200TH JOHN HANCOCK. Advanced Markets Central Intelligence

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1 JOHN HANCOCK Advanced Markets Central Intelligence 200TH ISSUE Celebrating 16 Years of Providing You With Timely Legislative Updates, Cutting-Edge Court Rulings, and Important IRS Revenue Rulings

2 ADVANCED MARKETS SPECIAL EXCERPT A Look back through 16 years of change. John Hancock Advanced Markets is proud to present the 200th edition of Central Intelligence (CI). CI was first produced in 1996, when the Advanced Markets team consisted of just four employees. Today, we have grown to a group of twenty talented individuals, including Attorneys, Advanced Markets Consultants, Marketing Consultants, and Programmers. Along with the size of the department, our readership has also grown. Randy Zipse, who wrote CI for five years, remembers faxing Special Editions of CI to our subscribers! The effort paid off; what started as a small communication now has over 8,500 devoted readers. The economic landscape has also changed continuously over the past 16 years yet the goal of CI has been the same to provide you with timely legislative updates, cutting-edge court rulings, and important IRS revenue rulings. Legislation will continue to evolve and every day financial markets will fluctuate. We have kept our promise to keep you informed and we will continue to provide the best support to help you understand key events affecting our industry into the future. As we look back, Central Intelligence has been at the forefront, reporting on important events. This timeline showcases the key concepts that were covered in Central Intelligence since the publication s inception FEB AUG AUG Manulife Financial Advanced Markets Department was created First Central Intelligence Published discussed Equity Split-Dollar (TAM ) First Special Edition Central Intelligence outlining Taxpayer Bill of Rights, Small Business Job Protection Act, and Health Insurance Portability and Accountability Act ( HIPAA ) Estate Tax Exemption of $600,000, Annual Exclusion of $10,000, Generation-Skipping Transfer (GST) Tax Exemption of $1M, Lifetime Gift Exemption of $600,000 with the maximum Estate, GST and Gift Tax Rate of 55% Special Edition Central Intelligence covering the Taxpayer Relief Act of 1997 (unified credit to increase over phase-in to $1,000,000) 1999 The Estate Tax and Lifetime Gifting Exemptions increased from $600,000 to $650,000 SEPT To get information out to our reader's faster, Central Intelligence went from a printed publication to an electronic one 2001 JUNE SEPT The Estate Tax and Lifetime Gifting Exemptions increased to $675,000. GST Exemption increased to $1.3M from $1M, with the highest rates still at 55% Economic Growth and Tax Relief Reconciliation Act enacted (Bush Tax Cuts) House passes Tax Relief Bill for victims of September 11th terrorist attack, which led to the Patriot Act (Anti-Money Laundering was addressed as part of that act) Page 1 of 8. Not valid without all pages.

3 ADVANCED MARKETS 2002 JULY Estate Tax and Lifetime Gift Exemptions increased to $1M, tax rates went down to 50%. Annual exclusions increased to $11,000 Sarbanes-Oxley enacted (affected, among other things, Deferred Compensation and Split-Dollar in publically traded companies) 2003 SEPT Final Split-Dollar Regulations go into effect OCT APRIL OCT AUG Estate Tax Exemption increased to $1.5M with 48% highest rate. This was the first year that the Estate Tax Exemption and Lifetime Exemption were NOT unified. Lifetime Gifting is limited to $1M American Jobs Creation Act of 2004 enacted (introduced, among other things, 409A statute governing Non-Qualified Deferred Compensation) Rev. Rul issued (introduced new PERC Valuation of Life Insurance Transfers) 409A Proposed Regulations issued Estate Tax Exemption increased to $2M, Annual Exclusions increased to $12,000, GST Exemption increased to $2M, Lifetime Gifting remained at $1M Pension Protection Act enacted (created 101(j) governing Employer-Owned Life Insurance) 2008 NOV 101(j) Final Regulations issued DEC Estate Tax Exemption increased to $3.5M, Annual Exclusions increased to $13,000, GST Exemption increased to $3.5M, Lifetime Gifting remained at $1M Estate Tax repealed, there is no Estate Tax or GST tax. Several billionaires died this year, including Yankees owner, George Steinbrenner. Lifetime Gifting Exemption for 2010 remained at $1M Finally, after many months of uncertainty, the Estate, Gift and GST Taxes were addressed in the 2010 Tax Act. The Act temporarily unified the Estate, Gift and GST Exemptions at $5M (increased for inflation) for two years with a temporary and unified exclusion of $5M for The Estate, Gift and GST Exemptions increased for inflation to $5.12M with a maximum rate of 35%. It is interesting to note that of the many changes that occurred, some were shocking (few believed that 2010 would have no estate taxes), and there have been many last minute changes to law. Next year there is no certainty as to what the exemptions will be, but we will keep you up to date on the ever-changing landscape. Page 2 of 8. Not valid without all pages.

