L E G A C Y. SYNTHETIC BASIS STEP-UP STRATEGY -U/HNW AUM Opportunity

Transcription

1 L E G A C Y SYNTHETIC BASIS STEP-UP STRATEGY -U/HNW AUM Opportunity Presented by: Paul DeLauro, JD, CTFA SVP, Mgr., City National Bank 1

2 Table of Contents -Transfer Taxes -Income and Capital Gains Taxes -Baseline Transfer Tax Planning -Transfer Tax Planning with Lifetime Gifting -Major Changes Looming to Transfer Tax Law? -Conclusions 2

3 Transfer Taxes Its Expensive to Transfer Assets Gift Tax Estate Tax Generation Skipping Transfer Tax Income Taxes Capital Gains Tax 3

4 Transfer Taxes Gift Tax Lifetime Exemption = $5,490,000 Annual Gift-Tax Exclusion = $14,000 Gifts > Exclusion = reduction in remaining Exemption If you ve exceeded the Exemption then tax due at 40% rate 4

5 Transfer Taxes Estate Tax Estate Tax Exemption = $5,490,000 If your estate > Exemption then tax due at 40% rate 5

6 Transfer Taxes Generation-Skipping Transfer Tax GSTT Exemption = $5,490,000 Applicable for gifts (direct or indirect) to skip generations ( > 37.5 years younger than the donor) Tax due (at 40%) at death of skip person for assets placed in a trust that exceeded the GSTT Exemption when the gift was made 6

7 Trust Taxation Income and Capital Gains Irrevocable non-grantor trust, trust pays income tax on undistributed income/gains Irrevocable non-grantor trust, beneficiary pays income tax on distributed income/gains (DNI) Irrevocable grantor trust, Grantor pays the trust s income tax 7

8 Trust Taxation Grantor s Payment of Income Taxes Not a Taxable Gift May Rev. Rul A grantor of an irrevocable trust may be treated as owner of the trust assets for income tax purposes but not estate tax purposes. Rev. Rul Grantor s payment of income taxes on investment income of assets held in an irrevocable trust was not a taxable gift. Rev. Rul A transfer of a life insurance policy from one irrevocable grantor trust to another irrevocable grantor trust does not (1) violate the transfer for value rule and (2) the death proceeds remained income-tax free [IRC 101]. Rev. Rul Exercising a power of substitution [IRC 675(4)(C)] would not lead to inclusion of the substituted assets in the grantor s taxable estate under either IRC Section 2036(a) (a retained life interest) or IRC Section 2038 (a power to alter, amend, or revoke). Grantor does not retain powers over non-grantor trusts (the trust pays its income taxes) 8

9 Trust Taxation Grantor Trusts Exceeding Annual Exclusion Limitations Grantor paying a grantor trust s income tax liability is not deemed a taxable gift increases a beneficiary s inheritance exceeds the Exclusion and Exemption limitations 9

10 Trust Taxation Capital Gains Tax Gifts at Death Gifts at death receive a step up in basis to the date of death value, or the alternative valuation date (6 months after the date of death) [IRC 1014 (a)]. If assets sold soon after donor s death, beneficiaries likely face little or no capital gains tax 10

11 Trust Taxation Capital Gains Tax Gifts During Life Gifts during life have carryover basis (donee s basis is the same as the donor s basis), whether assets were gifted in trust or not [IRC 1015]. No matter when the assets are sold, beneficiaries will face capital gains tax 11

12 Trust Taxation Knowledge Check Annual Exclusion = $14,000 per person per year Gifts > Annual Exclusion count against Lifetime Exemption ($5,490,000) Gifts > Lifetime Exemption taxed at 40% 12

13 Baseline Transfer Tax Planning Normal Planning Goals Efficiently transfer assets at death Gift assets during life so that the growth of those assets escape estate taxation Gift more than the limitations of the Exemption and Exclusion Protect a beneficiary s inheritance from bad marriages, creditors Avoid the generation-skipping transfer tax Have assets gifted during life step-up their basis in order to reduce capital gains taxation 13

14 Baseline Transfer Tax Planning Comprehensive Wealth Transfer Planning HNW Comprehensive Wealth Transfer Planning: Exemption Allocation at Death Lifetime Gifting Charitable Income Tax Planning UHNW Planning Adds a 4th Component: Charitable Estate Tax Deduction Planning 14

