Fundamentals of Estate Planning and Taxation: Understanding, Creating and Protecting the Legacy In a World of Legislative Uncertainty

Transcription

1 Fundamentals of Estate Planning and Taxation: Understanding, Creating and Protecting the Legacy In a World of Legislative Uncertainty Renzo A. Cerabino, JD, MBA, CFP Disclaimer This presentation does not provide tax, accounting or legal advice. Any information presented about tax considerations affecting financial transactions or arrangements is not intended as tax advice and should not be relied upon for the purpose of avoiding any tax penalties. This presentation nor the presenter provide tax, accounting or legal advice. Attendees should pursue any planned financial transactions or arrangements that may have tax, accounting or legal implications within the context of their personal expertise and as part of their client engagement. Those rendering advice to clients must have the required licensing and expertise to make such recommendations. The case studies presented are hypothetical and do not reflect specific strategies developed for actual clients. They are for illustrative purposes only and intended to describe potential application of the concepts discussed herein. They are not intended to serve as investment advice since the availability and effectiveness of any strategy is dependent upon individual facts and circumstances. Results will vary, and no suggestion is made about how any specific solution or strategy performed in reality. The opinions expressed are solely those of the author and do not represent the opinions of any of my employers or any of their subsidiaries or affiliates. In addition, the information contained herein is solely the interpretation of the author and do not represent the opinions or interpretation of any of my employers or any of their subsidiaries or affiliates. Investment products, insurance and annuity products: Are Not FDIC Insured Are Not Deposits Are Not Bank Guaranteed Are Not Insured by Any Federal Government Agency Are Not a Condition to Any Banking Service of Activity 1

2 Trump Administration Tax Proposal On April 26, 2017 President Trump and his administration presented the key principles of his proposed revisions to the Tax Code What will pass in the Senate? Two options: Find Democratic Votes Given the current tenor of the discussion that may be difficult Reconciliation A budget process that would allow Senate Republicans to pass a bill with just 51 votes -- or in other words, no Democratic support (Republicans control 52 seats in the chamber). The only caveat: The tax bill would not qualify for a simple majority vote if it adds to deficits beyond 10 years. 2

3 Trump Administration Tax Proposal: Income Tax Trump Administration Tax Proposal: Income Tax 3

4 Trump Administration Tax Proposal: Income Tax Trump Administration Tax Proposal: Income Tax 4

5 Trump Administration Tax Proposal: Business Income Tax Carried interest, or carry, in finance, is a share of the profits of an investment paid to the investment manager in excess of the amount that the manager contributes to the partnership, specifically in alternative investments (private equity and hedge funds). It is a performance fee, rewarding the manager for enhancing performance. Cite: Trump Administration Tax Proposal: Estate and Gift Tax 5

6 Trump Administration Tax Proposal The first question in my mind do you wait and see or plan now? YES, PLAN NOW!!! Why? Because estate planning is more than just tax planning. Focus of planning is on goals and being flexible to achieve those goals Trump Administration Tax Proposal Repeal of the Estate Tax: Estate planning is more than just tax planning. Families utilize various tools and techniques to avoid family strife, keep family wealth in the family, pass on family values, and deter heirs from mismanaging wealth. Trusts, life insurance policies, Powers of Attorney, wills and other planning documents would need to be reviewed to ensure they align with any new tax laws and to determine if they are the best solution to meet non-tax objectives. 6

7 Trump Administration Tax Proposal Reduction of income tax rates: If your tax rate were to be lowered, it would be an opportunity to examine contributing to a Roth IRA or a Roth 401(k) and/or doing a Roth IRA conversion. There is no way to predict future tax rates, so two key considerations would be if you expect tax rates to be increased in the future or if you expect to be in a higher income bracket in retirement. Trump Administration Tax Proposal Elimination of all but the charitable and mortgage interest deduction: Direct gifting would be one of the two ways to lower income. We believe it would be worthwhile to review how much you are directly gifting and if maximizing your deduction fits with your charitable gifting strategy. 7

8 The House: A Better Way Plan Introduced by House Republicans On June 24, 2016 Areas where the plans align may have a higher probability of becoming law: condensing the code to three tax rates; eliminating itemized deductions with the exception of mortgage interest and charitable contributions; doing away with personal exemptions; raising standard deductions, although the amounts in the plans are different; jettisoning the AMT; ridding the surtax on net investment income; lowering the corporate tax rate, with Mr. Trump s plan calling for 15% and the A Better Way plan, 20%; and eliminating the estate tax THE OLD DAYS When taxes ruled the estate planning world. 8

9 How I Fell In Love With Tax Planning. CAUTION: This example uses 2005 tax rules. For discussion purposes only. Client facts substantially changed. My first client meeting with a dairy farmer in Elmira, NY: Married with 3 children Assets: Real Estate (farm): $500,000 Personal residence: $100,000 Investable Assets: $200,000 Life Insurance: $1,000,000 (on farmer s life) How I Fell In Love With Tax Planning. I was ready to discuss how I could grow his $200,000 in investable and had some ideas. I took a look at his current allocation and knew I could add value. No interest in changing to a different bet when gambling in the stock market. I was losing my first prospect! I went into attorney mode and mentioned 9

10 How I Fell In Love With Tax Planning. In 2005 the federal estate tax exemption was $1,500,000. The farmer didn t see the issue as his assets were only $800,000. ($500k Farm + $100k personal residence + $200k investable assets). Discussed that his insurance was taxable. No way said the farmer! Income vs. Estate Tax His actual estate was $1,800,000 and now subject to federal estate tax. At roughly 45% he owed $135,000 Talked about an irrevocable life insurance trust to exempt amount from federal tax. He was very happy and I eventually got his assets to manage. 10

11 Cash Flow Base Facts (All Years) Prepared for CLIENT The Cash Flow report illustrates your income, savings, expenses, and resulting net cash flow on an annual basis. Year Age Income Flows Investment Income Planned Distributions Total Inflows Total Expenses Total Outflows Net Cash Flow Total Portfolio Assets $0 $0 $0 $0 $109,384 $109,384 ($109,384) $1,861, , ,659 (121,659) 2,512, , ,099 (124,099) 2,503, , ,697 (125,697) 2,492, , ,028 (127,028) 2,479, , ,349 (128,349) 2,464, , ,228 (129,228) 2,447, , ,525 (130,525) 2,427, , , , ,009 (120,204) 2,416, , , , ,955 (117,463) 2,407, , , , ,564 (118,644) 2,396, , , , ,150 (119,794) 2,383, , ,402 64, , ,724 (92,521) 2,354, , ,844 66, , ,180 (93,081) 2,323, , ,334 68, , ,682 (93,630) 2,287, , ,873 70, , ,220 (94,157) 2,248, , ,461 72, , ,781 (94,649) 2,204, , ,100 74, , ,388 (95,126) 2,157, , ,551 76, , ,942 (95,728) 2,105, , ,286 78, , ,600 (96,140) 2,049, , ,797 80, , ,207 (96,715) 1,988, , ,333 82, , ,838 (97,279) 1,922, , ,891 84, , ,475 (97,816) 1,851, , ,470 86, , ,145 (98,354) 1,774, , ,065 88, , ,816 (98,866) 1,692, , ,673 91, , ,518 (99,385) 1,604, , ,860 92, , ,084 (100,178) 1,510, , ,015 94, , ,644 (100,985) 1,409, , ,127 96, , ,191 (101,810) 1,302, , ,186 98, , ,722 (102,660) 1,188, , ,181 99, , ,228 (103,537) 1,067, , , , , ,506 (104,849) 939,524 Agenda Major Topics: How Is Wealth Taxed? Gifts That Do Not Generate Tax Marital Planning Portability / Formula Clauses Wealth Transfer and Succession (FLP s / GRATS / ILITS) Charitable Planning Case Study: Asking open questions 11