4 CENTRAL INTELLIGENCE ADVANCED MARKETS October 2012 IN THIS ISSUE Changes for 2013 Planning Value of Life Insurance in 419A Plan Taxable Income to Participant Loan from DBO Welfare Benefit Plan Actually Taxable Distribution CASE IN POINT: Endorsement Split-Dollar and Income For Executive Changes for 2013 Planning Next year brings many changes for estate planning. Based on the newly released Consumer Price Index (U.S. Department of Labor), below are reproduced selected inflation-adjusted numbers as they will apply in 2013 under current federal tax law. Of course, Congress has the power to change the statutes that drive these numbers, and they may do so. Gift Tax Annual Exclusion (IRC 2503(b)): $14,000 per donor per donee for gifts made in 2013, up from $13,000 in Gift Tax Annual Exclusion for Gifts to Non-Citizen Spouses (IRC 2523(i)): $143,000 for gifts to a non-citizen spouse in 2013, up from $139,000 in Applicable Exclusion Amount ( unified credit )(IRC 2010): $1,000,000 for decedents dying in 2013, down from $5,120,000 for decedents dying in Generation-Skipping Transfer Tax (GSTT)(IRC 2631): $1,430,000 total lifetime exemption available in 2013, down from $5,120,000 in Applicable 2% Portion for Deferred Estate Tax (IRC 6601(j) and 6166): $1,430,000 for decedents dying in 2013, up from $1,390,000 in Sunset of Economic Growth and Tax Relief Reconciliation Act Provisions: Most of our readers are aware that many of the provisions of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, extended for two years by Congress and President Obama on December 17, 2010, are again scheduled to expire at midnight on December 31, 2012, and (in many cases) revert to the law existing at the time that EGTRRA was enacted. Several other gift and estate tax provision unrelated to EGTRRA are also scheduled to expire. For our readers convenience, we summarize the changing provisions here. Of course, as noted previously, Congress has the power to change, reenact, or make permanent these provisions, either before the sunset or thereafter. Generation-Skipping Transfer Taxation (GSTT): The current GSTT law does not, by its own terms, apply to transfers after That limitation will expire with EGTRRA, and GST taxation will revert to its provisions in As shown above, the GSTT exemption is indexed for inflation. The top GSTT rate will be 55%. Estate Taxation: Likewise, the maximum estate tax rate reverts to 55% and the credit for state death taxes is reinstated, replacing the deduction for state death taxes under EGTRRA. The 5% surtax on large estates will revive, which gradually eliminates the effect of the estate tax rate tables as the estate size increases. Portability of Deceased Spouse Applicable Exclusion Amount: The provisions under IRC s2010(c)(4), which provide the use of a deceased spouse s unused applicable exclusion amount by a surviving spouse, expire at the end of Page 3 of 8. Not valid without all pages.

