WHAT TO EXPECT AFTER THE UNEXPECTED? PLANNING NOW FOR PROBABLE AND POSSIBLE TRUMP TAX LAW CHANGES

Transcription

1 WHAT TO EXPECT AFTER THE UNEXPECTED? PLANNING NOW FOR PROBABLE AND POSSIBLE TRUMP TAX LAW CHANGES Wednesday, December 14 th, 2016 Florida Bar PRESENTED BY: ALAN S. GASSMAN KENNETH J. CROTTY CHRISTOPHER J. DENICOLO BRANDON KETRON GASSMAN, CROTTY & DENICOLO, P.A. & JAMES H. BARRETT BAKER & MCKENZIE, LLP

2 It s tough to make predictions, especially about the future. --- Yogi Berra Those who cannot remember the past are condemned to repeat it. --- George Santayana If you re not confused, you re not paying attention. --- Tom Peters 2

3 INTRODUCTION Tax legislation normally occurs in September through November, to be effective the following year. Its is possible for tax legislation to occur earlier in the year, and to be retroactive. There are four (4) primary taxes for discussion Federal Income Tax Present highest rate reaches 39.6% at $415,051 for a single person and $466,951 for married filing jointly. The 3.8% Net Investment Income Tax (Medicare Tax) for most income exceeding $200,000 if single and $250,000 if married filing jointly. S-corporation dividends are not subject to this tax. FICA Taxes Social Security Taxes - 6.2% for the employer and 6.2% for the employee (12.4% total) on up to $118,500 of wages. Medicare Taxes % for the employer and 1.45% for the employee (2.9% total). An additional Medicare tax of 0.9% applies on wages in excess of $200,000 for single filers and $250,000 if married filing jointly. Federal estate tax on assets exceeding $5,450,000 per spouse goes to $5,490,000 next year. Also applies to lifetime gifts that cumulatively exceed the above. 3

4 INTRODUCTION The middle class supporters of President Trump are most concerned with the income taxes that apply to them, and the Medicare wage tax, which is 1.45% unless wages exceed $200,000 for single filers or $250,000 for married filing jointly. They are less concerned with the 3.8% Net Investment Income Tax (Medicare tax) and with the federal estate tax. An early move to repeal federal estate tax may cause Trump opposition to claim that he is really doing this primarily for himself and his billionaire friends. All tax reduction will likely be significantly delayed by filibuster unless or until sufficient Democrats are brought onboard by some sort of compromise so that there are 60 of the 100 Senators in agreement. Under the Byrd Rule, unless 60 of 100 Senators agree with changes related to the budget, then such changes will sunset in ten years, similar to what occurred with the Bush Tax Cuts in

5 INTRODUCTION If President Trump spends his political capital on building the wall, dismantling Obamacare, trade agreements, and other hot button items, how much capital will he have left for reducing taxes on the wealthy? Based upon the appointment process, President Trump appears to be spending political capital on those who supported him in the primaries and general election, to the consternation of those who were hoping for a balanced administration, according to many. One question is whether families should engage in estate tax planning while they can, wait to see what happens, or do nothing. Where planning is not expensive or intrusive, and can be reversed if not needed, the safest answer seems to be to assume that things will be business as usual if and when clients now have the opportunity to capitalize on expected transactions and situations that will cause significant estate tax if not properly handled. 5

6 GOOD REASONS TO CONTINUE/ACCELERATE ESTATE TAX PLANNING 1. The tax may not go away a compromise might be to increase the exemption and allow the 2704(b) regulations to be promulgated. 2. If the estate tax goes away, it may come back later with sharper teeth. What is done now and commonly acceptable may be grandfathered, such as the ability to fund an irrevocable trust in an APT jurisdiction that could later benefit the grantor. We doubt that the Bernie Sanders camp will allow this type of planning in the future, if they take power in The economy seems poised to ramp forward with exploding values for many clients are we going to leave these exposed to an unpredictable inheritance tax system? 4. Where estate tax planning is consistent with asset protection planning, this dynamic duo should be linked together, so that there is a solid business reason for establishing and funding APT trusts. If the client is convinced that the estate tax will be gone, why not use up what remains of the $5,490,000 exemption to fund an APT that would likely be grandfathered if the estate tax goes away and comes back with sharper teeth, and can protect assets from potential creditors. 5. Asset protection trusts for assets that would exceed the amount that can be funded without gift tax implications are typically structured now as incomplete gifts, which requires the grantor to retain the right to prevent distributions to those other than the grantor, and to direct how the trust assets pass by limited power of appointment according to CCA Being able to place unlimited assets into creditor protection trusts that will not have these requirements will be of great benefit to clients who wish to establish these trusts where there are truly independent fiduciaries. The debate will continue as to whether it is best to establish these trusts in domestic versus foreign jurisdictions. 6. Repurposing discount entities to become creditor protected family wealth preservation entities may be useful as discounting becomes less important and family unity and creditor protection become more important. 6

7 GOOD REASONS TO CONTINUE/ACCELERATE ESTATE TAX PLANNING 7. The APT GRAT is probably today s gold standard mechanism for estate tax planning with large estates. It may be reversible by Trust Protectors and there is zero risk of gift tax exposure. See Shenkman & Blattmachr Estate Tax Repeal is Not a Temporary or Permanent Certainity: How to Plan Now, Interactive Legal presentation Looking ahead towards basis planning. Under the Canadian system, only assets passing directly to a surviving spouse are immune from capital gains tax on death. It is possible that QTIP and general power of appointment marital deduction devices will qualify to delay capital gains on death if we end up with this regime. 9. Second marriage situations that have favored QTIP trusts for deferral/avoidance of federal estate tax will be retooled significantly if the estate tax is eliminated or exemptions are dramatically increased marked the 100 Year Anniversary of the modern estate tax, and planners should not overreact to one paragraph in a proposed tax plan on a President-Elect s campaign website. 7

