ESTATE & TRUST CONSIDER UTILIZING YOUR LIFETIME GIFT EXEMPTION BY FUNDING A SPOUSAL LIFETIME ACCESS TRUST BE IN A POSITION OF STRENGTH SM

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1 BE IN A POSITION OF STRENGTH SM WithumSmith+Brown s Tax Services Team Newsletter ESTATE & TRUST DON T FORGET ABOUT STATE TAXES IN YOUR ESTATE PLAN CONSIDER UTILIZING YOUR LIFETIME GIFT EXEMPTION BY FUNDING A SPOUSAL LIFETIME ACCESS TRUST A Spousal Lifetime Access Trust can provide a spouse with limited accessibility during his or her lifetime while keeping the assets out of both spouses taxable estates. withum.com Certified Public Accountants and Consultants New Jersey. New York. Pennsylvania. Maryland. Florida. Colorado

2 CONSIDER UTILIZING YOUR LIFETIME GIFT EXEMPTION BY FUNDING A SPOUSAL LIFETIME ACCESS TRUST Hal R. Terr, CPA, PFS, CFP, AEP, Partner We are half-way through the year and that much closer to the scheduled expiration of important estate and gift tax benefits at the end of The so-called Bush tax cuts will likely expire in a few short months and with them, a number of valuable estate planning opportunities may also disappear. The current federal gift exemption is $5,120,000, but on January 1, 2013, if no federal legislation is passed, this exemption returns to $1 million and the maximum gift and estate tax rate returns to 55%. While many high net worth individuals like the concept of utilizing their current lifetime gift exemptions, most of these individuals are concerned that the loss of access to income and principal of the gifted property may negatively impact their retirement lifestyle. A Spousal Lifetime Access Trust (SLAT) can provide the grantor s spouse with limited accessibility during the spouse s lifetime while keeping the assets out of both the grantor s and spouse s taxable estates. The SLAT must be irrevocable and the grantor must not have any incidents of ownership in the trust property. A properly drafted SLAT should not grant any beneficial interest to the grantor or give the grantor any power to replace the trustee with himself/herself. The grantor would make gifts to a lifetime credit shelter trust for the benefit of the grantor s spouse and possibly children. The trust would be designed to give as much control and flexibility to the surviving spouse as desired without creating tax or creditor concerns. Some high net worth individuals may want to go further and have each spouse create a SLAT for the other spouse. Care must be taken so that the trusts are structured to avoid the reciprocal trust doctrine and therefore avoid estate inclusion in both spouse s estates. TO AVOID THE RECIPROCAL TRUST DOCTRINE, POSSIBLE DISTINCTIONS THAT COULD BE BUILT INTO THE TRUSTS INCLUDE: Create the trusts at different times, separated by months and not days Fund the trusts with different assets and different values One trust allows distributions without any standard but the other trust imposes a limitation based upon ascertainable standards, i.e. health, education, maintenance and support One trust might require considering the beneficiary-spouse s outside resources and the other would not One trust may allow the beneficiary-spouse a 5 by 5 annual withdrawal power and not the other One trust could provide an inter-vivos or testamentary power of appointment and not the other Different termination dates and events Different trustees for the trusts, however, neither spouse should be the trustee of the other s trust