5 Value of Life Insurance in 419A Plan Taxable Income to Participant Cadwell v. Commissioner, 136 T.C. No. 2 (2012) This case extends the development of the tax implications of 419A(f)(6) plans to non-owner/employees of the participating employers in such plans, and includes a note on PERC (Premiums and Earnings Minus Reasonable Charges) under Rev. Rul Facts: The relevant period under examination for this case was the tax years of 2002 and Taxpayer is married with two daughters. On his IRS Forms 1040 for 2002 through 2004 (married filing separately), Taxpayer reported no taxable income. Corporation is a subchapter S corporation that has at all times been owned by Taxpayer s spouse. Corporation, in turn, owns 5% of Limited Partnership (LP), the sole source of its income in 2002 and Interests in LP are also owned by Taxpayer s spouse (90%), Taxpayer (2%), and their two daughters (1.5% each). In 2002, Taxpayer and spouse decided to secure a welfare benefit plan for Taxpayer and the two daughters and engaged Plan, a 419A(f)(6) multiemployer plan, which provided severance and death benefits to participants. Under the provisions of Plan, the employers of participants bore the full cost of benefits provided and the assets of Plan were beyond the reach of the creditors of those employers. Upon termination of Plan or employer withdrawal from Plan, an employee s nonforfeitable benefits are deemed to be 100 percent vested, regardless of the vesting schedule set by the employer. As part of the information provided to Plan administrator, Taxpayer disclosed that he was paid $50,000/year by Corporation. Taxpayer, as secretary of Corporation signed documents adopting Plan and selecting death benefits for himself and the two daughters in the amount of 20 times annual salary and severance benefits equal to a percentage of salary, accumulated for each year employed, up to a maximum of 200% of annual salary. Life insurance was selected as the Plan asset to fund the benefits, and a policy on the life of Taxpayer was purchased by Plan with a face amount of $1,000,000. Taxpayer named his two daughters as beneficiaries of this life insurance policy. Contributions to Plan for Corporation s obligations were made by LP on Corporations behalf. Late in 2004, Plan administrator notified employer-participants in Plan that Plan had been split into multiple single-employer plans. (Among the reasons stated in the notice was the concern that Plan might be subject to listed transaction penalties imposed by the recently passed American Jobs Creation Act of 2004, but stemming from IRS Notice issued more than nine years earlier.) The single-employer plans are not governed by IRC 419A(f)(6) and deductibility of contributions is markedly more limited than under such plans. In 2008, the IRS sent Taxpayer a notice of deficiency averring underreported taxable income for 2004 in the amount of $102,039 comprising the then-current value of life insurance on Taxpayer s life owned by Plan and contributions to Plan in excess of those necessary to provide benefits. Taxpayer filed this action; Taxpayer and the IRS each filed for summary judgment. Holding: The Tax Court held entirely for the IRS, that Taxpayer is liable for the accuracy-related penalties. Upon the split of Plan into individual single-employer plans for individual plans, the provisions governing the assets owned by Plan changed. After the split, the assets in Corporation s individual plan could only be used to satisfy the benefits of employees of Corporation. Furthermore, Corporation could terminate its individual plan at any time, upon which the assets would be required to be distributed out to the participants of the plan. The Court found that upon the conversion from a multi-employer plan under IRC 419A(f)(6) to a single-employer plan, the assets funding the plan were no longer subject to a substantial risk of forfeiture and, therefore, at that time Taxpayer became substantially vested in the assets in the plan funding his benefits, both the life insurance and the excess contributions. Under IRC 402, the value of those assets must be included in the participant s taxable income for the year in which they become substantially vested. The Court applied the PERC calculation under Rev. Rul to determine the value of the life insurance policy for income tax purposes, and held that Taxpayer may not reduce the PERC value by the surrender charge under the safe harbor provision of the Revenue Ruling. Page 4 of 8. Not valid without all pages.

6 Loan from DBO Welfare Benefit Plan Actually Taxable Distribution Todd, II v. Commissioner, 110 AFTR 2d , August 16, 2012 Facts: Taxpayer, a neurosurgeon, is the Director and President of PA, and its only shareholder. Beginning in 1995, PA participated in a death-benefit-only welfare benefit plan ( DBO ) as a benefit of its union membership. DBO provided death benefits to its participants up to eight times annual salary, to a maximum of $6,000,000. To fund this obligation, DBO secured life insurance on the participant s life in the face amount of the benefit. Participating employers paid an amount equal to the premiums on its employees policies to DBO. DBO also provided hardship loans to employee participants upon application and proper showing, up to the applicant s equity in the plan. In 2002, Taxpayer applied to DBO for such a hardship loan (for unexpected housing costs ) for $400,000, the maximum available against his equity in DBO. Upon applying for a matching loan to the issuer of Taxpayer s policy, DBO discovered unexpected, and ultimately unacceptable, borrowing costs (5% interest to DBO). DBO, with Taxpayer s consent, chose instead to implement a partial surrender of the policy, reducing the face of the policy to $5,600,000 and in September, 2002, issued a check to Taxpayer for $400,000 bearing the memo notation participant loan. DBO and Taxpayer eventually executed a note for $400,000 carrying interest in the amount of 1%, payable quarterly. The IRS determined that the payment of $400,000 was in fact not a loan and issued a notice of deficiency of taxable income for tax year 2002 in the amount of $400,000 and applied a penalty. Taxpayer brought an action in Tax Court to recover, and the Court held for the IRS. Taxpayer appeals. Holding: The Court of Appeals (5th Circuit) affirmed the holding of the Tax Court, for the IRS. The Court agreed that the transfer did not satisfy the analysis applied to determine whether a genuine loan obligation was created at the time of the transfer. Ultimately, the parties did not conduct themselves in manner evincing an intention to establish a debtor-creditor relationship. No note was executed before the payment was transferred, the note when finally executed did not comply with DBO guidelines, the interest was insufficient, and the payment schedule of the subsequently executed note was ignored. If the parties did not behave as if it was a real loan obligation, it probably was never intended to be one. Page 5 of 8. Not valid without all pages.