8 GOOD REASONS TO CONTINUE/ACCELERATE ESTATE TAX PLANNING 11. Dismantling and rearrangement of now existing plans is very likely for a material portion of affluent families who will reposition to take many of the factors discussed today into account. 12. It is easiest to have the middle class accept a gradual phased-in estate tax elimination program which may be legislated away after four years. For example, estate tax repeal was scheduled to be phased in over ten years under the Bush Tax Cuts, but was reinstated permanently in

9 GOOD REASONS TO CONTINUE/ACCELERATE ESTATE TAX PLANNING 9

10 WHAT TO EXPECT AFTER THE UNEXPECTED There will almost certainly be changes to the income tax rates, and to the corporate tax rates. When will this all happen? Will they compromise with enough Democrats to overcome filibuster? Budget reconciliation can be forced through with only a majority (as Obama did with the Affordable Care Act and Bush did in prior bills) will we have more ten year sunsetting legislation as a result? 10

11 WILL THE CHANGES APPLY FOR THE 2017 TAX YEAR? With the exception of a few provisions, the majority of The Tax Reform Act of 1986, which was signed by Ronald Reagan on October 22, 1986, was made effective for taxable years beginning after December 31, While the majority of the provisions of the Bush Tax Cuts of 2001 and 2003 were designed to be phased in over time, certain cuts took effect for year in which the bill was signed. It is possible that Trump s tax plan could be enacted and effective for the 2017 tax year, but time will tell what Congress can get done in

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15 SAY GOODBYE TO THE NEWLY PROPOSED 2704 TREASURY REGULATIONS REGARDING BUSINESS/ENTITY VALUATION Section (expansion and clarification of definition of controlled entity, not the most groundbreaking change) Section (lapse of certain rights, includes 3 yr rule) Section (transfers subject to applicable restrictions) Section (transfers subject to disregarded restrictions the most controversial and confusing) all the others are amendments, this one is completely new Section (effective date) Forget them! It is a near certainty these will never see the light of day now. Strongly reconsider any substantial gifts of entities that have been planned to be completed prior to these regs coming online. 15

16 TRUMP ON INDIVIDUAL INCOME TAX REFORM Trump proposes to reduce the top tax rate and establish three tax brackets with rates of 12%, 25% and 33%. This proposal calls for married couples filing a joint return to pay 33% on their taxable income in excess of $225,000, and unmarried individuals to pay 33% on their taxable income in excess of $112,500. Itemized deductions would be limited to $200,000 for married couples filing a joint return, and $100,000 for unmarried individuals. The 3.8% Medicare Net Investment Income surtax on AGI over $250,000 would be eliminated. This appears to be entirely deficit funded, with no explanation of revenue offset. 16

17 TRUMP ON INDIVIDUAL INCOME TAX REFORM Trump has proposed to tax compensation received from carried interest as ordinary income to close the carried interest loophole. This would increase the rate from 23.8% to 33% under Trump s proposed tax plan. Carried interest is a contractual right given to a general partner that is typically received in exchange for a commitment to provide investment management services to a private equity funds, and entitles the general partner/investment manager to a share in the fund s profits. The general partner/investment manager will receive a portion of the fund s profits if the fund meets certain performance goals, and is typically a majority of the compensation received by the investment manager. Amounts received from carried interest rights are treated as capital gains subject to the additional 3.8% Net Investment Income Tax resulting in a total tax of 23.8%. This results in the majority of hedge fund and private equity managers being taxed at significantly lower tax rate than other highly compensated individuals paying taxes at the highest individual rate of 39.6%. For further discussion on carried interest see: 17

18 TRUMP ON ESTATE AND GIFT TAX REFORM Trump (along with majority of Republicans in Congress) proposes to eliminate the estate and generation skipping transfer tax. Note that most Republican proposals on estate tax keep the gift tax intact to avoid gaming the income tax system through unlimited tax free gifts. Trump has not mentioned any difference here. However, Trump has proposed a new regime based upon the following paragraph from Trump s website: The Trump Plan will repeal the death tax, but capital gains held until death and valued over $10 million will be subject to tax, to exempt small businesses and family farms. To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent s relatives will be disallowed. Note that the above quoted language is the only discussion on Trump s website regarding the estate tax. Thus, it is unclear as to what the final form of his estate tax proposal would look like, whether such tax changes would be phased in over a period of time or come into effect as of a particular date, and whether the current estate tax regime (or a harsher system) might come back at some point in the future. It is also unclear whether assets in excess of $10,000,000 would be subject to capital gains tax at death or would be subject to carry-over basis treatment. 18

19 TRUMP ON CORPORATE INCOME TAX REFORM Trump proposes to reduce the top tax rate applicable to C corporations from 35% to 15%, and to eliminate most corporate tax expenditure deductions except for the R&D credit. Repatriation of corporate profits held overseas (over $2 trillion) at low tax rates (perhaps up to 10%, perhaps lower) is now highly likely. Firms engaged in manufacturing in the US may elect to expense capital investment and lose the deductibility of corporate interest expense. Could this lead to less bank borrowing by corporations? Both parties have proposed and agreed in principal for years on lowering the corporate tax rate and closing loopholes but historically they can t agree on which ones, and whether the changes should be revenue neutral (Democrats) or be deficit funded (favored by Republicans). 19

20 HOW A TAX BILL BECOMES LAW 20

21 House and Senate Tax Proposals In June, Republicans in the House of Representatives released their Tax Reform Blueprint. The proposal would eliminate the estate and gift taxes. It would also raise the standard deduction for individual income taxes, which would reduce the number of taxpayers itemizing their deductions from 33% to 5%. The proposal would also eliminate all itemized deductions other than for mortgage interest and charitable contributions. 21