15 Baseline Transfer Tax Planning Traditional Estate Planning Assumptions Estate Tax > Gift Tax Transfer Taxes > Capital Gains or Income Taxes 15

16 Baseline Transfer Tax Planning Typical U/HNW Estate Consist of illiquid, low-basis assets Can t avoid the estate tax at death, requires lifetime gifting Lifetime gifting leads to capital gains tax problems for heirs For UHNW clients, lifetime may not be enough, estate-tax charitable deduction planning needed Lifetime gifting converts estate tax cost to an income/gains tax cost With income/gains tax almost equal to estate tax, why bother tax planning? 16

17 Baseline Transfer Tax Planning Capital Gains Tax is the Problem Gifts at death = estate tax, but no capital gains tax Gifts during life = no estate tax, but capital gains tax 17

18 Baseline Transfer Tax Planning At First Trustor s Death John and Jane Doe Trust Administrative Trust Baseline Community Property State Estate Plan Marital Trust Survivor s Trust At Second Trustor s Death Exempt Trust Disclaimer Children s Trusts Exempt Non-Exempt 18

19 Baseline Transfer Tax Planning At John s Death John Doe Trust Administrative Trust Baseline Common Law State Estate Plan Marital Trust At Jane s Death Exempt Trust Disclaimer Children s Trusts Exempt Non-Exempt 19

20 Baseline Transfer Tax Planning De Minimis Estate Plan Pros Management of affairs during disability Probate avoidance Beneficiaries receive a step-up in basis 20

21 Baseline Transfer Tax Planning Baseline Estate Plan Cons Estate tax benefits only take place at death Growth of assets during life subject to estate tax at death Outright inheritances, or where left in trust with the beneficiary as sole trustee, are often lost (spendthrifts, predators, creditors) Clients mistakenly believe their estate plan is done Individual trustees hire attorneys and accountants after making significant errors Personal liability Personal conflict Have own lives to lead 21

22 Transfer Tax Planning with Lifetime Gifting Enhanced Estate Tax Plan Many U/HNW clients have a lifetime gifting program in place Gifting programs often includes Irrevocable Grantor Trusts (IGTs) Grantors often retain a power to reacquire the trust corpus by substituting other property of an equivalent value [ 675(4)(C)] An IGT s income/gains tax is paid by the Grantor, not the trust Gifts to IGTs have carryover basis (subject heirs to capital gains tax) 22

23 Transfer Tax Planning with Lifetime Gifting Enhanced Community Property State Plan At First Trustor s Death Estate Tax Structure John and Jane Doe Trust Administrative Trust Gift Lifetime Exemption Gift Annual Exclusion Gift-Tax Structure IGTs Marital Trust Survivor s Trust Exempt Trust Disclaimer At Second Trustor s Death Children s Trusts Child 1 Trust Child 2 Trust 23

24 Transfer Tax Planning with Lifetime Gifting Enhanced Common Law Property State Plan At John s Death Estate Tax Structure John Doe Trust Gift Lifetime Exemption Gift Annual Exclusion Gift-Tax Structure IGTs Administrative Trust Marital Trust Exempt Trust Disclaimer At Second Trustor s Death Children s Trusts Child 1 Trust Child 2 Trust 24

25 Transfer Tax Planning with Lifetime Gifting Planning Concept If IGT holds high-basis assets, heirs will have little/no capital gains problem Client s low-basis assets receive a step-up in value at death Annually rebalance the IGT by substituting the IGT s low-basis assets for the client s high-basis assets NOTE: Cash is best high-basis asset possible 25

26 Transfer Tax Planning with Lifetime Gifting Planning Concept Result The trust steps-up its basis (to cash or to the higher-basis substituted assets) Grantor holds low-basis assets until death, receives an IRC 1014 step-up Beneficiaries (or trust) avoid/mitigate capital gains tax problem 26