3 THE FOLLOWING IS AN EXAMPLE OF A SLAT: Jim and Mary create irrevocable trusts for the benefit of the other spouse for the remainder of their lives and thereafter for their children and grandchildren. Jim and Mary authorize their estate attorney to prepare the trusts and understand that the plan, in effect, accelerates the credit shelter trust for each other that are provided for at death under their current estate planning documents. Jim and Mary fund each trust with cash and marketable securities of $5.12 million each. Jim may receive from the trust Mary establishes for his benefit income and principal for his health, support and maintenance. Mary can receive from the trust Jim establishes for her benefit income annually and she and the children can receive principal from the trust based on trustee s discretion. Under these SLATs, Jim and Mary, while both alive, still have access to the amounts gifted to the trusts but it is outside of their taxable estates. Jim and Mary will each allocate $5.12 million of gift and generation skipping transfer tax exemption on their 2012 gift tax returns so that these trusts would be excluded from their estates and would also avoid inclusion in their children s estates. Besides the risk of estate inclusion due to reciprocal trust doctrine, there are other risks high net worth individuals should consider before funding SLATs. Recipients of gifts receive the grantor s basis in the gifted asset, as opposed to a basis equal to the fair market value at the date of death for inherited property from a decedent s estate. If there is significant appreciation in the gifted property, the donee will have long term capital gain exposure when the property is sold. The current long-term capital gains rate on marketable securities is 15%, but this rate is scheduled to lapse on January 1, 2013 and return to 20%. In addition, there is a potential risk of claw back if the estate tax exemption at the time of death is less than the current $5.12 million exemption. If the estate tax exemption is less than the amount of exemption utilized by the grantor during their lifetime, the excess may be brought back into the grantor s estate and be taxed at the estate tax rate in effect at that time. Most commentators do not believe claw back was intended by Congress when the original legislation was enacted and maybe grandfathered if any reduction in the estate exemption occurs, however, the risk still remains. Even in the unlikely event the claw back applies; making lifetime gifts is still beneficial because the appreciation in the assets gifted is removed from the grantor s estate. While many states have an estate tax, most states do not have a gift tax. By making lifetime gifts high net worth individuals can avoid future state estate taxes for the amounts transferred during their lifetime. With some estate tax law provisions expiring after 2012 and the uncertainty over what actions Congress will take regarding estate tax law, you may have concerns about how your estate plan could be affected. We would be pleased to work with you and your estate planning attorney to ensure that your estate plan takes full advantage of the higher gift exemptions this year and has the flexibility required to manage future estate tax law changes.

4 DON T FORGET ABOUT STATE TAXES IN YOUR ESTATE PLAN Barry H. Horowitz, CPA, MST, Partner & Hal R. Terr, CPA, PFS, CFP, AEP, Partner By now, most high net worth individuals are aware that the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 has created an historic opportunity to transfer wealth to their heirs. Until the end of this year, the lifetime federal gift and generation skipping tax (GST) exemption is $5.12 million and the federal estate and GST tax rate is 35%. However, while this legislation has significantly reduced federal estate and gift taxes, it has not had the same impact to the estate tax laws for most states. The Economic Growth and Tax Relief Reconciliation Act of 2001 changed the credit for state estate taxes paid to a deduction on the federal estate tax return. In response to this change, states like New Jersey and New York made changes to their state estate taxes. Although the federal estate tax exemption is currently $5.12 million, the exemption for New Jersey and New York estate taxes is $675,000 and $1 million, respectively. Therefore, residents of New Jersey and New York who might not be impacted by the federal estate tax due to the increases in the federal estate exemption may still incur a state estate tax liability. Conversely, as long as state estate taxes are only a deduction on the federal estate tax return, residents of Florida are not subject to state estate taxes. Florida had a pick-up tax based on the state estate tax credit that the IRS previously allowed on the federal estate tax return. Unless Congress intervenes, then the Florida estate tax will return for Florida residents dying on or after January 1, FOLLOWING IS A COMPARISON OF STATES CURRENT ESTATE TAX LAWS: NEW JERSEY NEW YORK PENNSYLVANIA FLORIDA Does State Have an Estate Tax? Yes Yes No No Does State Have an Inheritance Tax? Yes No Yes No Estate Exemption $675,000 $1MM N/A N/A Highest Tax Rate 16% 16% 15% N/A States generally use two definitions in determining the residency status of a resident individual. An individual may be a resident for personal income tax purposes, and taxable as a resident, even though that same individual would not be deemed a resident for other tax purposes.