12 A Little History Estate tax started in 1916 to replace tariff revenue lost from World War I. IRS noticed it was collecting very little revenue. It turned out the rich were giving their money away (e.g. DuPont and the Vanderbilt). In response, the federal government enacted the gift tax in In 1986 Congress passed a third type of tax called the generation skipping transfer tax. In 2001 Congress and the President passed EGTRRA which provided generally more favorable tax to encourage economic growth. The Act was due to sunset on Dec 31, The Tax Relief, Unemployment Insurance Authorization and Job Creation Act of 2010 temporarily prevented the sunset of EGTRRA until 2013 at higher rates. In 2013 Congress instituted the American Taxpayer Relief Act which set the exclusion at $5MM (which we will review). How if the Transfer of Wealth Taxed? Federal Tax System Imposes 3 Types of Taxes Estate Tax: Assets Transferred at Death Gift Taxes: Assets Transferred During Your Lifetime Generation Skipping Transfer Tax: Assets Transferred to Grandchildren or Future Generations 12

13 Estate and Gift Tax Year Exclusion Amount Maximum Tax Rate 2011 $5,000,000 * 35% 2012 $5,120,000 35% 2013 $5,250,000 40% 2014 $5,340,000 40% 2015 $5,430,000 40% 2016 $5,450,000 40% 2017 $5,490,000 40% * Exemption amount is subject to cost of living adjustment. 13

14 Estate and Gift Tax Estate / Gift Tax can be used either during life or at death but the total cannot exceed the total exclusion amount Ex: in 2017 there is a $5,490,000 exclusion An unmarried person cannot gift $5.49MM while alive then pass an additional $5.49MM at death An unmarried person can gift $1MM while alive then pass $4.49MM at death for a total of $5.49MM Marital deduction exempts assets left to a spouse Must be a US citizen, there are different rules for non-citizen spouse that we will discuss later For a spouse that is a US citizen, couples may now use their spouses unused exclusion to protect up to $10.98MM in assets (this is called portability and will be discussed later) What is the difference between an exclusion and an exemption? Generation Skipping Transfer Tax (GSTT) Year Exclusion Amount Maximum Tax Rate 2011 $5,000,000 * 35% 2012 $5,120,000 35% 2013 $5,250,000 40% 2014 $5,340,000 40% 2015 $5,430,000 40% 2016 $5,450,000 40% 2017 $5,490,000 40% * Exemption amount is subject to cost of living adjustment. 14

15 GSTT Example Assume Grandfather has used his gift and GSTT with prior gifts He now wants to give his granddaughter a $1MM gift How much will granddaughter receive? $1,000,000 Gift - $400,000 Gift Tax at 40% -$400,000 GSTT at 40% -$160,000 GSTT at 40% on the Gift Tax Paid TOTAL TAX: $960,000 Estate, Gift and GSTT Note that the tax rates are the same This is often referred to as the unified credit Can be confusing What makes these 3 taxed unified is that they are the same number an the same rate however.. They are all in fact separate taxes Example: I could gift $1MM to my son while I am alive and that is an application of the gift tax At my death I could leave $4.45MM to my son and that is an application of the federal estate tax exclusion I could also leave an addition $5.45MM to my grandchild and apply only my GSTT exclusion Meaning I would pay estate tax on the $5.45MM gift to my grandchild but not GSTT 15

16 Introduction to Trusts and to the Role of the Trustee July 11,

17 What is a Trust? about the requirements. Settlor An intent to create a trust by a legally competent settlor is required before a trust can be created. The settlor must declare with clarity and precision the terms of the trust in sufficient detail to create a legal obligation for the trustee. The purpose of the trust must be legal. If its purpose is not legal, the trust will not be enforceable. Trust agreement The settlor s intent is most commonly expressed in writing in a trust agreement called an express trust. This document: 1) creates a trust into which assets are placed, 2) appoints a trustee, 3) defines the powers and duties for managing the trust, and 4) identifies how profits and principal are to be distributed. What is a Trust? about the requirements. Trustee A trustee must be named for a trust to be valid. A trustee can be an individual, financial institution or trust company. The trustee holds the legal title to trust property and manages that property for the benefit of others. It is the trustee s duty to administer the trust according to the terms of the trust document and the law. How it works - An owner placing property into a trust turns over part of his or her rights to the trustee, and that is what separates the property s legal ownership and control from the equitable or beneficial title that belongs to the beneficiaries. 17

18 What is a Trust? about the requirements. Beneficiaries For a trust to be valid, the beneficiaries of the trust must be identified. Beneficiaries are those individuals or entities who benefit economically from the trust. Generally, beneficiaries are classified according to when the benefit is available to the beneficiary, and conditions that must be met before the beneficiary may receive the benefit. Vested vs. contingent interests A beneficiary who has the right to receive current or future benefits without any conditions has a vested interest in the trust A beneficiary that has a right to benefits only after a condition is fulfilled has a contingent interest in the trust Benefits of a Trust - Management of Special Assets Some individuals own special assets that require an extraordinary amount of care or management expertise. A trust can provide a trustee with the authority and expertise to manage the assets during the settlor s life after the settlor s death; or during the lives of beneficiaries. Family Business Real Estate, Art Partnership Interest Private Equity 18

19 Inter Vivos versus Testamentary Trusts Inter vivos Trust Inter vivos trusts (sometimes called a living trusts ) are created during the settlor s lifetime. The trustee acts on behalf of the settlor. Assets are held in trust in perpetuity or may be distributed in accordance with the trust agreement. Living trusts can be revocable or irrevocable. Testamentary Trust A testamentary trust is created at death under a will. These trusts are not effective during the life of the settlor since the will takes effect at death. The trust is not funded until death and can be modified or revoked by changing the will. Once the settlor dies, the trust becomes irrevocable and may not be modified. The Duty of Care The most basic duty, the duty of care, requires a Trustee to carefully manage trust assets. What is appropriate may be determined by the terms of the governing document or by state law. To the extent the document and law disagree, the document will usually control. A Trustee may and should hire any necessary advisors, including attorneys, accountants, and financial advisors. Ultimately, however, the Trustee must make or approve the decisions and may not delegate that duty. If decisions are improperly delegated and loss results, the Trustee will be liable for the loss. 19

20 The Prudent Investor Rule In making investments, a Trustee is governed by the "prudent investor rule," which requires a fiduciary to use reasonable care, skill, and caution in managing assets. The prudent investor rule requires a Trustee to continually monitor all investments to make them productive and to avoid losses. It is not necessary to maximize return. All financial actions must be fully accounted for to the interested parties. An accounting must be transparent, and beneficiaries have the right to review all financial documents. Taxes must be filed and paid. A fiduciary must protect non-cash assets. Real estate must be secured and insured. Personal property must be safeguarded and insured. Businesses must be managed. Assets must be sold at proper prices and on proper terms. Estate Taxation Determining the Tax Gross Estate 20

