax rates are imposed at 10%, 15%, 25%, 28%, 33% and 35%. These tax rates expire at the end of 2010. The Baucus bill would make permanent the 10%, 25% and 28% tax rates.  The 15% tax rate is already permanent law. This bill would make permanent the reduced tax rate on capital gains and dividends for taxpayers in the 10%, 15%, 25% and 28% brackets.

As you might remember, a 2003 tax bill created a new tax rate of 15% (5% for low-and middle-income taxpayers, going to 0% in 2008) for dividends.   Before the passage of the 2003 bill, dividends were taxed at ordinary income rates. The 2003 bill also reduced the capital gains tax rate from 20% (10% for low- and middle-income taxpayers) to 15% (5% for low- and middle-income taxpayers, going to 0% in 2008). These reduced tax rates originally were set to expire at the end of 2008, but they were extended until the end of 2010 in the Tax Increase Prevention and Reconciliation Act of 2005.

Stay tuned to see what amendments the Republicans will propose and for the final passage.

Still not convinced you need a will?

March 16th, 2009

Last Will & Testament Did you know that the most popular estate plan in America is to do nothing?  Perhaps it is because we don’t like to think about our mortality, but approximately 70% of people in the United States do not have a will.

If you do not have a will, your estate will be disposed of by the laws of your estate.  Dying without a will is called dying “intestate” and believe me, it is as painful as it sounds.  Under the laws of South Carolina, if you are married and have children, then your estate is split 1/2 to your spouse, and 1/2 among your children.  I don’t know many parents who would like to own their home with their children.  If those children are minors, then the property cannot be transferred without a guardianship and conservatorship hearing in the probate court, an invasive and expensive procedure that could have been avoided.  Having a will is also the only way for you to leave a portion of your estate to friends or charity.

If you made a will, but then got married, or had children who were not provided for in the original will, then your omitted spouse or child can petition your estate for their share under South Carolina law.  All the more reason to update your will when you make any life change.  Don’t forget to review the beneficiaries of your life insurance and retirement plans as well – those beneficiary designations control no matter what your will says.

Many people think that a good will substitute is to add their spouse or children onto the deed to their house and their bank accounts.  This action constitutes a gift to the spouse or child.  Generally, at the first death between spouses, this isn’t a problem, but if the surviving spouse adds the children, it can become a big problem.  First of all, the gift tax exemption this year is $13,000,  so if the gift is in excess of that amount, then a gift tax return must be filed.  Second of all, if the surviving spouse has more than one child, but only one is named on the bank accounts (generally, because that child is the one helping to write checks and pay bills), then those bank accounts pass automatically to that child.  The will cannot control how the joint accounts pass at death.  Most of my clients tell me that that child will “do the right thing” by transferring money to the other children, but if the bank accounts have any significant value, then we run into the same gift tax problem mentioned above.  The worst plan is one that causes more problems than it solves, especially when it causes taxes that would not have been due otherwise.   Joint ownership is no substitute for estate planning.  What if the child you added to your bank accounts or house gets into creditor problems or gets a divorce?  Those assets would be subject to the claims of the child.

I know that you have heard about will kits that you can get on the internet for cheap, but you get what you pay for.  I see many of those plans and have to tell the person that they wasted their money.  Most of the time, you have to check certain boxes to choose the type of will, durable power of attorney or healthcare power of attorney you want.  If you do not check the right boxes or strike out the right provisions, the document may be ineffective because of mistakes in the execution.  For example, there are two types of power of attorney, general and durable.  While both types have no effect after death, a general power of attorney ends upon the incompetentcy of the maker (called the principal), while a durable power of attorney continues through the principal’s incompetentcy until their death.   In the estate plan kit online, the power of attorney usually has two options buried in the document, one says “this power of attorney is not affected by my subsequent disability or incapacity.”  The average person usually thinks, “gosh, I don’t want someone managing my estate if  I can’t tell them what to do,” or more commonly, skips that section all together and just signs the last page.  You need someone who specializes in estate planning to ensure that your documents are crafted specifically to your circumstances and contain all of the right provisions.