22 GOP TAX REFORM BLUEPRINT INDIVIDUAL INCOME TAX REFORM 22

23 GOP TAX REFORM BLUEPRINT INDIVIDUAL INCOME TAX REFORM The GOP proposals would eliminate the Alternative Minimum Tax (AMT), cap business income tax at 25%, top long-term capital gains tax rate at 16.5%; eliminate domestic production activity deduction. Simplify the multiple education credits/deductions Increase Standard Deduction to $24,000 for Married Filing Joint, $18,000 for single parents, and $12,000 for single individuals Eliminate all itemized deductions except for the mortgage interest deduction and the charitable contribution deduction. The proposed elimination will result in the loss of deductions for medical expenses, state and local taxes, investment interest, casualty and theft losses, gambling losses, and other miscellaneous deductions. Propose consumption tax similar to European VAT. 23

24 SHOULD I STILL MAKE AN S-CORP ELECTION? 24

25 GOP TAX REFORM BLUEPRINT ESTATE AND GIFT TAX REFORM Similar to Trump s proposal, the below quoted language is all we have for the GOP Blueprint: Under current law, the estate tax applies under specified circumstances to transfers of wealth when a person dies. An additional tax may apply to generation-skipping transfers, which generally involve a person making a gift that skips one or more generations - for example a gift from a grandfather to a grandchild or great grandchild. This Blueprint will repeal the estate and generation-skipping transfer taxes. This will eliminate the Death Tax, which can result in double, and potentially even triple, taxation on small businesses and family farms. 25

26 GOP TAX REFORM BLUEPRINT CORPORATE TAX REFORM Flat Corporate Tax Rate of 20% Allow full expensing of both tangible and intangible assets in the year of purchase (i.e. unlimited 179 deduction) Interest expense can only be deducted against interest income, and any non-deductible amount may be carried forward to offset future interest income. Net Operating Losses (NOLs) can be carried forward indefinitely and will be increased by an interest factor, however any NOL carry forwards can only offset 90% of taxable income in future years. No Carrybacks of NOLs will be allowed. Continue to provide R&D credit to incentivize innovation. 8.75% Repatriation tax on cash and cash equivalents held overseas, and a 3.5% tax on other assets held overseas, and can elect to pay the resulting tax liability over a period of eight (8) years. 26

27 SENATE FINANCE COMMITTEE PROPOSALS RESA WOULD KILL THE STRETCH IRA This fall, the Senate Finance Committee UNANIMOUSLY (full bipartisan support) approved the Retirement Enhancement and Savings Act of 2016 ( RESA ). RESA would change the post death RMD (Required Minimum Distribution) rules to generally require that all distributions after death (regardless of whether to a designated beneficiary ) be made by the end of the fifth calendar year following the year of death. Exceptions would be made for a surviving spouse, disabled, or chronically ill, or an individual who is not more than 10 years younger than the decedent, or is a child who has not reached the age of majority. In addition, RESA would provide that the new 5 year distribution requirement only applies to the extent that the amount of an individual s aggregate account balances under all IRAs and defined contributions plans, determined as of the date of death, exceeds $450,000 (indexed for inflation) 27

28 SENATE FINANCE COMMITTEE PROPOSALS RESA WOULD KILL THE STRETCH IRA If passed, there will need to be consideration of different drafting solutions for adapting conduit trusts v. accumulation trusts, which are dependent on whether the owner/settlor s goals lean towards asset protection or income tax avoidance. Also whether disabled, minor or similar age beneficiaries are named (who would be exceptions). Some conduit trusts/trusteed IRAs may stay the same, with owners wanting to avoid highly compressed trust tax brackets causing much higher income tax on IRA distributions, while others may move to an accumulation trust. Others might simply scrap the idea of using a stretch trust because of the relatively minimal benefits afforded in light of the 5-year rule s broader application. 28

29 SENATE FINANCE COMMITTEE PROPOSALS RESA WOULD KILL THE STRETCH IRA Accumulation trusts should be changed depending on goals, perhaps moving to a modified conduit arrangement whereby payments to avoid higher trust income tax rates are encouraged. Because we can throw out inane designated beneficiary rules, we can now add power of appointment or other provisions to enable the spraying of income to lower bracket beneficiaries, older beneficiaries or charities without destroying any stretch tax deferral benefit. Because we can throw out inane designated beneficiary rules, we can now add power of appointment or other provisions to enable the spraying of income to lower bracket beneficiaries, older beneficiaries or charities without destroying any stretch tax deferral benefit. Moreover, we can use the accumulation trust rules against the IRS by naming a contingent beneficiary no more than ten years younger as a potential beneficiary. For example, John, age 60, names his children and grandchildren as beneficiary in a dynasty trust, with his 55 year old younger sister as a contingent beneficiary the stretch is preserved based on the 55 year old s life expectancy. In contrast to outright beneficiary designations that currently offer the same tax benefit over using a trust, a trust would now offer much superior stretch deferral! 29

30 EFFECT OF TRUMP & GOP BLUEPRINT PROPOSALS Such proposals may simplify taxation, but also reduce incentives for domestic production rather than import (Section 199 domestic production activities deduction would be eliminated), and reduce or potentially eliminate the use of IC DISCs for export, and the tax incentives for captive insurance companies, since the tax rate delta would be much smaller, hence less savings through using more complicated structures and deductions. A U.S. consumption tax (favored by House, but without any specific endorsement or backing by Trump) might favor the wealthy simply consuming more abroad. A broad, complicated additional tax system could be unwise, could lead to more spending, and may face significant opposition from some Republicans as well as Democrats. 30