21 What s Included as You Calculate Estate Tax GROSS ESTATE May Include: Probate Estate Assets Living Trust Assets Life Insurance Owned by You IRA Keogh Pension and Profit Sharing Joint Ownership Interests Community Property Claims and Accounts Receivables Business Interests Taxable Gifts Reduced by Unlimited Marital Deduction Allows property transferred to a surviving spouse to escape gift and estate taxes State Death Tax Deduction Debts, Expenses, Costs, Fees Charitable Contributions TAXABLE ESTATE Determination of the Estate Tax 1. Calculate the Gross Estate I.R.C Subtract deductions I.R.C Determine adjusted taxable gifts and add them back to the taxable estate Adjusted taxable gifts are the total taxable gifts made by the decedent after 1976 other than gifts that are includable in the gross estate 4. Determine the estate tax rates and apply to determine a tentative tax 5. Subtract the federal gift tax payable on post 1976 gifts 6. Subtract credits allowed by I.R.C

22 Calculation of Your Estate Tax TENTATIVE TAXABLE BASE Tax on Tentative Taxable Base PLUS: TAXABLE GIFTS Apply credit for Gift Taxes Paid Subtract: Tax on Applicable Exclusion Amount TAXABLE ESTATE ESTATE TAX Gifts That Do Not Generate Tax Annual Exclusion Gifts Education and Medical Expense Gifts College Savings Plans Planning Issues and Asset Selection 22

23 Annual Exclusion Gifts I.R.C. 2503(b) Allows a donor to exclude from her adjusted taxable gifts the first $14,000 (in 2016) of any present interest gift during the calendar year The amount is not added back to the donor s taxable estate for the purposes of calculating the estate tax Also avoids gift tax and GST tax Indexed for inflation Not cumulative To the extent not used in a year the balance is lost and not carried forward If the donor can afford and desires to use this gift a valuable exclusion may be wasted Annual Exclusion Gifts Present Interest Gifts: An outright gift is a present interest gift A gift in trust has two components: Income interest May qualify as a present interest gift Remainder interest Is a future interest and does not qualify for the annual exclusion (but may qualify for other exclusions) 23

24 Annual Exclusion Gifts Split Gift If the donor is married, each spouse may use the annual exclusion One spouse may provide all the property for the gift (provided that the nondonor spouse agrees to treat the transfer as if made one-half by each spouse) Election made on IRS Form 709 (U.S. Gift Tax Return) and the return must be timely filed Annual Exclusion Gifts Tax Cost Basis I.R.C. 1015(a) - Carryover basis: for property gifted when the donor is alive, the donee assumes the cost basis of the donor I.R.C Stepped up basis: if transferred at death the cost basis is stepped up to the fair market of the asset on the date of death or alternate valuation date Tax Cost Basis for property that is at a loss basis is equal to the lesser of donor s basis or the fair market value of the property on the date of the gift Typically advise to sell the asset and use the loss then gift the proceeds 24

25 Education and Medical Expense Gifts I.R.C. 2503(e): amounts paid on behalf of a donee for tuition at an educational institution or for payment to a provider for medical care will not be treated as a gift for estate tax purposes Will not be treated as an adjusted taxable gift Will not be treated as a generation-skipping transfer Payments must be made directly to the educational institution or the provider of medical care to qualify for the exclusion Education and Medical Expense Gifts Very Valuable: In addition to the annual exclusion Not limited to $14,000 (i.e. no limit) Education Gifts: Donor must pay tuition only Related expenses such as room, board, books, travel and tutoring not covered Educational institution must normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on Medical Gifts: Excludes payments covered by medical insurance However payments for medical insurance are qualified payments 25

26 529 Plans 529 Plans Generally 2 types of plans: Prepaid Tuition Plan Defined benefit plan that locks in current tuition rates at an in-state institution The present tuition purchased is translated into units that are redeemable for future tuition and fees College Savings Plan Defined contribution plan that allows contributions to grow tax deferred but with some investment risk 26

27 529 Plans The basics: Tax-deferred growth and federal tax-free withdrawals on earnings when used for qualified education expenses Account owner has control Can access money at any time (subject to penalty) Change beneficiary Choose and change investment vehicles (subject to plan availability) Like a revocable trust Contributions are completed gifts 529 Plans Qualified education expenses. Must be required by the institution. Tuition and fees Books, supplies, and equipment The purchase of computer technology, equipment, or Internet access and related services Expenses for special needs services needed by a special needs beneficiary Expenses for room and board must be incurred by students who are enrolled at least half-time. The expense for room and board qualifies only to the extent that it is not more than the greater of the following two amounts. The allowance for room and board The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution (Cant rent the penthouse) 27

28 529 Plans Five (5) Year Gifting Rule: Contributions between $14,000 - $70,000 (or $28,000 - $140,000 for married coupled filing jointly) made in one year can be prorated over a five (5) year period without incurring gift taxes or reducing the federal estate and gift tax credit If contribute less than the $70,000 ($140,000 for married coupled filing jointly) maximum, additional contributions can be made without incurring federal gift taxes up to a prorated level of $14,000 ($28,000 for married couples filing jointly) per year Gift taxation may result if a contribution exceeds the available annual gift tax exclusion amount remaining for a given beneficiary in the year of contribution For contributions between $14,000 - $70,000 (or $28,000 - $140,000 for married coupled filing jointly) made in one year, if the account owner dies before the end of the five-year period, a pro-rated portion of the contribution may be included in his or her taxable estate 529 Plans Considerations Penalties Donor can withdraw funds for non-educational expenses but is subject to a 10% federal penalty and possible state taxes Successor owners Most plan applications request this Without a designation the plan may become part of the probate estate and the successor in interest could liquidate the account Change of beneficiary No tax consequence if changes to another member of the family of the donee Upon death of the beneficiary the account holder can close the account and take the distribution without penalty (earnings are taxable) 28

29 529 Plans: PA Tax Benefits Pennsylvania residents who contribute to a PA 529 plan receive a state income tax deduction of up to $14,000 "per beneficiary If a couple files a joint tax return, the allowable deduction is doubled to $28,000 per return as long as both spouses each have earned income of at least $14,000 Unlike some states, Pennsylvania residents receive a tax deduction for contributing to any state's Section 529 plan Considering that Pennsylvania has a flat state income tax rate is 3.07%, each deduction of $14,000 can save a taxpayer up to $ at tax time Withdrawals are exempt from PA state tax when used for qualified educational expenses Source: Additional Reference: Marital Planning Marital Deduction & QTIP Trusts Credit Shelter Trusts Portability 29