27 Transfer Tax Planning with Lifetime Gifting Single Taxpayer, LTCG Effect on IGT Death in Year IGT BOY FMV Exemption Exemption Inflator Total Exemption Gifted Gain Substitution Exemption Growth Annual Exclusions Annual Exclusion Growth LTCG Gain IGT EOY FMV Total LTCG State LTCG Tax Fed. LTCG Tax Total LTCG Tax 1 $0 $5,490,000 $0 $5,490,000 $0 $274,500 $42,000 $2,100 $2,747,100 $5,808,600 $2,749,200 $365,644 $654,310 $1,019,953 $0 0.00% 2 $5,808,600 $5,599,800 $109,800 $109,800 $100,000 $570,420 $42,000 $2,100 $2,649,200 $5,962,500 $2,651,300 $352,623 $631,009 $983,632 $36, % 3 $5,962,500 $5,709,600 $114,192 $114,192 $100,000 $583,605 $42,000 $2,100 $2,551,300 $6,120,792 $2,553,400 $339,602 $607,709 $947,311 $72, % 4 $6,120,792 $5,823,792 $116,476 $116,476 $100,000 $597,229 $42,000 $2,100 $2,453,400 $6,281,368 $2,455,500 $326,582 $584,409 $910,991 $108, % 5 $6,281,368 $5,940,268 $118,805 $118,805 $100,000 $611,082 $42,000 $2,100 $2,355,500 $6,444,273 $2,357,600 $313,561 $561,109 $874,670 $145, % 6 $6,444,273 $6,059,073 $121,181 $121,181 $100,000 $625,167 $42,000 $2,100 $2,257,600 $6,609,555 $2,259,700 $300,540 $537,809 $838,349 $181, % 7 $6,609,555 $6,180,255 $123,605 $123,605 $100,000 $639,490 $42,000 $2,100 $2,159,700 $6,777,260 $2,161,800 $287,519 $514,508 $802,028 $217, % 8 $6,777,260 $6,303,860 $126,077 $126,077 $100,000 $654,056 $42,000 $2,100 $2,061,800 $6,947,437 $2,063,900 $274,499 $491,208 $765,707 $254, % 9 $6,947,437 $6,429,937 $128,599 $128,599 $100,000 $668,869 $42,000 $2,100 $1,963,900 $7,120,136 $1,966,000 $261,478 $467,908 $729,386 $290, % 10 $7,120,136 $6,558,536 $131,171 $131,171 $100,000 $683,934 $42,000 $2,100 $1,866,000 $7,295,406 $1,868,100 $248,457 $444,608 $693,065 $326, % 11 $7,295,406 $6,689,706 $133,794 $133,794 $100,000 $699,256 $42,000 $2,100 $1,768,100 $7,473,301 $1,770,200 $235,437 $421,308 $656,744 $363, % 12 $7,473,301 $6,823,501 $136,470 $136,470 $100,000 $714,840 $42,000 $2,100 $1,670,200 $7,653,871 $1,672,300 $222,416 $398,007 $620,423 $399, % 13 $7,653,871 $6,959,971 $139,199 $139,199 $100,000 $730,692 $42,000 $2,100 $1,572,300 $7,837,170 $1,574,400 $209,395 $374,707 $584,102 $435, % 14 $7,837,170 $7,099,170 $141,983 $141,983 $100,000 $746,817 $42,000 $2,100 $1,474,400 $8,023,253 $1,476,500 $196,375 $351,407 $547,782 $472, % 15 $8,023,253 $7,241,153 $144,823 $144,823 $100,000 $763,220 $42,000 $2,100 $1,376,500 $8,212,176 $1,378,600 $183,354 $328,107 $511,461 $508, % 16 $8,212,176 $7,385,976 $147,720 $147,720 $100,000 $779,908 $42,000 $2,100 $1,278,600 $8,403,996 $1,280,700 $170,333 $304,807 $475,140 $544, % 17 $8,403,996 $7,533,696 $150,674 $150,674 $100,000 $796,885 $42,000 $2,100 $1,180,700 $8,598,770 $1,182,800 $157,312 $281,506 $438,819 $581, % 18 $8,598,770 $7,684,370 $153,687 $153,687 $100,000 $814,157 $42,000 $2,100 $1,082,800 $8,796,557 $1,084,900 $144,292 $258,206 $402,498 $617, % 19 $8,796,557 $7,838,057 $156,761 $156,761 $100,000 $831,731 $42,000 $2,100 $984,900 $8,997,418 $987,000 $131,271 $234,906 $366,177 $653, % 20 $8,997,418 $7,994,818 $159,896 $159,896 $100,000 $849,612 $42,000 $2,100 $887,000 $9,201,415 $889,100 $118,250 $211,606 $329,856 $690, % 21 $9,201,415 $8,154,715 $163,094 $163,094 $100,000 $867,806 $42,000 $2,100 $789,100 $9,408,609 $791,200 $105,230 $188,306 $293,535 $726, % 22 $9,408,609 $8,317,809 $166,356 $166,356 $100,000 $886,321 $42,000 $2,100 $691,200 $9,619,065 $693,300 $92,209 $165,005 $257,214 $762, % 23 $9,619,065 $8,484,165 $169,683 $169,683 $100,000 $905,162 $42,000 $2,100 $593,300 $9,832,849 $595,400 $79,188 $141,705 $220,893 $799, % 24 $9,832,849 $8,653,849 $173,077 $173,077 $100,000 $924,335 $42,000 $2,100 $495,400 $10,050,026 $497,500 $66,168 $118,405 $184,573 $835, % 25 $10,050,026 $8,826,926 $176,539 $176,539 $100,000 $943,848 $42,000 $2,100 $397,500 $10,270,664 $399,600 $53,147 $95,105 $148,252 $871, % LTCG Savings IRR 27