31 TRUMP & GOP BLUEPRINT PROPOSALS EFFECT ON FINANCIAL PLANNING The House is not going to get everything it wants, without Senate and Presidential approval, but it is a starting point for negotiation. Lowering rates and adding a consumption tax (like a sales tax, similar to European value added tax) would change a lot of financial planning dynamics : Buy muni bonds v. taxable corporate bonds (analysis which relies on tax rates)? Will long term municipal bonds tank in value accordingly? Conversion of Roth IRAs may be a foolish bet at this point, and taxpayers may want to recharacterize any recently converted Roth IRAs, since tax rates could well be lower in future years. A Roth IRA conversion that occurred in 2016 can be rescinded until as late as October 2017, which is the deadline to file 2016 income tax returns, including extensions. Similarly, if only 5% of taxpayers would itemize, reducing the importance of mortgage interest deduction, this would clearly affect how fast you may pay off your mortgage. 31

32 TRUMP & GOP BLUEPRINT PROPOSALS EFFECT ON TAX PLANNING Clients will want to defer income into future years, as it is a strong possibility that rates will drop in the future. On the other hand, Clients will want to accelerate as many deductions as possible this year. Client should consider postponing the sale of stock or businesses until 2017 to take advantage of a potential capital gains rate decrease in

33 TRUMP & GOP PROPOSALS EFFECT ON ESTATE/TAX PLANNING If there is no estate tax, but 100% step up in basis for businesses and farms up to $10,000,000, as Trump has proposed, this basically gives the super- wealthy less incentive to hold onto assets until death for a step up in basis, since there would be none forthcoming (beyond $10,000,000). Of course, it gives estate planners the opportunity to shoehorn more or all of a family s assets into the small business category that would be granted a 100% step up. It would encourage business owners and farmers to hold onto assets until death for the step up, potentially affecting business succession and delaying transition to the next generation. It is not clear whether Trump s proposal will provide for a carryover basis regime or for a capital gains tax to be assessed on death with respect to assets in excess of $10,000,000. Further, it is not clear whether the gift tax would be repealed along with the estate tax if Trump s proposal comes to fruition as law. Remember, there are no firm or concrete proposals for this, only one paragraph from Trump s website, and no House/Senate bills pending on this point, so it is not a given that the above proposal will be enacted. 33

34 TRUMP & GOP BLUEPRINT PROPOSALS EFFECT ON CURRENT GIFTING PLANS Any large substantial gifts, perhaps planned to avoid implications of the proposed 2704 regulations, should be reevaluated, but not necessarily cancelled state tax law and non tax reasons will also inform the decision of whether to continue or not. For many of our clients who have life expectancies that go beyond the next several years, there is always the possibility that whatever changes are made during the Trump administration could be undone, and that the estate tax could come back and be harsher than it currently is. Gifting is NOT, however, a no harm, no foul situation using up gift tax exclusion may create a situation where it is difficult, impossible or costly to undo, but you just lost an important step-up in basis benefit for no corresponding estate tax savings. State estate/inheritance tax avoidance (depending on the state) skews the analysis towards exploiting completed gift planning, since advantages may accrue aside from any federal estate tax. While we have no firm proposal, this may be more important for true operating businesses and farms, as noted by the exceptions in the Trump tax proposal website. We could have a mark to market tax at death for all but businesses and farms, up to $10 million or some number, which would still give donors income tax incentives to gift non farm/business property prior to death. 34

35 POTENTIAL PLANNING TECHNIQUES AND STRUCTURES 35

36 FOUR TECHNIQUES THAT HELP AVOID DONOR S REMORSE : Enable the trustee to make a qualified disclaimer of assets pursuant to 2518, so assets can revert back to settlor to undo a transaction. Make sure the donative instrument (aka deed of gift) and state law are clear of the result and remember the doctrine of acceptance and control that negates the ability to disclaim. This only gives the family a nine month window of opportunity though. If the settlor is married (and there is no divorce likelihood!), enable the trustee to make an inter vivos QTIP election over the trust. If the election is made within 9 months, or 15 months with timely filed extension, this enables the gift to use the marital deduction, and the QTIP could thereafter be terminated and assets distributed to spouse no gift tax exclusion used, and no worry that trustee acceptance disqualifies the technique. Like Clayton QTIPs, best to have someone other than spouse as trustee. Like a DE, AL, NV, OH, etc., DAPT that enables settlor to remain or be added as a beneficiary. However, this may still use gift tax exclusion, unless the gift is an incomplete gift based upon the trust providing for the settlor to retain powers under the trust incompliance with CCA Use and exploit swap powers in irrevocable grantor trusts to anticipate possible swapping of assets should tax changes come about favoring family business/farms. Enable trust protectors and/or lifetime limited powers of appointment to radically change the trust. 36

37 WHAT DO WE TELL CLIENTS TO DO BEFORE YEAR END? 1. Consider the possibility of transferring assets to a trust established in an asset protection jurisdiction (such as Nevada) and allowing the trust protectors can add the Grantor as a permissible beneficiary. 2. Consider the use of GRATs and disregarded Grantor Trusts, which may also not be around in their present form after It would be extremely beneficial for the client to establish and fund a Grantor Trust in 2016 (even if only with nominal assets) in the event that future legislation abrogates the use of un-grandfathered Grantor Trusts. 3. Use Trust Protectors in all irrevocable structures to provide flexibility in the event of future law changes. 4. Make your hard decisions about whether the client is financially comfortable placing assets permanently outside of his or her use and benefit or whether a trust with discretionary benefits for the Grantor should be established in a creditor protection jurisdiction and possibly modified a few years up the road when more information is available. 5. Use formula transfer clauses or formula remainder to charity clauses both in transfer documents and in trust agreements as and when possible before these are legislated out of existence. 6. Installment sales using low interest notes could be the play of the century where a grandfathered Grantor Trust is involved. Consider using a Self-Cancelling Installment Note (SCIN) where the client s actual life expectancy is likely shorter than his or her life expectancy under the IRS tables, or where the client s desired cash flow is greater than what he or she would receive under a traditional installment sale. Interest rates are currently at historically low levels. 7. Year end planning. Prior practices that involve paying as much in expenses as possible and delaying the active collection of accounts receivable will be beneficial due to the potential of decreased tax rates in If the Estate Tax goes away, then there is time to concentrate on things like: A. Fine-tuning inheritance planning B. Elective share planning. C. Homestead planning D. Trying to make children self-sufficient E. Creditor Protection Planning 37