Estate planning is important; it is an investment in your legacy.  These days, the stock market and economy are uncertain, but I promise that an investment in your estate planning will hold its value for years to come.

If your spouse died today – would you be prepared?

February 17th, 2009

In some younger families, one spouse is the breadwinner and another stays home to take care of the children.  Each spouse plays an important role – at the most basic, one provides income and the other provides services.  Most of these types of families are young with young children, and they have not yet accumulated many assets with much equity.  This is  normal progression.  Life insurance plays an important role in this family’s estate.

For example, if Husband is the breadwinner (I know – stereotypical), making $75,000 per year, and Wife stays at home with the children, but has no earned income of her own, then the family needs to have enough life insurance to replace the roles that they play in the family.  Term insurance is great for these types of needs, because as the family accumulates assets, their need for the insurance will decrease.

If Husband were to die first, the Wife’s expenses are not very different than when Husband was living.  She must continue to pay for the home they live in and daily living expenses.  This is generally not a great time to discover that she must go back to work (and put the children in day care?) In order to continue their lifestyle.  They should have enough life insurance on the Husband’s life to replace the income stream.  $1.6 million, assuming an interest rate of 5%, would yield $80,000 per year, thus replacing his income.

Now what if Wife were to die first?  Husband’s expenses will increase because there is no one at home taking care of the children.   Husband will probably want to decrease the amount of time he works so that he can spend more time at home.  The family should have enough life insurance on Wife to replace the value that she brings to the family.  All too often, this part of the plan is overlooked, but it is so important.

You need to talk with your estate planning attorney to ensure that the beneficiaries of these policies mesh with your estate plan.  For example, this family should, at the most basic, have Wills that create a trust for any minor children after both of their deaths, so that the children do not inhereit any assets directly.  Their Wills should also contain a nomination of a guardian for the minor children, along with an alternate.

If the minor children inherit proceeds of life insurance directly, a Probate Court proceeding will be needed to appoint a conservator, a very involved and expensive process; however, if the contingent beneficiary is the Trust for the minor children, then the court proceeding is avoided.  If you also need tax planning in your estate, then other beneficiary designations may be recommended.  Whatever you do, avoid naming your minor children as the beneficiaries under your insurance policies to avoid the conservatorship proceeding.

10 years sounds like a long time . . . .

February 16th, 2009

Doesn’t it?  In South Carolina, we have a statute of limitations that requires estates to be probated within 10 years of the date of death.  If the estate isn’t probated within that time period – SC law provides that the distribution must be as if the deceased did not have a Will.  In addition, you must hire an attorney to file a Petition asking the Probate Court to determine the heirs of the decedent.  This means that you must have witnesses to prove who the children of the deceased were – and they need to be uninterested witnesses – not family members.  The Probate Court requires that the surviving spouse (if there is one), the children and the uninterested witnesses all attend a hearing.

I bring this topic up because although most people know that probate administration is required when there are lots of assets that need to be transferred out of the deceased name, but sometimes if it is just one or two assets and the beneficiaries don’t need to sell the assets right away, the probate administration seems less important.

For example, Wife dies and she only has joint ownership of the house.  If Husband plans to continue to live there and doesn’t need to refinance the home, then he may just continue to live there.  The fact that the house is jointly titled doesn’t affect Husband – it just means that his wife’s name is still on the property tax notice.  This issue only becomes important when Husband needs to go to a nursing home or do something else with the property.  More likely than not, Wife’s will provided that all of her assets at her death should be transferred to Husband, but if more than 10 years have passed, then her will is of no effect.  Under SC law, her assets pass according to the intestate statute, which says that one-half of her assets pass to her spouse, and the other half pass to her children.

If the family members all get along, after the hearing, the children might decide to transfer the house back to Husband.  If the family relationships are not good, though, this could cause significant problems.  What if one child really needs the money and requires her father to buy back her interest in the house?

I know that probate administration occurs during a difficult time and that sometimes it may seem better not to deal with it at all.  Please let us assist you with this process so that time doesn’t fly by, making the process even more difficult.

