ASSET PROTECTION & ESTATE PLANNING WHY NOT HAVE BOTH? HOT TOPICS IN ESTATE PLANNING AND ASSET PROTECTION

Transcription

1 ASSET PROTECTION & ESTATE PLANNING WHY NOT HAVE BOTH? HOT TOPICS IN ESTATE PLANNING AND ASSET PROTECTION By Barry A. Nelson, Esq. Presented to: Florida Institute of Certified Public Accountants (FICPA) Florida Institute on Federal Taxation Conference (FIFT) Orlando, Florida November 5, 2010 SECTION I Estate Tax Update: Recent Developments... 1 SECTION II Current Legal and Ethical Developments in Asset Protection Planning Strategies SECTION III Flowchart Analyses of Preferred Estate and Asset Protection Holdings NELSON & NELSON, P.A Sunny Isles Boulevard, Suite 118 North Miami Beach, Florida info@estatetaxlawyers.com T F

2 Asset Protection & Estate Planning - Why Not Have Both? Hot Topics in Estate Planning and Asset Protection Barry A. Nelson Nelson & Nelson, P.A Sunny Isles Boulevard, Suite 118 North Miami Beach, FL Barry A. Nelson, a Florida Bar Board Certified Tax and Wills and Trusts and Estates Attorney, is a shareholder in the North Miami Beach law firm of Nelson & Nelson, P.A. He practices in the areas of tax, estate planning, asset protection planning, probate, partnerships and business law. He provides counsel to high net worth individuals and families focusing on income, estate and gift tax planning and assists business owners to most effectively pass their ownership interests from one generation to the next. He assists physicians, other professionals and business owners in tax, estate and asset protection planning. As the father of a child with autism, Mr. Nelson combines his legal skills with compassion and understanding in the preparation of Special Needs Trusts for children with disabilities. Mr. Nelson is a Fellow of the American College of Trust and Estate Counsel (ACTEC) and serves as Chairman of its Asset Protection Committee. Mr. Nelson is named in Chambers USA: America s Leading Lawyers for Business 2010 edition as a leading estate planning attorney in Florida. He is one of seven lawyers receiving Chambers and Partners highest rating of "Band 1" in the Florida Estate Planning category. He is also listed as a notable practitioner in Florida Tax. Mr. Nelson has been listed consecutively in The Best Lawyers in America since 1995 and is a Martindale-Hubbell AV-rated attorney. He has been listed as a top Florida attorney in Florida Super Lawyers since 2006 and The South Florida Legal Guide since Mr. Nelson served as an adjunct professor for the University of Miami School of Law LL.M. in Taxation program from He served as an adjunct professor at the University of Miami s Graduate Department of Accounting from Mr. Nelson is active in professional organizations and frequently serves as a consultant for other attorneys and certified public accountants on complex tax issues. He lectures extensively for the Florida Bar, Florida Institute of Certified Public Accountants (FICPA) and has presented at the University of Miami Heckerling Institute on Estate Planning, the Notre Dame Tax and Estate Planning Institute, the Southern Federal Tax Institute and the American College of Trusts and Estates Counsel (ACTEC). He has published numerous articles in professional publications. As the Founding Chairman of the Asset Preservation Committee of the Real Property, Probate and Trust Law Section of the Florida Bar from he introduced and coordinated a project to write a new treatise authored by committee members entitled Asset Protection in Florida (Florida Bar CLE 2008). Mr. Nelson wrote Chapter 5 entitled Homestead: Creditor Issues. He is a past President of the Greater Miami Tax Institute. Mr. Nelson is a co-founder of the Victory Center for Autism and Behavioral Challenges (a notfor-profit corporation) and served as Board Chairman from He served as the Mayor of the Town of Golden Beach, Florida from