38 WHAT DO WE TELL CLIENTS TO DO BEFORE YEAR END? 9. Defer income to next year. 10. Accelerate expenses to the extent you can. 11. Defer buying capital assets to the extent not deductible under Section Trigger large net operating losses that can be carried back. 13. Take all itemized deductions that you can this year. 14. Accelerate charitable contributions in the most effective manner. 15. Consider making an S election and make proper minutes to declare bonuses to eliminate unrecognized built in gain before year end. 16. Leave foreign profits offshore. 17. Complete gifting to trusts if in progress, but consider using a clone APT Trust. 18. Expect the unexpected. 19. Don t panic. 38

39 FACILITATE HAVING CREDIT SHELTER TRUST LANGUAGE BE FLEXIBLE TO ALLOW TRUST ASSETS TO BE INCLUDABLE IN THE ESTATE OF THE SURVIVING SPOUSE TO GET AN INCOME TAX BASIS STEP-UP. CHOICE ADVANTAGES DISADVANTAGES 1. Outright Marital Devise with 1.Easy to 1.In some states this may expose assets to Disclaimer to Credit Shelter Trust understand and creditors of the surviving spouse if the Permitted. In lieu of a devise to a insert into present creditors exist when the first dying spouse Credit Shelter Trust, everything is and future trust passes. devised outright to the surviving documents. 2. Surviving spouse loses his or her power to spouse, with the spouse having the 2. Would be simple appoint how trust assets in the Trust pass on his ability to disclaim all or a portion of to administer. or her subsequent death (to the extent of the these assets into the Credit Shelter 3.Allows the assets disclaimed into the Trust). Trust. surviving spouse to 3.The surviving spouse may be trustee only if decide which assets his or her ability to distribute the trust assets is he or she will own limited by an ascertainable standard. outright and which assets will be held in trust for his or her benefit. 39

40 CREDIT SHELTER TRUST ALTERNATIVES FOR CLIENTS WHO WANT FLEXIBILITY IN THEIR PLANNING Alternative #1 Outright Marital Devise with Disclaimer to Credit Shelter Trust Permitted. Under this strategy, the first dying spouse s trust can provide for an outright devise to the surviving spouse, and to the extent that the outright devise is disclaimed by the surviving spouse, the trust assets would pass to a Disclaimer Shelter Trust. The Disclaimer Shelter Trust is essentially a Credit Shelter Trust that would not be subject to federal estate tax on the surviving spouse s subsequent death. This technique is described in great detail in BNA portfolio 800-2nd, at Section XII.C.1. The disclaimed assets would then be subject to a probate, and under a typical estate plan would pour over into the Credit Shelter Trust established on the death of the deceased spouse. In addition to disclaiming outright devises, the surviving spouse may be able to disclaim one-half or more of any assets that were jointly owned with the deceased spouse. Life insurance benefits can work the same way, if the spouse is the named beneficiary and the estate of the decedent or the Credit Shelter Trust is the alternate beneficiary. IRA benefits can also work this way, if the spouse is the named beneficiary and the Credit Shelter Trust is the alternate beneficiary, but the minimum distribution rules under Internal Revenue Code Section 409 and applicable Treasury Regulations must be taken into account in determining whether Credit Shelter Trust funding is more important than delaying distributions until the year after the surviving spouse reaches the age 70 1/2. The stretch trust techniques that can be used for Credit Shelter Trusts may become more important for clients who would have otherwise had sufficient assets to fund a Credit Shelter Trust with non-ira assets before the exclusion went up to $5,000,

41 Methods of Providing a Stepped-Up Basis on the Surviving Spouse s Death for Assets That Would Typically Be Held Under a Credit Shelter Trust to Avoid Estate Tax CHOICE ADVANTAGES DISADVANTAGES 2. Special Trustees May Cause Credit 1. Easy to 1. Giving the surviving spouse outright Shelter Trust Assets to be Transferred understand and ownership of assets can be unwise from a to Surviving Spouse. An independent insert into present creditor protection, spendthrift, remarriage advisor or committee will have the and future trust and undue influence standpoint, and this could power to cause Credit Shelter Trust documents. result in many fortunes being lost. assets to be devised directly to the 2. Would be simple 2. Would cause the distributed assets to be surviving spouse to get a stepped up to administer. included in the estate of the surviving spouse, basis on his or her death. which could be problematic if estate tax repeal is not applicable at that time. 3. What fiduciary duties are involved with monitoring health and circumstances to know if and when to activate this? 41