30 Case Study: Using Portability Client situation $2 million of exemption unused Spouse 1 $3 million $3 million free of estate tax A couple has $10 million in assets that they want to leave to their children The first spouse to pass away holds $3 million in assets; the surviving spouse holds $7 million Tax Consequences $2 million estate taxfree with portability Children Spouse 2 $7 million $5 million estate taxfree with exemption At the death of the first spouse, the entire $3 million passes to the children estate tax-free That leaves $2 million of unused exemption At the death of the second spouse, $5 million passes estate tax-free using the second spouse s exemption The remaining $2 million can pass estate-tax free using the first spouse s unused exemption amount Note Portability is not automatic Portability Caution (a.k.a. malpractice risk): Recall that portability must be elected Notice states that for decedents dying after 2010 to claim decedent s spouse exclusion a complete and timely Form 706 must be filed, even if the first spouse s estate is under the $5.45MM filing limit Malpractice risk exists if the second estate is worth more than $5.45MM currently and the second spouse dies shortly after the first, a Federal Estate tax will be due and the second spouse s estate will go back to the executor of the first person to hold it accountable for not making the portability election The requirement to file a full blown 706 in the first estate may be overkill in that it can create an additional expense to smaller estates that would otherwise not be required to file a

31 The Marital Deduction I.R.C There is an unlimited marital deduction for all qualifying dispositions of property to or for the benefit of the decedent s surviving spouse When considering the goals of the client, the use of a Credit Shelter Trust along with a marital deduction trust becomes a balancing act How much in each? How is that amount determined? How much control is required or requested? The Marital Deduction Requirements for property to qualify for the marital deduction: The marital deduction is mandatory and must be taken in full Taxpayers must be married Determined at time of death Common-law marriages depend on state laws Spouse must survive Common accident presumption of survivorship is sufficient 31

32 The Marital Deduction Requirements for property to qualify for the marital deduction (continued): Spouse must be a U.S. citizen Utilize a Qualified Domestic Trust for non U.S. spouse Property must be included in the decedent s estate Property must pass to the surviving spouse Will Joint tenancy Certain qualifying marital trusts Terminable Interest Property No marital deduction is allowed for property passing to the spouse that terminates upon the lapse of time or upon the occurrence or nonoccurrence of an event or contingency Life estate Term of years Patent Copyright Conditional gift Motivated by control from the grave! 32

33 Exceptions to the Terminable Interest Rule Survivorship A transfer conditioned on survivorship of six months or less so long as the condition is met Providing for more than six months is problematic Charitable Remainder Trust Property passing to a charitable remainder trust so long as there are no other non-charitable beneficiaries of the trust Exceptions to the Terminable Interest Rule Power of Appointment Trust Historically the surviving spouse provided life use with a remainder interest to the children I.R.C. 2056(b)(5) allows for this concept but certain conditions must be met: The surviving spouse must be entitled to all the income from the trust payable at least annually The right must be enforceable The trust must provide the surviving spouse with a general power of appointment which is freely exercisable including to the spouse of the estate Significant Side Note: General powers of appointment are includable in the estate of the person who has the power to exercise it. Limited powers of appointment are NOT includable in the estate of the person who has the power to exercise it. No other person can be a beneficiary of the trust during the surviving spouse s life 33

34 Exceptions to the Terminable Interest Rule Qualified Terminable Interest Property (QTIP) Allows the testator to control the ultimate disposition of the property while maintaining the marital deduction This is for control (used frequently with second marriages) not tax but it is frequently paired with a credit shelter trust Requirements: All income generated by the property must be payable at least annually to the surviving spouse for life The right to income must be enforceable Distribution of any part of the property to anyone other than the surviving spouse is barred during the surviving spouses lifetime The decedent s executor must make the QTIP election on the decedent s estate tax return Once made it s irrevocable Election may be partial Spousal Credit Shelter Trust Plan For Current, Protective Use of Gift and Gen-Skipping Tax Exemptions Husband Wife Gift of assets TO WIFE in trust, using lifetime exemption Gift of assets TO HUSBAND in trust, using lifetime exemption Credit Shelter Trust FOR WIFE and Descendants (Irrevocable) Mandatory or permissive distributions for spouse, descendants or both Children and grandchildren Credit Shelter Trust FOR HUSBAND and Descendants (Irrevocable) 34

35 Spousal Credit Shelter Trust Plan For Current, Protective Use of Gift and Gen-Skipping Tax Exemptions Credit Shelter Trusts can have a wide range of provisions: The spouse-beneficiary could be mandatory or permissive beneficiary of income, principal or both. Children could be current and/or remainder beneficiaries. Spouse can have optional, defined annual withdrawal rights, enhancing access to capital despite trust restrictions. Spouse can have limited power of appointment during life or at death. Spousal power of appointment could be broad enough to appoint assets back to original donee spouse. Can help to reduce state estate taxes Protect beneficiary from creditors including beneficiaries' divorce Can be structured to encourage gainful employment Spousal Credit Shelter Trust Plan For Current, Protective Use of Gift and Gen-Skipping Tax Exemptions Other matters to consider: This arrangement enables spouses to move capital out of their taxable estates while keeping it within their reach if wanted or needed later. To the extent that a spouse refrains from receiving or demanding distributions from his/her trust, the trust s capital will compound estate tax-free for younger generation(s). To avoid adverse estate tax results, the spouses trusts should NOT be identical ( reciprocal ). The Reciprocal Trust Doctrine The creator of each trust may be responsible for income taxes on trust income, deductions and gains/losses under the grantor trust rules. 35

36 Credit Shelter Trusts A credit shelter trust can have a wide range of provisions: The spouse-beneficiary could be mandatory or permissive beneficiary of income, principal or both. Children could be current and/or remainder beneficiaries. Spouse can have optional, defined annual withdrawal rights, enhancing access to capital despite trust restrictions. Spouse can have limited power of appointment during life or at death. Spousal power of appointment could be broad enough to appoint assets back to original donee spouse. Can help to reduce state estate taxes Protect beneficiary from creditors including beneficiaries' divorce Can be structured to encourage gainful employment Credit Shelter Trusts Other matters to consider: This arrangement enables spouses to move capital out of their taxable estates while keeping it within their reach if wanted or needed later. To the extent that a spouse refrains from receiving or demanding distributions from his/her trust, the trust s capital will compound estate tax-free for younger generation(s). To avoid adverse estate tax results, the spouses trusts should NOT be identical ( reciprocal ). The creator of each trust may be responsible for income taxes on trust income, deductions and gains/losses under the grantor trust rules. 36

37 Credit Shelter Trust: Case study Client situation John s Will was drafted in 2005 when his net worth was $5 million His children are beneficiaries of a bypass trust to be funded with his remaining exemption amount His second wife will receive the balance Had John died in 2005, $1.5 would have gone to his children and $3.5 million would have gone to his wife Current impact Estate planning documents often contain formula clauses Designed to minimize estate taxes Eliminate the need to update documents as exemption amounts change Higher estate exemption may leave certain beneficiaries with less than you intend John s net worth is now $6 million If he passes away before the end of 2016, the bypass trust will receive $5.49 million, leaving his wife with just $510,000 Possible Solutions to Formula Clauses Limit amount that passes into the credit shelter trust e.g. the largest amount, if any, which my federal taxable estate may be increased without causing an increase in the federal estate tax payable by reason of my death; or two million dollars ($2,000,000) 37