3 SECTION I ESTATE TAX UPDATE:RECENT DEVELOPMENTS Presented by: Barry A. Nelson Estate Planning and Asset Protection are fundamentally interwoven. Changes in one will virtually always effect changes in the practice of the other. These materials will discuss recent developments in a variety of areas such as case law, the federal tax code, and practitioner trends, and how these developments will affect the practice of these related fields. EXHIBIT & TITLE PAGE NO. 1 Jane G. Gravelle: Estate Tax Options April 23, Scroggin Sample Client Letter Describing Estate Tax Legislation and Repeal* Nelson & Nelson: Tax Update March 9, Nelson & Nelson: Tax Update December 21, Scroggin & Douglas: Should Clients Consider Gifting Before the End of 2010?* Description of Revenue Provisions Contained in the President s Fiscal Year 2011 Budget Proposal Republican Estate Tax Proposal (proposed by Mitch McConnell) September 13, Democrat Estate Tax Proposal (proposed by Linda Sanchez) July 15, Nelson & Nelson: Tax Planning Letter for 2010 Planning for Terminally Ill Client Based Upon Repeal Seven Steps for Coping with Carryover Basis* Interest Rates and AFRs October Intra-Family Loans and AFRs October 2010 Example The GRAT Rush of 2010-Short Term GRAT Planning May be Prohibited* New Florida Statute Gives Courts Flexibility to Construe Formula Dispositions* Pierre Valuation of Gifts of Single Member LLC Interests (Pierre 2)* Ludwick: A Wake-up Call for Lawyers* Forum Shopping For Favorable FLP and LLC Law: 2010 LLC Asset Protection Planning Table (May 2010)* Forum Shopping For Favorable FLP and LLC Law: 2010 LLC Asset Protection Planning Table (Sept 2010)* Robertson v. Deeb-Inherited IRAs Not Asset Protected Under Interpretation of Fla. Law* Nessa-Inherited IRAs Protected Under Bankruptcy Law* Chilton Inherited IRAs Not Protected Under Bankruptcy Law* Holman v. Comm. Dell Stock Owned By Partnership Limited to Discounts of Less Than 25%* PLR : IRS Grants Extension of Time to Make QTIP Election for Inter Vivos Transfer* Price v. Commissioner: Annual Exclusion Gift of FLP Interests* Black v. Commissioner: Graegin Loan not Respected In Combination With FLP* Petter v. Commissioner: Defined Value Clause Respected In Combination With LLC* Estate of Christiansen: Formula Gift in Favor of Noncharitable and Charitable Benes Respected* Berall: Problems Caused by Absence of Estate & GST Taxes and Reinstitution of Carryover Basis Materials supplemented through September 27, *Provided by: Steve Leimberg s Asset Protection & Estate Planning Newsletter. * * * These materials are intended to assist readers as a learning aid but do not constitute legal advice and, given their purpose, may omit discussion of exceptions, qualifications, or other relevant information that may affect their utility in any planning situation. Diligent effort was made to insure the accuracy of these materials, but Nelson & Nelson, P.A. assumes no responsibility for any reader s reliance on them and encourages all readers to verify all items by reviewing all original sources before applying them. The reader should consider all tax and other consequences of any planning technique discussed. Anyone reviewing these materials must independently confirm the accuracy of these materials and whether any cases or rulings have been superseded. An attorney in the state of domicile of any potential debtor should be engaged for any individual planning. Nelson 1

4 SECTION I - EXHIBIT 1 Estate Tax Options Jane G. Gravelle Senior Specialist in Economic Policy April 23, 2010 CRS Report for Congress Prepared for Members and Committees of Congress Nelson 2 Congressional Research Service R41203

5 SECTION I - EXHIBIT 1 Estate Tax Options Summary The Economic Growth and Tax Relief Act of 2001 (EGTRRA; P.L ), among other tax cuts, provided for a gradual reduction and elimination of the estate tax. Under EGTRRA, the estate tax exemption rose from $675,000 in 2001 to $3.5 million in 2009, and the rate fell from 55% to 45%. In 2010, the estate tax was eliminated. As with other provisions of EGTRRA, however, the estate tax changes will sunset in 2011; the exemption will become $1 million (as scheduled in pre-egtrra law) and the tax rate will return to 55%. There is general agreement that some sort of estate tax will be retained. A proposal to make the 2009 rules ($3.5 million exemption and 45% rate) permanent was included in President Obama s 2010 and 2011 budget outlines and was passed by the House in December 2009 (H.R. 4154). Senate Democratic leaders have indicated a plan to enact the 2009 rules permanently (and make them retroactive to 2010). The Senate Republican leadership has proposed a $5 million exemption and 35% rate. With any of the exemption levels, few estates are affected by the tax. In 2011, the shares of estates taxed are projected by one study to be 1.76%, 0.25%, and 0.14% for the exemption levels of $1 million, $3.5 million, and $5 million, respectively. These numbers would grow to 3%, 0.46%, and 0.23% by The revenue yield in 2011 is projected to be $34.4 billion, $18.1 billion, and $11.2 billion for the $1 million exemption/55% rate, $3.5 million exemption/45% rate, and the $5 million exemption/35% rate. The estate tax accounts for a small share of revenue. The estate tax is a highly progressive tax; it not only applies to the largest estates, but within the distribution of estates a large share is concentrated in the over $20 million estate level: 62% for the $3.5 million exemption/45% rate and 73% for the $5 million/35% rate. Because of various exemptions and deductions, the effective tax rates on estates are much smaller than the statutory rate, with an average 16% rate on estates over $20 million for the $3.5 million exemption/45% rate and 12% for the $5 million exemption/45% rate. When distributed with respect to income, 96% falls in the top quintile of the income distribution, 72% in the top 1%, and 42% in the top 0.1%, under the $3.5 million exemption/45% rate. Although concerns have been raised about the effects of the tax on small businesses and farmers, estimates indicate that the share of estate taxes paid by small business estates under the proposed revisions would be small (16% to 18%) and the share of estates of small business owners taxed is small (about 0.2% of decedents with at least 50% of their assets in businesses). Evidence suggests that the number of returns with inadequate liquid assets to pay the estate tax is negligible. Other effects are likely small. The effects on savings are uncertain but likely small relative to the economy because the tax is small. Moving to either the $3.5 million plan or the $5 million plan would be projected to decrease charitable contributions by a small amount: 1% to 2%. Recent evidence suggests that the costs of administration and compliance are around 7% of revenues. Structural reforms that might be considered are inheritance of spousal exemptions, and some reforms directed at abuses. A provision to restrict Grantor Retained Annuity Trusts (GRATS), which can be used to virtually eliminate estate tax by providing an annuity with a remainder, is contained in H.R Other provisions in President Obama s budget outline include restricting discounts for estates left to family partnerships and conforming fair market value for purposes of the estate tax and future capital gains realizations for heirs. Congressional Research Service Nelson 3