42 CREDIT SHELTER TRUST ALTERNATIVES FOR CLIENTS WHO WANT FLEXIBILITY IN THEIR PLANNING Alternative #2 Having Special Trustees Who Can Later Cause Credit Shelter Trust Assets to be Transferred to Surviving Spouse. As described in the above chart, this strategy is a relatively simple solution to providing flexibility with respect to the decision of whether to fund a Credit Shelter Trust or to use portability on the death of the first dying spouse. Language can be added to clients revocable trusts to provide this flexibility on the death of the first dying spouse, and can also allow the Trustee or Trust Protectors to bestow a general power of appointment on the surviving spouse to provide for greater flexibility. Sample language is as follows: In order to provide for possible future tax planning under the XYZ Credit Shelter Trust, if and when formed and funded, I hereby appoint, and as Distribution Advisors, and, by majority vote of them, any assets held under said Family Trust may be distributed to or for my said spouse, regardless of need, provided that I request that her interests and the interests of our decedents be carefully considered before any such distribution is made. Such transfer may be outright to my spouse, or into a separate trust created by the Distribution Advisors which would be identical to this trust, but may provide my spouse with a testamentary power of appointment exercisable in favor of creditors of my spouse s estate, which I am advised may be beneficial from a tax planning standpoint. Further, said Distribution Advisors shall have the power to provide for my spouse to have a Power of Appointment over all or a portion of the assets of the XYZ Credit Shelter Trust, exercisable in favor of the creditors of my spouse s estate, if they deem this to be appropriate after receiving written advice from a lawyer who is Board Certified in Estate Planning or Taxation. If a majority of, and are unable to act, then the party that would appoint Trustees in the event of a vacancy in the office of Trustee under Section of this Trust Agreement shall appoint one or more of a duly licensed lawyer that is Board Certified by the Bar in Wills, Trusts & Estates, a CPA who has done work for our family for at least 15 years, or a Licensed Trust Company to serve as Distribution Advisors. Notwithstanding the previous sentence, in no event can any person or entity be appointed if such person or entity is considered as a related or subordinate party with respect to me or to my said spouse as such term is defined under Internal Revenue Code Section 672(c). 42

43 Methods of Providing a Stepped-Up Basis on the Surviving Spouse s Death for Assets That Would Typically Be Held Under a Credit Shelter Trust to Avoid Estate Tax CHOICE ADVANTAGE DISADVANTAGES 3. Clayton QTIP Arrangement. An 1. Works well if the 1. Not easy to explain this Clayton QTIP independent committee is given the family is best off system to clients. power to cause the Credit Shelter Trust taking the marital 2. May require slightly more complicated to be a QTIP trust (a Clayton QTIP ) deduction on the drafting than a simple payment enablement so that it will be subject to federal first death, and clause as described in Choice 2. estate tax on the surviving spouse s expects to have 3. Would cause the QTIP assets to be included death without having to transfer the portability apply to in the estate of the surviving spouse, which assets outright to the surviving spouse. eliminate estate tax could be problematic if estate tax repeal is on the second not applicable at that time. death. 43

44 CREDIT SHELTER TRUST ALTERNATIVES FOR CLIENTS WHO WANT FLEXIBILITY IN THEIR PLANNING Alternative #3 Clayton QTIP Arrangement. Under prior estate tax law, the IRS would not permit a QTIP trust to qualify for the federal estate tax marital deduction if the personal representative of the decedent s estate (or the Trustee of the decedent s revocable trust) had the power to determine whether the trust would meet all of the requirements of the marital deduction. These requirements, which are unchanged by the new estate tax law, are basically that all income must be payable to the surviving spouse, that the surviving spouse be the sole lifetime beneficiary of the trust, and that the surviving spouse have the power to make the trust assets productive. After much litigation, the IRS issued Treasury Regulations Section (b)-7(d)(3)(i) which explicitly says that a trust is not required to meet the marital deduction requirements above, except as to any portion that is to actually qualify for the marital deduction by the QTIP election filed on the first dying spouse s estate tax return. It is prudent that the surviving spouse not be appointed as the personal representative or Trustee who makes the QTIP election. This is because the power of appointment rules under Sections 2041 and 2514 may cause the value of the assets in the non-qtip portion of the trust to be included in the spouse s gross estate upon his or her subsequent death, or the spouse may be deemed to have made a gift to the extent that assets are not used to fund a QTIP trust. 44

45 CREDIT SHELTER TRUST ALTERNATIVES FOR CLIENTS WHO WANT FLEXIBILITY IN THEIR PLANNING Alternative #3 Clayton QTIP Arrangement Continued. The following is potential language to amend a client s revocable trust to allow a Credit Shelter Trust to become a Clayton QTIP with outright disposition rights, in the instance that the family elects to use portability. I hereby appoint, and as Independent Fiduciaries for the purpose of allowing them to determine whether there should be an alteration of the CLIENT Credit Shelter Trust established under Section 4.02(d) of this Trust Agreement whereby some or all of such assets may be held as a QTIP Marital Deduction Trust, as separate QTIP Marital Deduction Trusts, and/or paid, in whole or in part, outright to my spouse for income and estate tax planning purposes in view of the new estate tax law. In order to facilitate this, said Independent Fiduciaries shall have the power on a timely filed federal estate tax return filed with respect to my estate, to designate that all or a portion of the CLIENT Credit Shelter Trust shall qualify as a Qualified Terminal Interest Property Trust under Internal Revenue Code Section 2056(b)(7) in which case such Trust shall meet the following requirements, and shall be construed to have the following provisions effective upon my death: (a) the Trustee shall pay all income to my spouse beginning upon my date of death, no less frequently than annually; (b) the Trust assets shall be used solely for my spouse during said spouse s lifetime, with any and all distributions to be made solely to said spouse; and (c) the Trustee shall be required to keep the Trust assets under such Trust productive, provided that such requirements shall not apply except to the extent that my Personal Representative, upon the written instructions from the majority of the Independent Fiduciaries, elects for such Trust to qualify for the federal estate tax marital deduction by making a Clayton QTIP Election pursuant to Internal Revenue Code Section 2056 and Treasury Regulation (b)-7)(d)(3)(i). In addition, if determined appropriate by the Independent Fiduciaries, the Trust assets may be paid in whole or in part outright to my said spouse. If a majority of, and are unable to act, then the party that would appoint Trustees in the event of a vacancy in the office of Trustee under Section of this Trust Agreement shall appoint one or more of a duly licensed lawyer that is Board Certified by the Florida Bar in Wills, Trusts & Estates, a CPA who has done work for our family for at least 15 years, and/or a Licensed Trust Company to serve as Independent Fiduciaries, provided that at all times there shall be at least two individuals or a Licensed Trust Company serving as Independent Fiduciaries. Notwithstanding the previous sentence, in no event can any person or entity be appointed if such person or entity is considered as a related or subordinate party with respect to me or to my said spouse as such term is defined under Internal Revenue Code Section 672(c). 45