28 Transfer Tax Planning with Lifetime Gifting Other Considerations/ Alternatives Substitute what you can, its not all or nothing Hold-back inflation-adjusted Exemption until near-death (step-up). Borrow from a bank when survivor is near-death Each spouse funds an ILIT with perm insurance on the other spouse. Upon a spouse s death, the survivor borrows the CSV and substitutes for IGT s low-basis assets. NOTE: The ILIT debt may be deductible on Form

29 Transfer Tax Planning with Lifetime Gifting An IGT is a Gift-Tax Planning Chassis Example Short-Term Loans to IGTs Investment spread > AFR benefits IGT (beneficiaries): Grantor loans cash to an IGT for a three-year or less term IGT invests the cash IGT pays Grantor an annual (or balloon) short-term AFR interest rate (0.96% as of Jan. 2017) At end of loan, Grantor receives all principal, any earnings above the shortterm AFR stay in trust, gift-tax free Hurdle rate tied to inflation, asset management fees, and short-term AFR 29

30 Major Changes Looming to Transfer Tax Law? New Developments May Change Everything Republican Controlled House of Representatives Republican Controlled Senate Donald J. Trump won the Nov. 8, 2016 Election Is estate tax going away? 30

31 Major Changes Looming to Transfer Tax Law? Potential (Temporary) End of the Estate Tax? Is estate tax intended to raise revenue or redistribute wealth? Historical likelihood the U.S. will end the estate tax? Consequences to taxpayers? Consequences to advisors? 31

32 Major Changes Looming to Transfer Tax Law? Historic Transfer Taxes Vicesina Hereditatium Caesar Augustus imposed a tax on transfers to all but close relatives Egypt imposed death taxes as far back as 700 BC and permitted numerous tax shelters (typically charitable) 32

33 Major Changes Looming to Transfer Tax Law? Historic Transfer Taxes The early English feudal transfer tax system was based on transfer followed by lease-back rights from the king. The 1540 Statute of Wills required a competent firstborn heir, else land escheated to the crown. Fees were paid to the crown for the Probate process. 33

34 Major Changes Looming to Transfer Tax Law? U.S. Estate Tax History Revenue-Generation Period Wealth Redistribution Period Political Period 34

35 Major Changes Looming to Transfer Tax Law? Revenue-Generation Era (AKA The Pay for War period) 1797 Stamp Tax Act The Revenue Act of 1862 Internal Revenue Law of 1864 War Revenue Act of

36 Major Changes Looming to Transfer Tax Law? Progressive Era (AKA You Didn t Build That period) Teddy Roosevelt Revenue Act of 1916 Franklin Roosevelt 36

37 Major Changes Looming to Transfer Tax Law? Progressive Era Revenue Act of 1935 Revenue Act of 1948 Franklin Roosevelt... The individual does not create the product of his industry with his own hands... The desire to provide security for oneself and one's family is adequately served by a reasonable inheritance. Great accumulations of wealth cannot be justified on the basis of personal and family security. The transmission from generation to generation of vast fortunes by will, inheritance, or gift is not consistent with the ideals and sentiments of the American people 37