38 Possible Solutions to Formula Clauses Disclaimer Allows the surviving spouse to control how much exemption equivalent is to be used upon the death of the first spouse Advantages Whatever portion the spouse disclaims would find the trust Maximum flexibility Maximum leverage of GST exemption Disadvantages Spouse may be unwilling Retain competent counsel Disclaimer must be made within 9 months of the decedents death so spouse may not receive timely advice Careful not to take possession of the assets prior to disclaiming Possible Solutions to Formula Clauses Divisible QTIP Dispose of the entire estate to a QTIP trust and give the power to the executor to divide the QTIP trust to maximize estate tax savings Similar to disclaimer but it vests the power in the executor rather than the spouse This should be used when it is intended that the spouse be the primary beneficiary of the estate 38

39 Possible Solutions to Formula Clauses Clayton QTIP A variation of the divisible QTIP Here the estate passes to a QTIP trust only to the extent the executor elects The remaining portion of the estate passes to a non-marital deduction trust (credit shelter trust) This should be used when it is intended that the spouse is not the primary beneficiary Life Insurance Trusts ILIT 39

40 Life Insurance Trusts Uses: Provide liquidity to estates made up of non-liquid assets (such as a family business) Replace portions of the assets lost to estate taxes Life insurance proceeds are includable in the gross estate if: The estate is the beneficiary; The beneficiary has a legally binding obligation to use the proceeds for the benefit of the estate; or The decedent possessed, at his or her death, incidents of ownership exercisable alone or in conjunction with another person. I.R.C

41 Life Insurance Trusts In general: The trust must be irrevocable Grantor is the insured (but does not have to be) Grantor makes further annual contributions in an amount sufficient to pay the premiums Coordinate with annual exclusion or amounts above the exclusion if meets the grantor planning goals No obligation to make further contributions Transfers to the trust must be a completed gift (a present interest gift) for gift tax purposes Life Insurance Trusts Continued: Grantor may not retain any incidences of ownership in the policy Examples include right to cancel, change the beneficiary, assign the policy, borrow against the value or pledge the policy Upon death the life insurance proceeds will be collected by trustee and paid per the terms of the trust If done correctly, proceeds are estate, gift and GST tax free 41

42 Life Insurance Trusts: Transfer vs. Purchase The grantor may transfer an existing policy that s/he owns. Issue: If, within three (3) years of death a donor transfers any of the following interests, the value of such interest at the date of death is includable in the gross estate: Life insurance policies; Retained life estate; Reversionary interest; Power to revoke, alter, amend or terminate if the property is subject to a life estate, interest or power; and A transfer where the decedent continued to possess the life estate, interest or power until death. Annual exclusion gifts made from revocable trusts made within three (3) years of death will not be brought back into the gross estate Trust may be drafted so that if the grantor dies within 3 years the proceeds may be paid outright or to a QTIP trust For these reasons, it is preferable to have the trust purchase a new policy. Life Insurance Trusts: Crummey Power Annual exclusion are available only for present interest gifts. The nature of a life insurance trust is for a future interest so how do we create a present interest? Crummey matter solved this issue. When the grantor makes the contribution to the trust for the payment of the premium each year, the trustee must notify each of the beneficiaries in writing that s/he has the right to receive his/her proportionate share of the contributions Right will expire (usually after 30 days) Practically, the beneficiaries will not exercise their right of withdrawal 42

43 Life Insurance Trusts Second to Die Life Insurance Trusts Policy insures the lives of two individuals A second to die policy should not be held in the same trust as a single life policy as the proceeds of the single life policy could be includable in the estate of the second spouse to die In general, do you need a trust? Life insurance trusts: Leveraging your gift Gifts to an irrevocable life insurance trust enable you to take advantage of the unique estate and income tax provisions that apply to insurance $3,000,000 Irrevocable Life Insurance Trust Estate and income tax-free payment Assumptions: Married couple: 50 year old female and 58 year old male, both in good health Policy is held until death with no withdrawals of any kind Second death expected in 39 years $3,000,000 Insurance Premium IRR on Death Benefit at Second Death: 5.39% $3,510,800 Life Insurance $23,212,262 Policy Life Insurance Policy on both Husband and Wife Death Benefit Can also be structured with a single life policy FOR ILLUSTRATIVE PURPOSES ONLY, NOT AN ACTUAL CASE. 43

44 Family Limited Partnerships FLP Family Limited Partnerships Typical structure Parents create a family limited partnership (FLP) and establish a partnership agreement detailing the nature of the business and the roles of the general and limited partners Parents contribute property in a tax free exchange Parents take back a 1% general partnership interest and a 99% limited partnership interest Parents then gift the limited partnership interest to the children over time and utilizing the annual exclusion The limited partnership units may be transferred at a discount due to lack of marketability and minority interest discount 44

45 Family Limited Partnerships Control FLP consist of one or more general partners (GP) and one or more limited partners (LP) The same person can be a GP and an LP But note this is a partnership so need more than one owner GP is responsible for the day to day operation of the business GP controls all of the distributions and has the right to retain assets Partnership Agreement may contain restrictions on the LP right to transfer ownership However GP also has unlimited personal liability for the business Can use a corporation as the GP LP has no say in the day to day aspects of the business Note LP may vote on certain matters such as a sale of substantially all the assets of the business and removal of a GP However, LP has limited liability (can lose only the amount contributed) Family Limited Partnerships Lower Transfer Tax Valuations Fair market value : the price at which property would change hands between a willing buyer and a willing seller, neither of whom is under any compulsion to buy or sell, and both having reasonable knowledge of the relevant facts FMV of 1% of the LP units is less than 1% of the value of the assets Minority interest Lack of marketability VERY BIG DEVELOPMENTS UNDER SECTION 2704! 45

46 FLP Discounts Minority Interest Lack of control or say over the day to day operation of the business Lack of marketability Who would buy a 1% interest in a family business where the GP controls everything? Who sets the value? Best to have an independent appraiser who will write a detailed report What is a reasonable discount? Varies greatly with the nature of the business but courts have permitted discounts up to about 45% FLP: Tax and Asset Protection Phantom Income Partnerships are pass-through entities for tax purposes meaning that the entity does not pay tax The partners will report the income on their personal returns (form K-1) whether the partnership distributes income or not So the partners may be forced to pay tax from their own resources Phantom income and lack of control can create a degree of asset protection Creditors cannot become partners but can obtain the right to distributions Distributions are controlled by the GP who may elect to distribute nothing at all so the creditor may have to wait a long time to receive money Plus the creditor may have to report the phantom income 46

47 Challenges to FLPs Issues: Lack of business purpose Valuations not supported (no appraisal) Book and records of the FLP not kept Commingling partnership and personal funds GP salary or fees too high Distributions not pro-rata No statements of non-tax purposes FLP Example Mom and Dad own a thriving furniture store located on a prime location on Main Street with a very favorable long term lease and excellent contracts with manufacturers. They decide to transfer some assets to their child. They however are not ready to give up control of the business. They are also not enamored with their child s fiancée whom they feel is from a questionable family. They decide to transfer their partnership and create a FLP using the assets of the business worth $5,000,000. In 2016 they decided to gift $100,000 in LP units to their child. They prudently obtain a appraisal and determine that the LP units are entitled to a 40% discount. What is the value of the total gift made by the parents to the child? $100,000 x 60% = $60,000 Can the LP units be placed in trust? 47