6 SECTION I - EXHIBIT 1 Estate Tax Options Contents Introduction...1 Brief Description of the Estate Tax...2 Basic Structure...2 Exemptions and Deductions...2 Special Provisions for Small Businesses, Farms, and Landowners...3 Step Up in Basis for Appreciated Assets...3 Differences in the Treatment of Bequests and Gifts...4 Options for Revision...4 An Introduction to the Issues...5 Coverage of Decedents...5 Liabilities and Revenue Loss...6 Distributional Issues...8 Effects on Small Businesses and Farmers Effects on Savings and Output...13 Effect on Charitable Contributions...15 Administrative and Compliance Cost...15 Other Design Issues...16 Portability of the Spousal Exemption...16 Grantor Retained Annuity Trusts...17 Minority Discounts...17 Consistent Valuation...18 Conclusion...18 Tables Table 1. Percentage of Decedents Subject to Estate Tax...6 Table 2. Estate Tax Liability Under Alternative Proposals ($billions)...7 Table 3. Estate Tax Liability 2011: Exemption and Rate ($ billions)...8 Table 4. Percentage Distribution of Taxable Estate Tax Returns by Size of Estate, Table 5. Percentage Distribution of Estate Tax Revenue by Type of Return, Table 6. Effective Estate Tax Rate (Tax as Percentage of Assets), Table 7. Distribution of Estate Taxes by Income Class...10 Table 8. Coverage of Estates with At Least Half of Assets in a Business, Table 9. Taxes Paid on Small Business Estates, Table 10. Number of Farm Estates or Estates Claiming QFOBI Deductions with Estate Tax Liability at Different Exemption Levels...12 Table 11. Number of Farm Estates or Estates Claiming QFOBI with Insufficient Liquid Assets to Pay the Tax...13 Congressional Research Service Nelson 4

7 SECTION I - EXHIBIT 1 Estate Tax Options Contacts Author Contact Information...18 Congressional Research Service Nelson 5

8 SECTION I - EXHIBIT 1 Estate Tax Options Introduction The Economic Growth and Tax Relief Act of 2001 (EGTRRA; P.L ), among other tax cuts, provided for a gradual reduction in the estate tax. The estate tax applies to wealth transferred at death and had, at that time, a unified exemption for both lifetime gifts and the estate, of $675,000. Under EGTRRA, the estate tax exemption rose from $675,000 in 2001 to $3.5 million in 2009, and the rate fell from 55% to 45%. Although combined estate and gift tax rates are graduated, the exemption is effectively in the form of a credit that eliminates tax due at lower rates so there is a flat rate on taxable assets. The gift tax exemption was, however, restricted to $1 million. For 2010, EGTRRA scheduled the elimination of the estate tax, although it retained the gift tax and its $1 million exemption. EGTRRA also provided for a carryover of basis for assets inherited at death, so that, in contrast with prior law, heirs who sold assets would have to pay tax on gains accrued during the decedent s lifetime. This provision has a $1.3 million exemption for gain (plus $3 million for a spouse). As with other provisions of EGTRRA, the tax revisions expire in 2011, returning the tax provisions to their pre-egtrra levels. The exemption would revert to $1 million (a value that had already been scheduled for pre-egtrra law) and the rate to 55%. The carryover basis provision effective in 2010 would be eliminated (so that heirs will not be taxed on gain accumulated during the decedent s life when they inherit assets). Most agree that the 2010 provisions will not be continued, and, indeed, may be repealed retroactively. President Obama proposed a permanent extension of the 2009 rules (a $3.5 million exemption and a 45% tax rate), and the House provided for that permanent extension on December 3, 2009 (H.R. 4154). The Senate Democratic leadership has indicated a plan to retroactively reinstate the 2009 rules for 2010 and beyond. Senate Minority Leader McConnell proposed an alternative of a 35% tax rate and a $5 million exemption. 1 A similar proposal for a $5 million exemption and a 35% rate, which also includes the ability of the surviving spouse to inherit any unused exemption of the decedent, is often referred to as Lincoln-Kyl after the two Senators who have supported it. Others have argued for a permanent estate tax repeal. 2 To address abuses and tax avoidance, President Obama has included proposals in his 2011 budget outline. One of these proposals, to reform the Grantor Retained Annuity Trust (GRAT), is included in H.R This provision is discussed in detail below. After a brief description of the estate and gift tax and of options, this report compares the alternatives, focusing largely on a $1 million exemption and 55% rate, a $3.5 million exemption and a 45% rate, and a $5 million exemption and a 35% rate. Several policy effects and issues are analyzed: the share of decedents subject to tax, revenue effects, distributional effects, and effects on savings, charitable contributions, and compliance and administration. The report also 1 See Chuck O Toole, Estate Tax Expiration Imminent After Congress Fails to Complete Action, Tax Notes Today, December 17, 2009, 2009TNT For a discussion indicating that there would not be a legal issue with a retroactive tax, see Jay Starkman, Can an Estate Tax be Retroactive? Tax Notes, February 22, 2010, pp In addition to H.R. 4154, numerous bills have been introduced in the 111 th Congress to address the estate tax. See CRS Report R40964, Estate Tax Legislation in the 111 th Congress, by Nonna A. Noto. Congressional Research Service 1 Nelson 6

