Capital Gains Tax Planning In A World Without Estate Tax

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1 BRUCE GIVNER ( bruce@givnerkaye.com) OWEN D. KAYE ( owen@givnerkaye.com) KATHLEEN GIVNER ( kathy@givnerkaye.com) NEDA BARKHORDAR ( neda@givnerkaye.com) JACQUELINE BURBANK ( jacqueline@givnerkaye.com) LAW OFFICES SUITE WILSHIRE BOULEVARD LOS ANGELES, CALIFORNIA South Bay Estate Planning Council PHONE (310) (818) FAX (310) (818) I. LIKELY MAXIMUM 2017 RATES COMPARED TO MAXIMUM 2016 RATES. Ordinary (Earned) Income. 2016: 39.6% federal plus (13.3% X 60.4% = ) % = % 2017: 33% federal plus 13.3% 1 = 46.3% = 97.2% (a reduction of % in the rate itself). Ordinary (Passive) Income. Capital Gain. 2016: 39.6% federal plus (60.4% x 3.8% = ) % % = % 2017: 33% federal plus 13.3% = 46.3% = 92.73% (a reduction of % in the rate itself) in the A.M.T. 2 Passive. 20% + 3.8% % = 37.1% Materially Participating. 20% % = 33.3% 2017: depends on what rate you believe will be enacted. Compare: Trump 20% % = 33.3% House (1/2 max. pers rate) 16.5% % = 29.8% II. passive will be 33.3% 37.1 = 89.76% or 29.8% 37.1% = 80.3% Materially particip g 33.3% (same) or 29.8% 33.3% = 89.5% LIKELY 2017 NEVADA ADVANTAGE. Ordinary (Earned) Income (Maximum). Before: % vs. 39.6% = 83.14%. An % rate advantage (the deductible California tax rate). Now: 46.3% vs. 33%. 33.3% 46.3% = 72%. A 13.3% rate advantage (California tax no longer deductible). 1 No deduction for state and local taxes. 2 Both President Trump and the Republicans plan eliminate the A.M.T. 3 Can Congress have a transition period of several years in which the A.C.A. stays in existence, while it comes up with a replacement, in which it repeals the 3.8%? If so, that creates a huge hole in the deficit.

2 Page 2 of 33 Capital Gain. Before: Passive: 37.1 vs Nevada was 64% of California tax. Now: Materially Participating: 33.3 vs. 20. Nevada was 60% of California tax. Trump: 33.3% vs. 20%. Nevada will be 60% of California tax. III. GOP: 29.8% vs. 16.5%. Nevada will be 55.4% of California. CAPITAL GAINS TAX PLANNING Preliminary Which Rate Will Prevail? If you think the House rate will prevail, the argument to Pay The Tax And Pocket The Proceeds is stronger than ever as 29.8% is a great rate. If you believe that rate is unattainable, and the rate will be 33.3%, the same analysis applies in 2017 as in 2016: those with large capital gains will want to examine alternatives to paying all of the tax Timing. Timing: the most important element in all tax planning (and asset protection planning). Teaching the client the wisdom of owning nothing, controlling everything. Own Control. Make client comfortable the client can control the children s trust. Maintenance programs Statutory Wealthy real estate families don t do 1031s. IRS: gave up on drop and swap after: Bolker, 760 F2d 1039 (9 th 1985). Magneson, 753 F. 2d 1490 (9 th 1985). FSA : Although we disagree with the conclusion that a taxpayer that receives property subject to a prearranged agreement to immediately transfer the property `holds the property for investment, we are no longer pursuing this position in litigation. FTB Project: drop and swap and swap and drop. Rago Development Corporation, June 23, 2015 SBE upheld swap & drop: Taxpayers held property for 7 months before drop into LLC.

3 Page 3 of 33 Transfer to the LLC was the lender s requirement. See FTB Form 3840 attached (e). The best capital gains tax planning as it is on the face of the Code. See the attached diagram. Problem? Finding taxpayers more than 2 years in advance. Impact of Woelbing and Davidson audits. IRC 453A: $5,000,000 per seller limit. You must pay interest, at the underpayment rate (currently 4%), on the tax inherent in the installment notes A See the four pages comparing countries tax burdens. Mark to market exit tax borrowed from Canada. $699,000 for 2017 is the excluded gain. $164,000 is the average annual net income for the 5 preceding taxable years. $2,000,000 or more is the net worth test to be a covered individual. Security for deferred tax is only a bond or LC. Very restrictive. 30% withholding from a non-grantor trust. No more than 120 days per year to avoid the 7701(a) substantial presence test, but arguably no more than 30 days. Reed Amendment: Any alien who is a former [U.S.] citizen who officially renounces Citizenship and who the Attorney General [determines] to have renounced citizenship for the purpose of avoiding taxation is inadmissible. Gross income of a bona fide resident of the Virgin Islands does not include any amount included in gross income on that person s V.I. income tax return. 932(c)(4). This applies only if the V.I. resident reports all income from all sources on the V.I. return, identifies each item s source and pays the amount determined under 934 as V.I. income tax liability. See Publication 1321 about filing in Puerto Rico. Gross income of a bona fide resident of Puerto Rico, who is a resident for the entire taxable year, does not include income derived from sources within P.R. 933(1). Gross income of a U.S. citizen who has been a bona fide P.R. resident for a period of at least two years before the date on which the P.R. residency ends does not include income derived from sources with P.R. attributable to the period of P.R. residency. 933(2). Neither exclusion applies to amounts paid for services performed as a U.S. or agency employee. Doesn t work with encumbered real estate. Parents plus 3 children works: See diagram and calculations.