It’s Tax Season

February 11th, 2009

April 15 Calendar

Tis the season when CPAs are working around the clock to prepare all of our income tax returns; however, it is also the season of the Gift Tax Return.  Did you know that if you gave away property valued at more than $12,000 to any individual or irrevocable trust last year that you must file a gift tax return by April 15th to report those transfers?

If you transferred a house to a child in 2008 – the child did not buy it from you – you need to file a gift tax return to report the transfer (and any other transfers that you may have made last year).    One of my clients moved to a nursing home last year and transferred his house to his niece.  This year, we will file a gift tax return reporting the date of the transfer and the fair market value of the house.

If you are married, the IRS allows you to split your gifts with your spouse (provided they give you permission).  For example, Husband gave $24,000 to his daughter last year.  Because he could only give $12,000 individually, he will want to use Wife’s exemption to avoid paying any gift tax on the transfer (provided Wife did not make any gifts to daughter last year).  In order to split the gift with Wife, Husband must file a gift tax return electing the splitting of gifts, and both Husband and Wife must sign the return.  If they do this, no gift tax will be due on the transfer to daughter.

More than likely, as you report these transfers, you will not have to pay any tax out of pocket because of the Gift Tax Exemption.  This exemption is $1,000,000 during your lifetime, which means you can give away $1,000,000 worth of property over the annual exclusion (last year, $12,000) and still not pay any tax out of pocket.  The gift tax return will just show that you have used a portion of your Gift Tax Exemption.   For my clients who do not have taxable estates, this generally does not affect their estate planning; but for those with taxable estates, this reduction of credit means that the Estate Tax Exemption ($1,000,000 of which includes the Gift Tax Exemption) will be reduced at their death, so that we may pay a little more estate tax when they pass away.

Most individuals who must file gift tax returns each year are those who have set up irrevocable life insurance trusts, and who make transfers to the trust each year in order to pay the premiums.  These clients have been educated about the gift tax when the trust was created; however, if they have not set up this sort of complicated planning, most people are not aware that the Gift Tax even exists.

In 2009, the annual exclusion (which is adjusted for inflation) increased to $13,000, so this year you can give $13,000 to as many individuals as you like.  The annual exclusion is per person, and there is no limit to the number of people you can make gifts to.   If you need help structuring a gift transaction, please contact us and we are glad to help.

Happy Tax Season!

The Goal of this Blog

January 19th, 2009

Early last year, I discovered that there are things more important than how many hours you sit at the shiny desk in your associate’s office at the big firm, and that sometimes just the ability to help people who need it in this area of law is enough – or more than enough.  I opened my own practice soon after that realization.  I discovered that I wanted to practice law in a way that allows me to help my clients without always thinking about my collections goal.  Sure, getting paid is essential – no small practice can survive solely on charity, but I want to provide the best client service on a smaller scale. I invite you to make this journey with me, as I grow my practice into the future.  Some of my posts will be about estate planning and probate administration – with almost eight years of experience I have lots of stories to tell – and some of them will be about my practice and the latest and greatest.

A New Year, New Rules

January 18th, 2009

As of January 1, the Estate Tax Exemption has been increased to $3.5 million per person.  As a result, those persons whose estate plans create trusts based upon the exemption amount need to review their plans to ensure that their planning goals are met.

For example, a Husband has a Will that creates two trusts when he passes away, a Marital Trust for his wife for her lifetime, and a Family Trust (also called a Credit Shelter Trust) for his children from his first marriage.  These trusts are funded by language that is based on the estate tax exemption.  This worked well years ago when the plan was drafted, when the estate tax exemption was only $1.5 million, leaving $1.5 million directly to the children by a prior marriage and the balance of Husband’s estate to the Marital Trust for his wife.  However, with the increase this year, the formula actually disinherits his wife, leaving his entire estate to his children.

If your estate plan leaves property to a Family Trust that provides for the surviving spouse and the children, you may want to consider revising the trust to provide that the spouse’s needs are to be considered primary and that the children’s are considered secondary in order to give the Trustee some idea of what your intent.  This works well in a first marriage.

Please call us to see if you need to revise your estate plan based upon the new exemption amount.