9 SECTION I - EXHIBIT 1 Estate Tax Options considers other aspects of the proposals, such as whether the exemptions are indexed for inflation, a proposed inheritance of the exemption for spouses, and proposals to address perceived abuses. Brief Description of the Estate Tax This section describes the estate tax as it existed in 2009 and will exist in 2011 absent legislative change. For 2010, there is no estate tax, although the gift tax remains and there is a tax on gains accumulated during the decedent s lifetime when assets are sold by heirs (with a $1.3 million exemption plus $3 million for a spouse). As mentioned above, few expect this treatment to continue. Basic Structure The estate and gift tax is a unified tax, so that assets transferred as gifts during a person s lifetime are combined with those transferred at death (bequests) and subject to a single rate schedule. 3 The tax is imposed on the decedent s estate and the rate structure applies to total bequests and gifts given; heirs are not subject to tax. In the past, a single effective exemption applied, but under the 2001 tax revisions effective in 2009, the gift tax exemption was more limited than the combined exemption for both estate and gift taxes. Thus, while a unified rate schedule applies to both bequests and gifts, the exemptions differed in The combined exemption was $3.5 million, while the exemption for gifts was $1 million. In 2011, the combined exemption will be $1 million, absent change. Although the rates of the tax are graduated, the exemption is applied in the form of a credit and offsets taxes applied at the lower rates. Individuals are also allowed to exempt annual gifts of $13,000 per recipient, which are not counted as part of the lifetime exemption. The annual gift tax exemption is indexed for inflation in $1,000 increments. A generation skipping tax is also imposed, to address estate tax avoidance through gifts and bequests to a later generation. 4 Exemptions and Deductions Estates are allowed to exempt some assets from the estate tax and take a deduction for selected other transfers. Transfers between spouses are exempt. Estates are also allowed to take deductions for charitable contributions and administrative expenses. Currently estates are also allowed a deduction for taxes paid on estates and inheritances imposed by states. Prior to 2001, a credit was allowed, subject to a cap, for state estate taxes, but the credit was phased out and replaced by a deduction in that legislation. (Should EGTRRA provisions expire, the state credit would reappear.) 3 CRS Report , Federal Estate, Gift, and Generation-Skipping Taxes: A Description of Current Law, by John R. Luckey provides a detailed description of the estate tax. 4 For example, parents may directly skip a generation by leaving some assets to grandchildren, or they may set up a lifetime trust for their children, with the assets subsequently inherited by the grandchildren. The generation skipping tax is imposed in these circumstances, although it also has an exemption. Congressional Research Service 2 Nelson 7

10 SECTION I - EXHIBIT 1 Estate Tax Options Special Provisions for Small Businesses, Farms, and Landowners A series of provisions benefit small businesses, including farms or landowners. These include the ability of family businesses to pay the tax in installments with only interest payments during part of the installment period, special use valuation, conservation easements, and, if the law reverts to its 2001 rules, a deduction for family owned business assets. Minority discounts, although granted by courts rather than specifically in the law, may also benefit small businesses. Although the estate tax return is due within nine months of the death, small businesses are allowed to defer payment (except for interest) for the next five years, and pay the remaining installment payments over 10 years. Since the last interest payment and the first installment coincide, the overall delay in full payment is 14 years. The benefit is allowed only for the business portion of assets and only if 35% of the estate is in a farm or closely held business. Small businesses are also allowed to value their assets at use as a farm or business. This provision is particularly beneficial to farms and allows a reduction in the estate value of up to $1 million. It means, for example, that the value of the farm will be what it could be sold for if restricted to farm use rather than, for example, to be subdivided for development. Heirs are required to continue use as a farm or business for 10 years. Farmers and other landowners may also benefit from conservation easements, a perpetual restriction on the use of the land where, in addition to the reduction in value due to the easement itself, an exclusion of up to 40% of the restricted value of the land, capped at $500,000, is allowed. In prior law, another provision benefitting small businesses was the Qualified Family Owned Business Income (QFOBI) deduction. This provision allowed estates with at least half of their assets in a family business to take a deduction for these business assets. This provision originally allowed up to $675,000 of business deductions at a time when the basic estate tax exemption was $625,000, and imposed an overall cap of $1.3 million on the total of both deductions. Once the regular exemption passed the $1.3 million level, the provision was no longer relevant. If the 2001 tax cuts sunset, the exemption will become $1 million and QFOBI will be relevant again, allowing an additional $300,000 exemption. If the $3.5 million exemption is reinstated for 2011, this provision would again become ineffective, unless revised. To qualify for the QFOBI deduction, heirs must continue the business for 10 years or the tax saving must be repaid. Step Up in Basis for Appreciated Assets Heirs take as their basis (the amount to be deducted from the sales price) for purposes of future capital gains the value of the asset at the date of the decedent s death. This treatment is referred to as step-up in basis and means that no capital gains tax is paid on the appreciation of assets during the decedent s lifetime. For example, if decedent purchased stock for $100,000 and the value of the stock at the time of death is $200,000, if the heir sells the property for $250,000 a gain of $50,000 ($250,000 minus the stepped-up basis of $200,000) is recognized. The $100,000 of gain that accrued during the decedent s lifetime is never taxed. The step up rules do not apply to gifts, where carryover basis is applied. In that case, the original basis of $100,000 would be carried over and the gain would be $150,000 ($250,000 minus $100,000). Both the gain accrued by the donor and the gain accrued by the donee are taxed. The step-up rules do not apply to bequests for 2010, where carryover basis, with an exemption, applies, as noted above. Congressional Research Service 3 Nelson 8