5 The term resident individual generally includes: 1. All persons domiciled in the jurisdiction, or 2. Any individual who is not domiciled in the jurisdiction, but who maintains a permanent place of abode for substantially all of the taxable year in the jurisdiction, and spends in the aggregate more than 183 days of the taxable year in that jurisdiction. Some states, such as California, have variations to the above rules for the determination of when an individual is a resident. Any person domiciled in a jurisdiction is a resident for personal income tax purposes for a specific taxable year, unless for that year such person satisfies all three of the requirements in the paragraph below: 1. Such person maintains no permanent place of abode in the jurisdiction during the taxable year. 2. Such person maintains a permanent place of abode outside the jurisdiction during the entire year. 3. Such person spends in the aggregate not more than 30 days of the taxable year in the jurisdiction. Most states follow the common law definition of domicile. Black s Law Dictionary defines domicile as follows: The place at which a person has been physically present and that the person regards as home; a person s true, fixed, principal, and permanent home, to which that person intends to return and remain even though currently residing elsewhere. In other words, domicile is where one lives and intends to make his or her permanent home. Because of the subjective nature of determining where one intends to make his or her permanent home, many states also provide a more objective definition for individuals who would be subject to the particular state s income and estate taxes. Domicile is viewed as a state of mind and the questions that need to be answered by an individual are: Where do you really want to live? Where do you want to spend most of your time? Where are your most precious possessions kept? Where is your business interests located? Where does your family live? These are just some of the questions that must be asked when an individual is contemplating a change in residence. When an individual does change their domicile, a taxpayer should follow the below checklist of items to be done: 1. Change car registration 2. Change driver s license 3. Change voter registration 4. Religious affiliations such as churches, synagogues, etc. 5. Moving of personal items 6. Insurance policies 7. File for homestead exemption, if applicable 8. Social affiliations such as country clubs, dining clubs, etc. 9. Execute a new will and any applicable trusts 10. Open new bank accounts and brokerage accounts

6 Failure to do most of the previous items will cause the jurisdiction to question whether a taxpayer has really changed their domicile. However, the above checklist is not all in-compassing. Each individual has their own distinct facts and circumstances and therefore, every taxpayer s situation is different. There have been many instances where an individual could be deemed a resident of more than one state or jurisdiction if they maintain residences in both jurisdictions. The most famous case in this area was the Estate of John T. Dorrance, who was the founder of Campbell Soup. Both Pennsylvania and New Jersey Courts claimed Mr. Dorrance was a resident of their respective states at the time of his passing, subject to state estate taxes. The U.S. Supreme Court would not provide an opinion since it determined that Mr. Dorrance had not clearly established a domicile in one state or the other. The result was the estate paid state estate taxes to both states of approximately $26 million. Taxpayers should keep contemporaneous diaries or detailed schedules. Hand written diaries or computer calendars are some of the resources that can be used. Third party documents such as credit cards, bills, passports, airline tickets, etc. should be kept in order to verify the taxpayer s record of days. The burden of proof is on the taxpayer to prove the number of days. Remember, any part of a day (with certain exceptions) in a jurisdiction counts as a day for residency purposes. This sounds like a lot work. However, the consequences can be very costly. Starved for revenue and hesitant to raise taxes, states are trying to get more revenue from residents through increased enforcement. Many of the estates where a change of residence has occurred will likely be reviewed and audited by the taxing authorities. This can lead the heirs to feel much frustration and anxiety. Proper planning and guidance should be done with your tax professional when residency issues arise to avoid any adverse tax consequences. GET TO KNOW WS+B S CORE EXPERTS ON OUR ESTATE & TRUST TAX SERVICES TEAM A partner based out of WS+B s New York office, Al has over 30 years of professional accounting experience. He specializes in trusts and estates and is a certified public accountant in the state of New York. Al helps clients plan their estates to facilitate a smooth transfer of wealth through the use of creative gifting techniques. He assists clients, attorneys, executors and trustees in the accounting, taxation and administration of trusts and estates. He also focuses on estate and gift tax planning and charitable planning through the use of private foundations, split-interest trusts and public charities. Alred La Rosa CPA, MS Estate & Trust Partner alarosa@withum.com Al received his BBA degree in accounting from Pace University and earned an MS degree in taxation from Baruch College. Al is a member of the American Institute of Certified Public Accountants (AICPA) and the New York State Society of Certified Public Accountants (NYSSCPA). He serves on the Estate Planning Committee and the Trust and Estate Administration Committee for the NYSSCPA. He is also a director of the Thomas and Jeanne Elmezzi Private Foundation and serves as an executor and trustee for estates and trusts. Prior to joining WS+B, Al was a partner with EisnerLubin llp (merged with WS+B in 2011). He resides in Nassau County, NY. In each issue, we ll feature a different Estate and Trust team member so you get to know our core experts.