7 CASE IN POINT: ENDORSEMENT SPLIT-DOLLAR AND INCOME FOR EXECUTIVES Initial Call to Advanced Markets Consultant: April 2012 Client Profile: A business partner who wanted to provide coverage for his family in the event of an early death and also needed a source of supplemental income. The executive was a 39-year-old male, Super Preferred Non Smoker who wanted to have additional income available at age 50. Background: Producer contacted the Regional Director s office requesting assistance with case design. The Regional Director and Sales Associate worked with the Advanced Markets Consultants to discuss possible non-qualified deferred compensation solutions. Business partners were father, son (client), and father s friend, who held only a minority interest. Due to age differences, anticipated retirement, and subsequent sale of minority interest, the partners did not agree on a funding method. Minority interest partner was not in favor distributing assets, wanting to keep the business value high due to subsequent sale of his interest at retirement. Solution: An Endorsement Split-Dollar plan is designed with the idea of distributing the policy to the insured executive beginning in year 11. The policy design is funded at the Non-MEC limit, with the increasing death benefit option for 10 years. In year 11, the policy death benefit option changes to level and the policy is then distributed to the executive. The executive then withdraws a lump sum to pay income taxes on the distribution and additional income for himself. All partners were agreeable to this design. The client was able to provide protection for his family at the cost of the economic benefit charges. The charges were double bonused so the executive had no out of pocket outlay. The minority interest partner was satisfied as the company assets were not reduced due to the endorsement split-dollar design. The additional income in year 11 might be available to be used for payments towards an installment buy out of minority interest or for early retirement income. Applications were submitted on this case in June, Client purchased an Indexed UL-type Universal Life policy for approximately $12M. The projected income at age 50 was exactly what the client was looking to cover. Resources Used: (1) Advanced Market Consultant Talked through the case and came up with a game plan. (2) Regional Director and Sales Associate Worked with producer and provided several different illustration design options. (3) JH Solutions Producer used our proprietary software to illustrate the concept. DID YOU KNOW... 1) Central Intelligence is written by an Attorney on the Advanced Markets Team? 2) Case in Point includes actual cases that our Advanced Markets Consultants have recently worked on and have sold? 3) Rates were first introduced in our third edition of Central Intelligence? At that time, in 1996, the 7520 rate was at 6.6% and went up to 7.6% by December, compared to the current rate of 1.2%. Page 6 of 8. Not valid without all pages.

8 ONE YEAR LIBOR RATE October 1, 2012:.99% PRIME RATE As of October 1, 2012: 3.25% IRC SECTION 7520 RATE October % September % August % The 7520 rate is used to value GRITs, QPRTs, CRATs, CLUTs, CLATs, private annuities, life interest, remainder and reversionary interests. To value a charitable gift for income, gift, or estate tax charitable deduction purposes, use either the rate for the month of the actual gift/transfer or the rate from either of the two previous months (use the highest of the three months for the largest charitable deduction). APPLICABLE FEDERAL RATES OCTOBER 2012 Annual Semi Annual Quarterly Monthly Short-term (3 years or less) 0.23% 0.23% 0.23% 0.23% Mid-term (more than 3 years up to and including 9 years) 0.93% 0.93% 0.93% 0.93% Long-term (more than 9 years) 2.36% 2.35% 2.34% 2.34% Central Intelligence is produced by John Hancock s Advanced Markets Group. We can be reached at (888) , option 3 or option 4; 197 Clarendon Street, C-07-01, Boston, MA 02116; Loans and withdrawals will reduce the death benefit, cash surrender value, and may cause the policy to lapse. Lapse or surrender of a policy with a loan may cause the recognition of taxable income. Policies classified as modified endowment contracts may be subject to tax when a loan or withdrawal is made. A federal tax penalty of 10% may also apply if the loan or withdrawal is taken prior to age Cash value available for loans and withdrawals may be more or less than originally invested. Trusts should be drafted by an attorney familiar with such matters in order to take into account income and estate tax laws (including the generation-skipping transfer tax). Failure to do so could result in adverse tax treatment of trust proceeds. This material does not constitute tax, legal or accounting advice and neither John Hancock nor any of its agents, employees or registered representatives are in the business of offering such advice. It was not intended or written for use and cannot be used by any taxpayer for the purpose of avoiding any IRS penalty. It was written to support the marketing of the transactions or topics it addresses. Comments on taxation are based on John Hancock s understanding of current tax law, which is subject to change. Anyone interested in these transactions or topics should seek advice based on his or her particular circumstances from independent professional advisors. Insurance products are issued by: John Hancock Life Insurance Company (U.S.A.), Boston, MA (not licensed in New York) and John Hancock Life Insurance Company of New York, Valhalla, NY John Hancock. All rights reserved. MLINY /12 Scan this code to find out more. Page 7 of 8. Not valid without all pages.