11 SECTION I - EXHIBIT 1 Estate Tax Options Differences in the Treatment of Bequests and Gifts Aside from the different exemption levels, there are other differences between the taxation of gifts and bequests. As noted above, gifts do not benefit from the step up in basis. The donor takes the basis in the hands of the donor, generally the original cost of acquiring the assets. The basis cannot be less than the fair market value at the time of the gift if a loss is realized. At the same time, the gift tax is tax exclusive (the tax is imposed on the gift net of the tax) whereas the estate tax is tax inclusive (the tax is applied to the estate inclusive of the tax). To illustrate, consider a 50% tax rate. Assuming the exemption is already used, to provide a gift of $1 million costs $1.5 million: the tax rate of 50% is applied to the gift of $1 million for a $0.5 million tax. To provide a net amount of $1 million for a bequest, $2 million is required: a tax of $1 million (50% of $2 million) and a net to the heir of $1 million. Another way of stating this is that the gift tax rate, if stated as a tax inclusive rate like the estate tax, would be 33%. Thus for the 55%, 45%, and 35% estate tax rates, the gift tax rate equivalents are 35%, 31%, and 26%. 5 Options for Revision The principal components of any policy that continues the estate tax are the amount of the exemption and the tax rate. 6 As indicated earlier, the estate tax will revert to an exemption of $1 million, absent a change in the statute, and while any level of exemption might be considered, the two most common levels mentioned are $3.5 million and $5 million. The level of the exemption affects not only the revenue but the number of estates that are subject to the tax. The second principal component of a continued estate tax is the rate, which will return to 55% absent legislative change; rates of 45% and 35% are most frequently discussed, although some proposals would apply the capital gains tax rate (currently 15% but scheduled to go to 20% in 2011) or some multiple of it. Another issue is whether to index the exemption for inflation. Some components of the income tax, such as rate brackets and standard deductions, are indexed, while others (such as child credits) are not. Over time, as prices rise, a fixed exemption causes more estates to be subject to tax. Without indexation, Congress may return from time to time to reconsider the exemption. A final issue is the potential carryforward of an unused estate tax exemption to the surviving spouse. The provision, contained in the Lincoln-Kyl proposal, would allow spouses to inherit unused estate tax exemptions. Since bequests to the spouse are excluded from the estate, the couple together can have a larger total exemption if the first spouse to die leaves assets to the children or other heirs large enough to absorb his or her estate exemption. This action will reduce the size of the estate subject to tax when the second spouse dies. There are reasons, however, that 5 To convert the statutory tax inclusive rate into an equivalent rate for a tax exclusive application, the formula is t/(1+t), where t is the tax inclusive rate. 6 Leaders of both parties have indicated an intention to continue an estate tax, although some bills propose its permanent elimination. If the estate tax is eliminated, the main options are whether or not to continue the gift tax and the carryover basis for appreciated assets. In the absence of an estate tax, a gift tax can limit certain abuses that can arise from the transfer of assets between taxpayers with differing tax rates. These issues are not discussed in detail in this report. Congressional Research Service 4 Nelson 9