48 Grantor Retained Annuity Trust GRAT The Rolling Game Grantor Retained Annuity Trust (GRAT) The grantor transfers property to the GRAT and pays gift taxes on the present value of the remainder. In turn, the GRAT trustee(s) makes fixed annuity payments to the grantor for a specified period. At the end of the trust term, if the grantor is living, the remaining assets go to the remainder beneficiaries free of additional gift or estate taxes. Property GRAT (Gift tax, unless zeroed out) Fixed Annuity At the end of the trust term, assets to heirs pass free of additional gift or estate taxes Remainder flows outright or in an irrevocable trust for children or other beneficiaries at end of the term 48

49 GRAT Basic Rules: Split Interest Trust under I.R.C Grantor passes property to an irrevocable trust and retains an annuity interest in the property for a number of years determined by the grantor The annuity may be a fixed dollar amount or a percentage The remainder (if any) is a gift to the named beneficiaries Formula Remainder = Value of property transferred Present value of the annuity interest GRAT More rules: May only be funded once Value of the remainder does not qualify as an annual exclusion gift Cannot allocate any portion of the GST tax exemption Well sort of May be funded with real estate, s-corporation stock, partnership units etc However will need to reappraise the assets each time an annuity payment is made Success or failure depends on Surviving the term of the trust (will be included in the gross estate if dies prior to the term of the trust) Beating the 7520 rate Annuity Payment 49

50 GRAT More rules: If the GRAT does not generate enough cash to pay the annuity to the grantor then the trustee may Distribute the assets in kind; Sell assets and distribute cash; or borrow against the GRAT The trustee may not issue a promissory note Because this is a grantor trust paying income tax is not a gift to the trust All tax consequences are realized by the grantor on his or her personal returns Careful consideration should be given so that the grantor has the funds necessary to pay for the tax should the trustee decide to sell the assets in the GRAT for diversification purposes GRAT Section 7520 rate = 120% of the applicable federal rate that applies to notes that have a term greater than 3 years but less than 9 (mid-term rate) Rate is set when the GRAT is funded and is constant for the term of the GRAT November 2016: AFR Annual Mid Term = 1.33% 120% = 1.60% Works well in a low interest rate environment 50

51 Zero GRAT (Walton GRAT) / Rolling GRAT Remainder = Value of property transferred Present value of the annuity interest A zero or Walton GRAT is when the present value of the annuity interest = $0 This results in a $0 gift and any appreciation over the 7520 rate passes without tax Rolling GRAT: take each annuity payment and start a new GRAT which may be another zero GRAT Traditional Rolling GRAT Strategy 2017 GRAT Initial Funding $5,000,000 BOY Value Remaining Value EOY Value EOY Annuity Payout EOY GRAT Value Less Annuity 2017 $5,000,000 $5,200,000 $2,560,164 $2,639, $2,639,837 $2,745,430 $2,560,164 $185, GRAT Initial Funding From 1st 2017 Annuity Payment $2,560,164 BOY Value EOY Value EOY Annuity Payout EOY GRAT Value Less Annuity 2017 $0 $0 $0 $ $2,560,164 $2,662, $1,310,887 $1,351, $1,351,683 $1,405,750 $1,310,887 $94, GRAT Initial Funding From 2nd 2017 Annuity Payment & 1st 2018 Payment $3,871,051 BOY Value EOY Value EOY Annuity Payout EOY GRAT Value Less Annuity 2017 $0 $0 $0 $ $0 $0 $0 $ $3,871, $4,025,893 $1,982,105 $2,043, $2,043,788 $2,125,540 $1,982,105 $143, GRAT Initial Funding From 2nd 2018 Annuity Payment & 1st 2019 Payment $3,292,992 BOY Value EOY Value EOY Annuity Payout EOY GRAT Value Less Annuity 2017 $0 $0 $0 $ $0 $0 $0 $ $0 $0 $0 $ $3,292,992 $3,424,712 $1,686,120 $1,738, $1,738,592 $1,808,136 $1,686,120 $122,016 TOTAL ASSETS TRANSFERRED TO NEXT GENERATION BY END OF 2021 $545,580 51

52 GRAT Assets Consider using: Assets likely to rapidly appreciate e.g. business that may go public in the near future or a growth stock 2008 stock valuations Assets with a high dividend payout If possible swap assets If the assets have rapidly appreciated, then the beneficiaries will receive low basis assets While the grantor trust status still applies (i.e. before distribution) the grantor may swap cash for the appreciated assets so the beneficiaries will receive low basis property Additional benefit is that the property will receive a step-up in basis upon the death of the grantor Grantor Retained Annuity Trusts Grantor Retained Annuity Trusts remain attractive for two reasons: They are still allowed. There has been speculation that the minimum term for GRATs would be 10 years thereby severely limiting their effectiveness; and They are an excellent way to leverage lifetime gifting especially when you have used up the lifetime credit 52

53 Intentionally Defective Grantor Trusts IDGT Intentionally Defective (Effective) Grantor Trust (IDGT) Review GRAT drawbacks: Death of grantor before GRAT ends No GST allocation allowed Annual payouts IDGT is an attempt to solve all of these issues Note that, unlike a GRAT, a IDGT has no statutory authority. It has been utilized for some time and is based on a combination of IRS rulings and case law. 53

54 IDGT What is a grantor trust in relation to a IDGT? When the law treats the grantor as the owner of the trust for income tax purposes How? Certain trust powers will cause the trust assets to be included in the grantor s gross estate for estate tax purposes These are not the ones we want Other trust powers will NOT cause the trust assets to be included in the grantor s gross estate for estate tax purposes These are the one we want IDGT Examples of the desirable trust powers: Giving the grantor, in an individual capacity, the power to reacquire trust assets by substituting his other own assets of equivalent value Giving the grantor, in an individual capacity, the power to borrow trust assets without adequate security (but with adequate interest) Giving a non-adverse person the power to add a charitable beneficiaries to the class of named beneficiaries to which the trust could make distributions of income and principal 54

55 IDGT Steps: Create an irrevocable grantor trust Can use a dynasty trust Make a gift to the trust of at least 10% of the value of the sale This gift is a taxable gift Selling assets to the trust in exchange for a promissory note Not a gift so long as the terms of the note are commercially reasonable Review: IDGT Grantor establishes the irrevocable trust with seed money; The trust is constructed to be defective for income tax purposes; that is, the grantor pays tax on all income, including net capital gains, realized inside of the trust Trust purchases assets from the grantor in exchange for an installment note IDIT can pay off the note or continue to make installment payments Value of note is included in grantor s estate if the note has not been paid off All growth in the trust is protected from estate taxation in grantor s estate (grantor has created a freeze) Benefit derived if trust appreciation exceeds interest on the note 55

56 Sales to Intentionally Defective Grantor Trusts The IDIT can be used by owners of closely held businesses (and certain other assets) to freeze the value of appreciating assets for federal estate tax purposes at their value at the date of transfer. Grantor makes transfer to trust Grantor taxed on trust income Installment note payments Grantor Trust All growth removed from the taxable estate of grantor Grantor Grantor Trust purchases asset from donor for installment note Family Income/Principal paid to children Qualified Personal Residence Trust QPRT 56