46 Methods of Providing a Stepped-Up Basis on the Surviving Spouse s Death for Assets That Would Typically Be Held Under a Credit Shelter Trust to Avoid Estate Tax CHOICE ADVANTAGE DISADVANTAGES 4. Committee to Provide a Power of 1. Allows for 1.Not easy to explain this Choice to clients. Appointment. Allow a committee or continued protection 2. Uncertainty as to whether the law will allow independent advisor to give the of assets. this strategy without causing inclusion of all of surviving spouse a power of the Trust assets in the surviving spouse s gross appointment all or a portion of the estate if estate tax repeal is not applicable. assets in the Credit Shelter Trust to 3. The individuals or institutions appointed to creditors of his or her estate, or a provide the power of appointment should not broader appointment power only be permitted beneficiaries of the trust and exercisable with consent of appointed nonadverse parties. should not be able to grant any power of appointment to themselves. The surviving spouse should not need the consent of the committee to exercise the power or the power may be deemed illusory. 46

47 CREDIT SHELTER TRUST ALTERNATIVES FOR CLIENTS WHO WANT FLEXIBILITY IN THEIR PLANNING Alternative #4 Committee to Provide a Power of Appointment. The authors are concerned that if assets are distributed outright, surviving spouses will not be as well protected as if they had funded a Credit Shelter Trust to benefit the surviving spouse for his or her lifetime. Asking someone who has just lost his or her lifelong spouse to make a significant financial decision within nine months of death by disclaimer, and to also give up the power to appoint how the trust assets will pass by power of appointment, is not an optimal solution. Neither is transferring assets outright to a surviving spouse who may lose them to creditors, divorce claims, or overly aggressive son and daughter-in-laws an ideal option. The Clayton QTIP strategy typically works well, but the decision must be made on the first dying spouse s estate tax return, which will be due no later than 15 months after the death of the first spouse, and explaining the mechanism to clients may be challenging. The authors therefore favor providing a committee of impartial advisors, who have the right to give the surviving spouse a power to appoint the trust assets to creditors of his or her estate. As a result, the surviving spouse will be considered the owner of the assets under the trust for estate tax and income tax step-up basis purposes, even though the power given to the surviving spouse may not be exercisable unless he or she has consent from one or more unrelated parties. If the estate tax is eliminated and a family wants to receive a stepped-up basis on the death of the surviving spouse, then the following clause may be used: 47

48 CREDIT SHELTER TRUST ALTERNATIVES FOR CLIENTS WHO WANT FLEXIBILITY IN THEIR PLANNING Alternative #4 Committee to Provide a Power of Appointment Continued I hereby appoint,, and as Independent Fiduciaries for the sole and limited purpose of having the authority to bestow upon my spouse a power of appointment whereby said spouse may appoint all or a portion of the Trust assets to creditors of my said spouse s estate, if deemed appropriate by any two of said Independent Fiduciaries at any time that the Trust is in existence, exercisable by a written instrument signed by a majority of the Independent Fiduciaries. The purpose of such power of appointment would be to allow for an increase in tax basis upon my spouse s death, if circumstances arise whereby federal estate tax is less of a concern than capital gains taxes, or other appropriate circumstances. The Independent Fiduciaries shall be indemnified and held harmless by the Trustee for any liability or expense incurred as the result of providing my said spouse with such power of appointment, and are encouraged to consider whether providing such power would make the trust assets subject to creditor claims of my spouse, and whether the situs of the trust should appropriately be transferred to a different state for creditor protection purposes before such power of appointment is granted. If a majority of, and are unable to act, then the party that would appoint Trustees in the event of a vacancy in the office of Trustee under Section of this Trust Agreement shall appoint one or more of a duly licensed lawyer that is Board Certified by the Florida Bar in Wills, Trusts & Estates, a CPA who has done work for our family for at least 15 years, and/or a Licensed Trust Company to serve as Independent Fiduciaries, provided that at all times there shall be at least two individuals or a Licensed Trust Company serving as Independent Fiduciaries. Notwithstanding the previous sentence, in no event can any person or entity be appointed if such person or entity is considered as a related or subordinate party with respect to me or to my said spouse as such term is defined under Internal Revenue Code Section 672(c). 48

49 WHEN YOU HAVE A FREEZE THAT IS NO LONGER NEEDED, WHAT DO YOU DO? With an Installment Sale to a Defective Grantor Trust ( Defrosting the Freeze ): Were guarantees limited to 10% of the value of the note? Reduction of the note can be considered a gift are the guarantors insolvent? The Grantor can swap appreciated assets with other assets of equal value in the Trust so that the appreciated assets will be in the Grantor s estate to facilitate the maximum step up in basis. With a GRAT consider selling the appreciated assets to the Grantor and/or completing the swap arrangement described above. 49