12 SECTION I - EXHIBIT 1 Estate Tax Options the taxpayer may prefer to leave more assets to a spouse (for example, if there are concerns about having enough assets to live in comfort or cover emergencies). The proposed change is to permit the second spouse to inherit any unused exemption and add it to his or her own future exemption. Proposals have also been made to increase the percentage or dollar limits of special use valuations and conservation easements. At the same time, there are proposals, including those in President Obama s budget, to restrict practices considered as abuses. One proposal, relating to a certain type of trust (a Grantor Retained Annuity Trust or GRAT) is being considered in H.R. 4849, the Small Business and Infrastructure Jobs Tax Act of Another proposal would restrict minority discounts for estates that are sometimes allowed by courts when no one heir has a controlling interest in the property. A third provision would require estates and heirs use the same fair market value in determining the valuation for purposes of the estate tax and for determining basis in the hands of the heir. An Introduction to the Issues Data, other empirical evidence, and economic theory can help address proposals to revise the estate tax. Relevant economic issues include the scope and effect of the tax on the total population and the distribution of the tax, the revenue yield, and the potential effects on family businesses, savings, administration and compliance, and charitable giving. To the extent possible, different options are compared in the context of these issues. Other issues are perhaps more philosophical or, as Gale and Slemrod discuss in their article on the estate tax, rhetorical. 7 For example, some people oppose the estate tax because they hold a philosophical view that the estate tax is a death tax and death should not be taxed. Arguments are also made that estate taxes result in a double tax, because assets have already been taxed under the income tax and should not be taxed again. Gale and Slemrod do point out, however, the complexity of the rhetorical questions. For example, they point out that for the vast majority of people (at the time they were writing, 98%) death actually brings potential tax benefits through the forgiveness of tax on accrued but unrealized gains (gains on assets that have not been sold). They also note that income from unrealized appreciation in assets is not taxed during the lifetime and so is not subject to double taxation. They indicate that 36% of estate assets and 80% of the wealth in closely held business and farm estates is from unrealized appreciation. Supporters of the estate tax may believe it is important to constrain the accumulation of wealth generation after generation. While empirical evidence can demonstrate that the estate tax is highly progressive, the degree to which taxes should be applied to large amounts of wealth in pursuit of reducing inequality in society, much like the question of whether it is wrong for death to trigger a tax, is a value judgment. Coverage of Decedents The estate tax has never affected more than a small fraction of decedents. Table 1 indicates that if the law reverts to the $1 million exemption, less than 2% of decedents would pay an estate tax. 7 William G. Gale and Joel Slemrod, Rhetoric and Economics in the Estate Tax Debate, National Tax Journal, vol. 54, September 2001, pp Congressional Research Service 5 Nelson 10

13 SECTION I - EXHIBIT 1 Estate Tax Options Table 1 also indicates that restoring the $3.5 million exemption leads to a quarter of 1% of decedents paying the tax. Moving to a $5 million exemption reduces the share to 0.14%. The column for 2019 illustrates the effects of indexing the $3.5 million and the $5 million for inflation, starting from Note that even with indexing for inflation, real asset growth leads to an increased share of decedents paying the estate tax. With or without indexing, the $3.5 million option will affect less than ½ of 1% of decedents and the $5 million option will affect less than ¼ of 1% of decedents. If the main focus of legislation is to exclude all but a small fraction of estates from the tax, the $3.5 million exemption and the $5 million exemption accomplish that goal, and indexing does not matter very much over short time horizons. Table 1. Percentage of Decedents Subject to Estate Tax Exemption Level $ 1 million $3.5 million $3.5 million, indexed for inflation $5 million $5 million, indexed for inflation Source: Based on data in Urban Brookings Tax Policy Center, Table T , numbers/displayatab.cfm?docid=2506&topic2id=60&topic3id=66&doctypeid= Note: For proposals that are indexed, the indexation begins from Liabilities and Revenue Loss An issue in the choice of estate tax provisions is the revenue cost. Although the estate tax accounts for a small share of total federal revenues, 1.3% in 2012 if the $1 million exemption/55% rate provisions are retained, concerns remain about revenue losses. Revenue costs are normally estimated against a current law baseline. Thus, the cost of keeping the 2009 rules in place retroactively to 2010, with a $3.5 million exemption and a 45% tax rate, would be compared to no estate tax in 2010; therefore there would be a revenue gain compared to no estate tax. In subsequent years, where current law reverts to a larger estate tax (a $1 million exemption and 55% rate) the smaller estate tax will lead to a revenue loss. Receipts are also measured when they flow into the Treasury and there is a delay in the filing of estate tax returns. The Joint Committee on Taxation (JCT) in 2009 estimated a gain of $0.5 billion in FY2010, then a loss, rising to $38 billion in FY2019 for a total of $234 billion over the 10-year period (FY2010-FY2019). Treasury s estimates are smaller, with a $3 billion and a $1 billion gain respectively in the first two fiscal years, becoming a $28 billion loss by FY2019, and losing $171 billion over a 10-year period. 8 Another way to examine the alternatives is to look at the estimated yield for alternative proposals, that is, the liability rather than the flow of revenue to the Treasury. Table 2 provides data from the Urban Brookings Tax Policy Center for the three exemption levels. In 2011, the scheduled rules 8 These Treasury and JCT numbers are reported on a year by year basis in CRS Report R40964, Estate Tax Legislation in the 111 th Congress, by Nonna A. Noto, p. 10. Congressional Research Service 6 Nelson 11