57 Qualified Personal Residence Trust (1) Asset (2) Use rent-free for term of Trust Grantor/Income Beneficiary (3) Qualified Personal Residence Trust (QPRT) Family/Heirs 1 Grantor irrevocably transfers residence* to trust. (4) Assets at termination 2 Grantor resides in residence rent-free for term of trust. 3 Transfer considered gift for gift tax purposes, equal to discounted value of the remainder interest. 4 Residence in trust passes to family and/or heirs at termination of trust. 5 At termination of trust, grantor rents home from family if he/she wishes to continue to use the property, providing additional reduction of the value of the grantor s estate, as rental payments are not considered to be taxable gifts. * Technique can be used for up to two (2) residences. Self Cancelling Installment Notes SCIN 57

58 Sale Using Self-canceling Installment Note (SCIN) (2) Asset Transferor/Seller (Parent) (1) (3) Installment Note Payment Transferee/Buyer (Child) (4) 1 Transferor sells asset to transferee under an agreement signed between transferor and transferee. 2 Transferor receives promissory note with self-cancellation provision at death. The promissory note is amortized over the life expectancy of the transferor and includes an interest rate or principal premium to compensate for the self-canceling provision. 3 The sale is treated as installment sale for income tax purposes. The transferor recognizes capital gains on payments received. 4 At transferor's death the installment payments cease and entire value of installment note is removed from transferor s estate due to the self-cancellation provision. Note: As with any complex estate planning technique, the use of a SCIN should be reviewed by a tax attorney or tax advisor. Sale By Private Annuity 58

59 Sale by Private Annuity (1) Asset Transferor/Annuitant (Parent) (2) Annuity Payment Transferee/Buyer (Child) (3) 1 Transferor irrevocably transfers asset to transferee under an agreement signed between transferor and transferee establishing Private Annuity. 2 Transferor receives annuity payment for life. 3 At transferor's death annuity payments cease and entire value of asset is removed from transferor s estate. 4 The annuity payment is calculated under IRS rules based on the fair market value of the assets transferred, the transferor s life expectancy, and assumed interest rates. Dynasty Trusts 59

60 Preserving assets for future generations with a Dynasty Trust Dynasty Trusts are helpful in minimizing estate and GST taxes - Important if you are taking advantage of the new higher gift tax exemption - Appreciation escape future transfer taxes Choice of state for trust administration may enable you to extend the term (consult with your legal counsel) - Delaware, for example, imposes no limit on the term May protects assets from creditors, spendthrifts and the effects of divorce Can be particularly effective when assets are used to purchase second-to-die life insurance policy Dynasty/Generation Skipping Trusts A dynasty trust is an estate planning tool that provides income and support to unlimited generations of the family. Income and appreciation is free from future estate, gift and generation skipping transfer (GST) tax, as long as GST tax exemption is fully allocated to the trust. The assets in a dynasty trust are not subject to estate tax in a trust beneficiary s estate, as long as the assets remain in the trust. Gift tax may be avoided on transfers into the trust, depending on the terms of the trust, size of the transfer exclusions or exemptions available to the transferor, and other taxable gifts the transferor has made. If the appropriate GST tax exemption is allocated, dynasty trusts allow assets to pass on for use by multiple generations without triggering the generation-skipping transfer tax. 60

61 Dynasty/Generation Skipping Trusts (Continued) Delaware Dynasty Trusts Delaware has partially repealed the Rule Against Perpetuities, allowing dynasty trusts holding personal property to continue indefinitely if they meet certain requirements. Delaware dynasty trusts are generally exempt from the payment of Delaware state income and capital gains tax if none of the trust beneficiaries reside in Delaware. Certain Delaware trusts may be subject to Delaware income tax, but only if the income is generated from real estate, tangible personal property or a trade or business held by the trust and located in Delaware. A Delaware dynasty trust must have a substantial relationship to Delaware, which can be satisfied by non-delaware residents naming a corporate entity with a Delaware situs as the trustee. Case Study: Transferring ownership in a family business Client situation Andrew and Eileen own a profitable business worth an estimated $7 million They eventually want to sell the business and anticipate its value will increase over time Although they want to gift interests to their children now to take advantage of the new, higher gift tax exemption, they want to maintain control of business decisions For Illustrative Purposes Only 61

62 Maintaining control with a Delaware Administrative Trust Client $5,000,000 company stock Delaware Administrative Trust Directed distributions Children Dividends Control of the company Company Andrew and Eileen contribute $5 million of company stock to a Delaware Administrative Trust, removing it from their taxable estate By serving as Investment Advisors to the trust, they are able to maintain control of The company The payment of dividends The decision to sell Retirement Accounts 62

63 Your Retirement Accounts And Your Estate Plan Make the most of retirement savings Beneficiary designations Stretch IRA strategy Leaving retirement assets to charity Disclaimers Stretching The Benefits Of An IRA This hypothetical example is illustrative only. It assumes a 6% annual return, that the account owner rolls over the account on Jan. 1 of the year he or she receives the assets, that all distributions are taken on the last day of each distribution year and that all d istributions are the required minimum amount. These amounts are not adjusted for inflation and do not reflect any state or federal income tax that may be due upon distribution. This cart does not reflect past or future performance of any specific investment vehicle. It also does not reflect the volatility that can occur in an equity-based account and assumes current tax laws remain in effect throughout. 63

64 Philanthropic Planning Charitable Lead Trusts Charitable Remainder Trusts Creating A Personalized Giving Strategy MAKING A DIFFERENCE THROUGH PHILANTHROPY Supporting your favorite causes Expressing your values and beliefs Giving back to your community Creating a family legacy of giving MAKING A DIFFERENCE THROUGH PHILANTHROPY 64

65 The Tax Benefits of Your Generosity 50% Organizations 30% Organizations Public Charities Private Foundations Percentage limitation Valuation limitation Percentage limitation Valuation limitation Cash 50% of AGI Fair market value 30% of AGI Fair market value Capital gains property 30% of AGI Fair market value 50% of AGI Cost 20% of AGI Fair Market Value for Qualified Stock; Basis for other property, e.g, real estate, closely held stock, etc. The Benefits of Philanthropic Planning Philanthropic Planning Can Result in a Variety of Benefits Including: Enable charitable organizations to continue their good work and mission Reduced risk through diversification of a concentrated security position Tax-free or tax-advantaged accumulation of assets for charity Potential increase in your current after-tax cash flow Potential tax-advantaged transfer of wealth to heirs or other beneficiaries Strategic management of designated capital to achieve both philanthropic and non-philanthropic goals 65

66 Philanthropic Giving Options Your Options for Making Charitable Gifts May Include One or More of the Following: Direct contribution of cash, securities, real estate, tangible personal property and other assets Donor-advised funds Charitable Remainder Trusts (CRTs) Charitable Lead Trusts (CLTs) Charitable gift annuities and pooled income funds Private family foundations Supporting organizations Philanthropic Giving Options: Charitable Remainder Trust What Is a Charitable Remainder Trust (CRT)? Tax-exempt trust Payment stream to beneficiaries for life or term of years At trust termination, remaining assets pass to charity Benefits of a CRT: Increase cash flow Reduce taxes Charitable income tax deduction Defer long-term capital gain tax Can reduce estate tax Diversify assets Future charitable gifts 66