50 More Than One Way to SCIN a GRAT? What if there is not time to appraise the underlying assets and entity discounts before completing a self-cancelling installment note transaction? GRAT provides that first $400,000 worth of assets remain in GRAT and any excess from initial contribution will be payable over 5 annual installments of excess amount plus the 7520 Rate. GRAT 100% CLIENT/GRANTOR SCIN $1,500,000 LLC Step 1 Client places assets in LLC owned by client and receives back a Self- Cancelling Installment Note. Step 2 Client gifts 100% ownership in the LLC to the GRAT. Step 3 A valuation firm values the assets under the LLC and actuarial tables are used to determine the SCIN value. Step 4 The excess of asset value over the SCIN value is the GRAT contribution amount. Step 5 The GRAT may provide for holding assets equal to $400,000, and distributing back 5 annual payments based upon any excess over $400,000. $2,000,000 - $1,500,000 = $500,000. $500,000 - $400,000 = $100,000. $100,000/5 = $20,000 Step 6 If the IRS determines that the valuation assumptions used are incorrect, any excess value will pass back to the Grantor over 5 annual payments, and will qualify for the estate tax marital deduction if the grantor dies during the first 5 years survived by a spouse. Assets estimated to be worth $2,000,000 ($500,000 in cash plus $1,500,000 in Grandpa s LLC interest (90%)) 90% Cash $500,000 Grandpa, 10% GRANDPA LLC $1,928,571 in assets ($1,928,571 x.9 x.7 = $1,500,000) 50

51 Don t Overlook the Benefits Tax and Otherwise of Private Operating Foundations by Thomas J. Ellwanger and Alan S. Gassman Affluent and charitably-inclined clients wanting to use an entity to carry out their private philanthropic plans have traditionally relied on private foundations. Since the foundation rules were tightened up in 1969, most clients have opted for foundations which are non-operating ; that is, foundations which do not carry out charitable work directly, but which rely instead on making grants to other charities which actually conduct charitable operations. The entire article can be found here: 51

52 CLEAN UP TIME 1. Forgive or reduce intra-family and inter-trust loans. (May be best to gift cash to the borrowing entity and let the borrowing entity, use that cash to repay the loan report a cash gift on the tax return.) 2. Pay off loans that may have been taken out on life insurance policies that are owned by irrevocable trusts or family. (Or is it best to keep a low interest loan or grandfathered split dollar arrangement in place and to use gifting allowances elsewhere?) 3. Have children who own life insurance policies on their parents use part of their own lifetime gifting exclusions to gift such policies to trusts, to preserve policy proceeds from potential future creditors, divorce, or unwise management or spending. 4. Fund irrevocable trusts that may buy out remainder interests, purchase existing Grantor Retained Annuity Trusts ( GRATs ) assets, purchase homes from Qualified Personal Residence Trusts ( QPRTs ), or otherwise assist in unwinding or unfreezing mechanisms and arrangements now in place. 5. Make further ballast gifts to irrevocable trusts which owe installment notes and are highly leveraged. 52

53 ALL HOPE IS NOT LOST FOR ESTATE PLANNERS Despite the federal estate tax possibly being eliminated, there are myriad reasons for clients to engage in appropriate and sophisticated estate planning. Specifically, assuring that assets are not left to undesired beneficiaries (which is akin to a 100% tax) should be a chief planning objective for clients. Creditor protection planning should also be considered, as there are many non-tax benefits to having inheritances left in trust as opposed to outright, and to safeguard assets from possible creditor situations. Trusts also will have a great use in allowing grantors to control assets from the grave whereby assets may only be distributed from the trust for certain purposes and based upon certain distribution standards. Additionally, trusts can provide that assets might be revested in the grantor or otherwise disposed of based upon powers of appointment given under the trust document. 53

54 INBOUND INVESTMENT Types of Investment Vehicles: Flow-through and Corporate U.K. Individuals U.K. Individuals U.K. LTD. U.K. Ltd. U.S LLC U.S. C Corp. U.S. Operations & USRPI Copyright 2016 Baker & McKenzie, LLP. U.S. Operations and USRPI 54

55 OUTBOUND INVESTMENT Copyright 2016 Baker & McKenzie, LLP. 55

56 INTELLECTUAL PROPERTY MIGRATION Copyright 2016 Baker & McKenzie, LLP. 56

57 TRUMP TAX INITIATIVES FOR U.S. COMPANIES Lower Tax Rate for Corporations and Passthroughs Reduced from 35% to 15% Repatriation 10% One-Time Deemed Repatriation Tax on Offshore Earnings of U.S. Corporations Annual Minimum Tax for Foreign Earnings Effect on IP Migrations, Transfer Pricing, Subpart F? Eliminate Inversions Change per se domestic corporation qualification threshold? Copyright 2016 Baker & McKenzie, LLP. 57

58 TRUMP TAX INITIATIVES FOR U.S. COMPANIES CONT D Recent Treasury Regulations Section 367(d) Proposed Regulations Section 385 Final Regulations Section 7874 Temporary Regulations EU State Aid Tax Treaties Information Exchange Regimes Copyright 2016 Baker & McKenzie, LLP. 58

59 TRUMP TAX INITIATIVES FOR INDIVIDUALS Collapsing of Tax Brackets 12%, 25%, 33% Carried Interest Estate Tax Net Investment Income Tax Copyright 2016 Baker & McKenzie, LLP. 59

60 WHAT TO EXPECT AFTER THE UNEXPECTED? PLANNING NOW FOR PROBABLE AND POSSIBLE TRUMP TAX LAW CHANGES Wednesday, December 14 th, 2016 Florida Bar PRESENTED BY: ALAN S. GASSMAN KENNETH J. CROTTY CHRISTOPHER J. DENICOLO BRANDON KETRON GASSMAN, CROTTY & DENICOLO, P.A. & JAMES H. BARRETT BAKER & MCKENZIE, LLP

61 What to Expect after the Unexpected: Planning for the Probable and Possible Trump Tax Law Changes James H. Barrett December 14, 2016