14 SECTION I - EXHIBIT 1 Estate Tax Options ($1 million exemption, 55% rate) are estimated to produce a liability of $34.4 billion; the $3.5 million exemption, 45% rate a revenue of $18.1 billion, and the $5 million exemption/35% rate a revenue of $11.5 billion. Thus, in 2010, the reduced liability from moving to a $3.5 million exemption with a 45% rate is $16.3 billion, whereas moving to the $5 million exemption with a 45% rate loses an additional $6.9 billion, for a total of $26.2 billion. The cost increases over time as the real and nominal value of wealth grows, so that, for example, the reduction in tax from moving to a $3.5 million exemption and 45% rate increases from $16.3 billion in 2011 to $30.7 billion in Table 2. Estate Tax Liability Under Alternative Proposals ($billions) Exemption Level/Rate $ 1 million, 55% rate $3.5 million/45% rate $3.5 million, indexed for inflation/ 45% rate $5 million/ 35% rate $5 million, indexed for inflation/ 35% rate Source: Based on data in Urban Brookings Tax Policy Center, Table T , numbers/displayatab.cfm?docid=2506&topic2id=60&topic3id=66&doctypeid= Notes: For proposals that are indexed,, indexation begins from Table 2 also contains estimates of estate tax liability if exemptions are indexed (assuming indexing back to 2009). Indexing does not make a great deal of difference over this time period. Real growth in wealth is more important. For example the difference between revenues in 2011 and 2019 for the $3.5 million exemption/45% rate is $13.4 billion but only $2.6 billion of the difference is due to lack of indexing for inflation. As indicated above, the two proposals generally discussed are the $3.5 million exemption and 45% tax rate, and the $5 million exemption and 35% tax rate. However, various combinations of rates and exemptions could be considered. Table 3 reports the estimates of estate tax liability for each of the three exemption levels at different rates. It shows that, compared with the default $1 million exemption, a larger amount of the revenue loss results from moving to the $3.5 million exemption rather than the 45% rate. Similarly, in moving from the $1 million to the $5 million exemption, the cost of the exemption increase is smaller than lowering the rate to 35%. However, once the exemption is set a $3.5 million and the rate at 45%, the cost of moving to a $5 million exemption ($14.2 billion) is about the same as the cost of moving to a 35% tax rate ($14.1 billion). The rate reductions tend to benefit, relatively, a wealthier group of estates than exemptions, and thus reduce progressivity of the estate tax. However, rate reductions also reduce the average marginal tax rate more than exemption increases, which could matter for economic efficiency. These distributional issues are discussed more fully in the next section. Congressional Research Service 7 Nelson 12

15 SECTION I - EXHIBIT 1 Estate Tax Options Table 3. Estate Tax Liability 2011: Exemption and Rate ($ billions) Exemption Level 55% rate 45% rate 35% rate $1 million $3.5 million $5 million Source: Based on data in Urban Brookings Tax Policy Center, Table T , numbers/displayatab.cfm?docid=2506&topic2id=60&topic3id=66&doctypeid= Distributional Issues One of the rationales for an estate tax is to impose a tax on high income and high wealth taxpayers, and contribute to the progressivity of the tax system. As indicated in the discussion of coverage, all of the proposals fall on a small proportion of decedents and thus, due to the size of the exemption level, on those with the greatest wealth. The alternative proposals have different effects on the size of estates covered and the distribution of taxes. As indicated in Table 4, the number of estates is concentrated in the smaller estates. With the $1 million exemption, about half of the estates subject to tax have assets of under $2 million and almost 80% have assets of under $3.5 million and these estates would be eliminated from estate tax coverage with either the $3.5 million or the $5 million exemption. With a $3.5 million exemption, the share of taxable estates under $5 million is smaller than the share falling between $5 million to $10 million group. Of the returns taxed under the $3.5 million exclusion, 23% are less than $5 million in assets and would not be taxed under the $5 million exclusion. Table 4. Percentage Distribution of Taxable Estate Tax Returns by Size of Estate, 2011 Size of Estate ($millions) $1 Million Exemption, 55% Rate (44,230 returns) $3.5 Million Exemption, 45% Rate (6,420 returns) $5 Million Exemption, 35% Rate (3,560 returns) Over Total Source: Based on data in Urban Brookings Tax Policy Center, Tables T , T , T As shown in Table 5, revenue from the estate tax is more concentrated in larger estates. The largest share of revenue is in the $20 million and above class regardless of the exemption. With a return to the $1 million exemption that class would pay one-third of the revenue; with a $3.5 Congressional Research Service 8 Nelson 13

16 SECTION I - EXHIBIT 1 Estate Tax Options million exemption it would pay over 60% and with a $5 million exemption it would pay almost three-quarters of the estate tax. These estimates indicate that the estate tax not only applies to high wealth families, but with either the $3.5 million or the $5 million exemption more than half the revenue is collected from estates with $20 million or more in assets. Table 5. Percentage Distribution of Estate Tax Revenue by Type of Return, 2011 Size of Estate ($millions) $1 Million Exemption, 55% Rate ($34.4 billion total) $3.5 Million Exemption, 45% Rate ($18.1 billion total) $5 Million Exemption, 35% Rate ($11.2 billion total) Over Total Source: Based on data in Urban Brookings Tax Policy Center, Tables T , T , T Although the statutory marginal tax rates are often criticized as being very high, the average share of the estate paid in tax is much lower. Part of the reason for the lower effective tax rate is the exemption. For example, even if a $10 million estate has no other deductions and exemption, a $3.5 million exemption means only $6.5 million is taxed. The tax of $2.95 million (45% of $6.5 million) is a tax of 29.5% on the $10 million. As shown in Table 6, the effective tax averages less than 20% for estates up to $20 million and the average rate on those estates is less than 20%. The effective tax rate also rises, generally, with estate size, which would be expected as the exemption is a smaller share of the estate. With the $1 million exemption, the tax is 16.5% in the highest class, while it is 16% under the $3.5 million exemption and 11.5% under the $5 million exemptions. Important reasons for lower effective tax rates are the exemption, spousal transfers, and charitable contributions. The decline in effective tax rate at the very highest estate size for the $1 million exemption may reflect the greater likelihood of charitable contributions and the lesser importance of the exemption. Table 6. Effective Estate Tax Rate (Tax as Percentage of Assets), 2011 Size of Estate ($millions) $1 Million Exemption, 55% Rate $3.5 Million Exemption, 45% Rate, $5 Million Exemption, 35% Rate Congressional Research Service 9 Nelson 14