4 Page 4 of Others. V. CONCLUSION. On surviving parent s death there is inclusion. Most people simply don t buy life insurance. Doesn t work with a personal residence: must convert to TorB or investment. Doesn t work with S corporations Charitable LLC. See the Jay Adkisson Forbes article. See the diagram and comparative advantage. See IRS Form Sale of LP interests followed by a 754 election. Avoid the 2 year holding period requirement of 453(e). 2/9/06 IRS Redemption Bogus optional basis tax shelter announcement. 4/28/16 SBE s Khoury decision. Michael Hamersley, Esq. Rev. & Tax Code 19774: see attachment Sale to a technically unrelated, but friendly, third party. How does your Uncle come up with 10% down? Your Uncle needs to make a profit. Wait until statute of limitations runs to drop it into an LLC which you manage Use of partnership to move basis from one asset to another. $10,000,000 apartment building with $1,000,000 of basis. In a partnership. Parents have a frozen interest. Children have a zero basis common interest. Partnership buys raw land for $9,000,000 for the next deal. Two years later the partnership redeems out the children s trust Professional third parties. Deferred Sales Trust by Monetized Installment Sale. Stan Crow. See BNA item on January, 2016, ABA meeting in Los Angeles Nevada non-grantor trust. See the FTB Information Letter. See the diagram. There will always be an estate tax. See the final pages about SB 726.

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10 Page 10 of 33 bulgaria-27--corporate-taxes-in-bulgaria-are-just-10-the-same-as-the-maximum-possible-income-taxcharged-to-individuals-in-the-country-that-numbers-is-one-of-the-five-lowest-in-europe-1 The total amount of taxes is the sum of five different types of taxes and contributions payable after accounting for deductions and exemptions: profit or corporate income tax, social contributions, and labour taxes paid by the employer, property taxes, turnover taxes and other small taxes. 29. Bulgaria 27%. 28. Thailand 26.9%. 27. Denmark 26%. 26. Ireland 25.9% 25. Laos 25.8% 24. Botswana 25.3% 23. Mauritius 24.5% 22. Mongolia 24.4% 21. Bosnia/Herzegovina 23.3% 20. Cyprus 23.2% 19. Oman 23% 18. Hong Kong 22.8% 17. Montenegro 22.3% 15. Canada 21% 15. Cambodia 21% 14. Namibia 20.7% 13. Armenia 20.4% 12. Luxembourg 20.2% 11. Croatia 18.8% 10. Singapore 18.4% 9. Georgia 16.4% 7. UAE 14.8% 7. Zambia 14.8% 6. Saudi Arabia 14.5% 5. Lesotho 13.6% 4. Bahrain 13.5% 3. Kuwait 12.8% 2. Qatar 11.3% 1. Macedonia 7.4%

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25 Page 25 of 33 California Revenue & Taxation Code (a) If a taxpayer has a noneconomic substance transaction [ NEST ] understatement for any taxable year, there shall be added to the tax an amount equal to 40% of the amount of that understatement. (b) (1) Subdivision (a) shall be applied by substituting 20% for 40% as to the portion of any NEST understatement as to which the relevant facts affecting the tax treatment of the item are adequately disclosed in the return or a statement attached to the return. (c) For purposes of this section: (1) The term NEST understatement means any amount which would be an understatement under IRC 6662A(b), as modified by (b) if IRC 6662A(b) were applied by taking into account items attributable to NESTs rather than items to which 6662A(b) applies. (2) A NEST includes: (A) The disallowance of any loss, deduction or credit, or addition to income attributable to a determination that the disallowance or addition is attributable to a transaction or arrangement that lacks economic substance including a transaction or arrangement in which an entity is disregarded as lacking economic substance. A transaction shall be treated as lacking economic substance if the taxpayer does not have a valid nontax California business purpose for entering into the transaction. (B) Any disallowance of claimed tax benefits due to a transaction lacking economic substance, within the meaning of IRC 7701(o) relating to clarification of economic substance doctrine except as otherwise provided. (i) For purposes of this subparagraph, the phrase apart from state income tax effects shall be substituted for the phrase apart from Federal income tax effects in each place it appears in IRC 7701(o)(1). (ii) For purposes of this subparagraph, the phrase any federal or local income tax effect which is related to a state income tax effect shall be treated in the same manner as a state income tax effect is substituted for the phrase any State or local income tax effect which is related to a Federal income tax effect shall be treated in the same manner as a Federal income tax effect in IRC 7701(o)(3).

26 Page 26 of 33 (d) (1) If the notice of proposed assessment of additional tax has been sent as to a penalty to which this section applies, only the FTB Chief Counsel may compromise all or any portion of that penalty. (2) The exercise of authority under paragraph (1) shall be at the FTB Chief Counsel s sole discretion and may not be delegated. (3) Despite any other law or rule of law, any determination under this subdivision may not be reviewed in any administrative or judicial proceeding [??!!]. (e) Despite anything to the contrary in this section, if a penalty has been assessed for federal income tax purposes pursuant to IRC Section 6662(b)(6) on an underpayment attributable to the disallowance of claimed tax benefits due to a transaction lacking economic substance, then a penalty shall be imposed under this section for that portion of an understatement attributable to that transaction, and shall not be abated unless the taxpayer can establish that the imposition of the federal penalty under IRC 6662 was clearly erroneous.

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