67 Philanthropic Giving Options: Charitable Remainder Trust Contribution of assets Charitable Remainder Trust Payment stream (cash flow) for life or term Charitable deduction at time of initial contribution to trust Remainder to charity Private Foundation or Other Charities 67

68 Philanthropic Giving Options: Tiered Tax Accounting Attributable to CRT Distributions Order of Income Distributed Ordinary Income Qualified Dividends Short-term Capital Gain Long-term Capital Gain Other Income (Including Tax-exempt Income) Return of Principal Philanthropic Giving Options: Charitable Remainder Trust Taxation Income Tax Considerations for Grantor: Deduction generated equals the value of the charitable interest Deductions are limited to 20%, 30%, or 50% of grantor s adjusted gross income Deduction may be reduced when: The contributed property is a partial interest in certain property, such as real estate, which may require a reduced deduction due to marketability discount, minority discount, etc. The contributed property is tangible property; in many cases the deduction is limited to the lesser of cost basis or fair market value (FMV). The same applies for short-term gain property. A private foundation is the remainderman of the charitable remainder trust. 68

69 Philanthropic Giving Options: Charitable Remainder Trust as Beneficiary of IRA Donor (IRA) (1) IRA/assets at death (2) Estate tax deduction Charitable Remainder Trust (3) Income (4) Remainder interest Donor s Heirs Charity or Private Foundation 1 Donor transfers IRA to CRT at death via beneficiary designation 2 Distribution to CRT avoids IRD, and qualifies for a partial estate tax charitable deduction 3 Heirs receive income from CRT for life or fixed term 4 Assets in CRT pass to charity at termination of CRT Philanthropic Giving Options: Charitable Lead Trust What Is a Charitable Lead Trust (CLT)? A charitable lead trust (CLT) is not a tax-exempt trust. A charitable lead trust may be designed as non-grantor, grantor or defective grantor trust. The income, gift, estate and GST tax consequences are dependent on the type of trust. The charity will receive annual payments (may be fixed or variable) from the trust for a specified period. Remainder beneficiaries of the trust (for example, family members) will receive the trust s assets upon termination. Any asset growth that occurs within the trust will be distributed to the remainder beneficiaries free of additional gift or estate tax. A CLT allows assets to be transferred to heirs at a significantly reduced, or eliminated, transfer-tax cost. A CLT enables grantors to pursue their philanthropic endeavors while living. 69

70 Philanthropic Giving Options: Charitable Lead Trust (Continued) Property Charitable Lead Trust Income, estate or gift tax charitable deduction Assets to individuals named by the grantor at the end of the trust term, often with no or reduced gift or estate taxes* Payment stream to charity for specified period Private Foundation or Other Charities *Consider the applicability of generation-skipping transfer taxes 70

71 Philanthropic Giving Options: Charitable Lead Trust Key Characteristics Non-grantor Charitable Lead Trust No income tax charitable deduction is allowed to the grantor on funding Trust receives income tax charitable deductions each year due to lead amount distributed to charity, which reduce the CLT s income tax liability Grantor receives a gift tax charitable deduction Appreciation of assets in a non-grantor lead trust is free of estate and gift taxes Remainder beneficiary is someone other than the grantor Philanthropic Giving Options: Charitable Lead Trust Key Characteristics (Continued) Grantor Charitable Lead Trust Charitable income tax deduction for grantor on funding for present value of payment stream to charity Grantor is responsible for the CLT s annual tax liability. All income, expenses and credits are reported to the grantor Grantor receives a gift tax charitable deduction for defective CLTs Remainder beneficiary is grantor or in the case of a defective CLT, someone other than the grantor 71

72 Philanthropic Giving Options: Charitable Lead Trusts Annual Taxation Grantor Charitable Lead Trust Income and capital gains are taxed to the grantor Grantor receives a charitable income tax deduction upon funding Non-grantor Charitable Lead Trust Income and capital gains are taxed to the trust Trust receives full income tax charitable deductions each year for amounts distributed to charity No income tax charitable deduction is allowed to grantor upon funding Super Charitable Lead Trust Income and capital gains are taxed to the grantor Grantor receives a charitable income tax deduction upon funding Grantor receives a gift tax charitable deduction Philanthropic Giving Options: Private Foundation A private foundation is a permanent or term endowment established by an individual or family for charitable purposes. It can provide greater flexibility and control in giving. Private Foundation Created as a legal entity, corporation or trust Donors and family members may serve as board members, trustees and staff May provide reasonable income (salaries) to family members within federal regulatory guidelines for services performed Provides flexible granting and investment opportunities Requires that annual qualifying distributions of at least 5% of the value of investment assets are made to public charities or for a wide range of specific charitable purposes Pays an excise tax of up to 2% of its net investment income 72

73 Philanthropic Giving Options: Private Foundation (Continued) Advantages Income tax deduction Family involvement High level of involvement in grant-making and charitable activities May engage family members as trustees or staff Family legacy, community leadership and multigenerational identification with a family s philanthropic interests Disadvantages Often complicated tax and legal requirements May be difficult and expensive to establish and maintain Assumes inclusion of subsequent generations or other designated persons Philanthropic Giving Options: Private Foundation (Continued) Contribution of assets Private Foundation Annual distributions to charity as determined by Board Charitable deduction at time of initial contribution to foundation Qualified annual distributions of at least 5% to charity Family members may receive salaries for serving on Board of Directors 73

74 Philanthropic Giving Options: Private Foundation Rules Private foundations are subject to federal rules and regulations commonly known as The Private Foundation Rules. These rules are designed to ensure that charitable organizations, which are not subject to public control and management, preserve and use the assets entrusted to them solely for charitable purposes. The Private Foundation Rules Are: The Self-Dealing Rule The Rule Against Jeopardy Investments The Minimum, or Required, Distribution Rule The Taxable Expenditures Rule The Excess Business Holding Rule The Excise Tax Philanthropic Giving Options: Private Foundation Rules (Continued) These Rules Affect: The type of assets that may be held by a private foundation How those assets are managed The types of transactions a foundation may conduct with its donors and closely related parties The types of activities in which the foundation may be involved How the foundation s assets are used to accomplish its charitable purposes Individuals and families involved in the creation and operation of private foundations need to be aware of these rules and understand how they affect the day-to-day operation of their foundation 74

75 Giving Through Donor- Advised Funds Donor-advised funds Planned giving strategy without the administrative requirements of establishing a private foundation Giving Through Donor- Advised Funds Potential Advantages Donate cash, stocks, or other assets acceptable to the charity Claim an immediate tax deduction based on fair market value of the assets, with timing to charity at separate time Recommend distributions and investment objective Make additional gifts at any time Engage in philanthropy without extensive administrative duties Tax-free asset growth Considerations Your gift is irrevocable and is wholly owned by the host charity. Investments chosen from options managed by the fund no direct investment management choice Requires a minimum balance to open a fund.* 75

76 Integrated Philanthropic Planning Donor CLT Public Charity, Donor Advised Fund or Private Foundation CRT ILIT HEIRS Case Study Discussion Open Questions: A Tough One For Some Lawyers 76