38 Major Changes Looming to Transfer Tax Law? Political Era (AKA The Silly and Misleading Law Title period) Tax Reform Act of 1976 Economic Recovery Tax Act 1981 Omnibus Budget Reconciliation Act of 1993 Taxpayer Relief Act of 1997 Economic Growth &Tax Relief Reconciliation Act of 2001 Jobs & Growth Tax Relief Reconciliation Act of 2003 Patient Protection and Affordable Care Act of 2010 American Taxpayers Relief Act of

39 Major Changes Looming to Transfer Tax Law? An Illusory Tax Transfer taxes generated 0.64% of federal revenue in 2014 Individual income Taxes Corporate income Taxes Social Insurance and Retirement Receipts Excise Taxes Estate and Gift Taxes Custom Duties Miscellaneous Receipts 39

40 Major Changes Looming to Transfer Tax Law? An Illusory Tax Compliance Costs: Collecting transfer taxes may cost more than the revenue derived. Capital Gains Taxes are Artificially Suppressed: Because of charitable estate tax deductions and stepped up basis avoidance techniques, income and capital gains tax revenues are synthetically depressed. The Estate Tax Does Not Redistribute Income: Transfer taxes may account for only 2% of income inequality. 40

41 Major Changes Looming to Transfer Tax Law? The Estate Tax Does Not Reduce Wealth Concentration: Only 27% of wealthy families increase their wealth following an inheritance. An Illusory Tax Heirs Don t Become Wealthy: Only 20% of children of wealthy parents are wealthy at their retirement. The Estate Tax Discourages Savings: Clients encouraged to die broke. If transfer taxes neither raise revenue nor redistribute wealth, and abolishing the step-up in basis increases federal revenue What opportunities arise under a modified capital gains tax system? 41

42 Major Changes Looming to Transfer Tax Law? Possible Market Reactions to End of Estate Tax Possible surge in Irrevocable Grantor Trust Planning Estate tax abolishment may be temporary Gift to trust as much as client can reasonably afford More equity-oriented accounts IGTs often established in States that have abolished the Rule Against Perpetuities (e.g., Delaware) Annual rebalancing between the client s assets and the trust becomes critical Possible Surge in Domestic Asset Protection Trust Planning Transfer taxes may be abolished, not creditors. Retained interest in trust alleviates client fear of over-gifting. Please see important disclosures on slide

43 Major Changes Looming to Transfer Tax Law? Possible Market Reactions to End of Estate Tax Possible surge in Income Tax Planning Private Placement Variable Life Insurance Captive Insurance ESOP Planning Possible surge in State Estate Tax Laws 43

44 Conclusions Take Aways Rebalancing high-basis assets for an IGT s low-basis assets is financially logical. An end to the estate tax may be temporary, leading to aggressive gifting in trust in the near future. City National can help you, either as a client-facing resource, a back-office resource, or a banking and lending resource. 44

45 Important Disclosures City National Bank, as a matter of policy, does not give tax, accounting, regulatory or legal advice. The effectiveness of the strategies discussed in this presentation will depend on the unique characteristics of the reader s situation and on a number of complex factors. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations. Any strategies discussed in this presentation were not intended to be used, and cannot be used for the purpose of avoiding any tax penalties that may be imposed. The strategies were not written to support the promotion or marketing to another person of any transaction or matter addressed. Before implementation, you should consult with your other advisors on the tax, accounting and legal implications of the proposed strategies based on your particular circumstances. The information in this presentation was compiled by the staff of City National Bank from data and sources believed to be reliable but City National Bank makes no representation as to the accuracy or completeness of the information. The opinions expressed, together with any estimates or projection given, constitute the judgment of the author as of the date of the presentation. City National Bank has no obligation to update, modify or amend this presentation or otherwise notify you in the event any information stated, opinion expressed, matter discussed, estimate or projection changes or is determine to be inaccurate. This presentation is intended to be a source of general information only. City National Bank, Member FDIC. 45

46 V I S I O N For More Information: Paul DeLauro, JD, CTFA SVP, Mgr., City National Bank Paul.DeLauro@cnb.com (213)