17 SECTION I - EXHIBIT 1 Estate Tax Options Size of Estate ($millions) $1 Million Exemption, 55% Rate $3.5 Million Exemption, 45% Rate, $5 Million Exemption, 35% Rate Over Source: Based on data in Urban Brookings Tax Policy Center, Tables T , T , T Most distributional analyses of taxes are reported relative to income. As shown in Table 7, the Tax Policy Center has estimated the distribution by income class of the tax for the $1 million exemption /55% rate and the $3.5 million exemption/45% tax rate. As this table indicates, the estate tax is highly concentrated in the higher income classes. For the $1 million exemption, 83% of the tax falls in the top quintile and 45% of the tax in the top 1%. For the $3.5 million exemption, 96% of the tax is imposed on the top quintile and 72% on the top 1%. These results indicate that the estate tax is a highly progressive feature of the federal tax system. 9 Table 7. Distribution of Estate Taxes by Income Class Income Share $1 Million Exemption, 55% Rate $3.5 Million Exemption, 45% Rate Bottom Quintile Second Quintile Middle Quintile Fourth Quintile Top Quintile th Percentile th Percentile th Percentile Top 1% Top 0.1% Source: Based on data from Urban Brookings Tax Policy Center, Tables T and T Notes: Distribution for the $1 million exemption is based on combined data with distributions for 2009 and 2012, weighted by 2010 revenue effects. Distribution for the $3.5 million exemption is for The corporate tax is estimated to have a similar amount of concentration at higher income levels as the estate tax at the $1 million exemption level; the $3.5 million level is more concentrated. The individual income tax is more progressive at the lower end of the distribution, however, because it provides subsidies. For comparisons of taxes see Urban Brooking Tax Policy Center Table T &topic2ID=40&topic3ID=81&DocTypeID=. Congressional Research Service 10 Nelson 15

18 SECTION I - EXHIBIT 1 Estate Tax Options Effects on Small Businesses and Farmers An issue that has played an important role in the debate over the estate tax is the possible impact on small businesses and farms. The role played by the small business issue in the original 2001 legislation is detailed by Graetz and Shapiro. 10 Arguments were made that the estate tax causes families to have to sell businesses to pay the estate tax because there are not enough liquid assets to pay the tax. According to aggregate data for 2008, farm assets account for 2.4% of assets reported on estate tax returns, and business assets constitute 17.9%. 11 These shares include assets of estates where business or farm assets may be a minor part of the estate. Evidence on the effect of the tax on small business suggests that the taxable business estates are a small share of all taxable estates and a small share of estates of all business decedents. Table 8 provides estimates for the coverage of the estate tax reported or derived from the Urban Brookings Tax Policy Center of estates with at least half of their assets in business. As shown in the table, these estates are less than 10% of taxable estates, and, as with other estates, only a small fraction of business estates pay the estate tax (0.2% for the $3.5 million and $5 million exemption). Table 8. Coverage of Estates with At Least Half of Assets in a Business, 2011 Exemption Taxable Estate Returns Percentage of all Taxable Estate Returns Estimated Taxable Estates of Businesses as a Percentage of Decedents with Business Assets $1 million $3.5 million $5 million Source: Based on data from Urban Brookings Tax Policy Center. Data on Taxable Estates of with Half of More of the Estate in Business Assets from Tables T , T09-0i98, and T numbers/displayatab.cfm?docid=2270&topic2id=60&topic3id=66&doctypeid= Data on total number of estates and total decedents from Table T numbers/displayatab.cfm?docid=2506&topic2id=60&topic3id=66&doctypeid= Data on the share of tax returns with at least half of income from business is from Table T numbers/displayatab.cfm?docid=2501&topic2id=60&topic3id=73&doctypeid= Notes: To estimate the share of decedents with business assets, the share of income tax returns with more than half of income from small business (7.5%) was multiplied by the total number of decedents. As shown in Table 9, data indicate that returns with business assets account for a somewhat higher share of the estate tax than they do of the number of taxable estates, suggesting some larger concentration of business assets in larger estates. (Note that in this case, the tax paid 10 Michael J. Graetz and Ian Shapiro, Death by a Thousand Cuts: The Fight Over Taxing Inherited Wealth, Princeton, N.J. Princeton University Press, See CRS Report RS20593, Asset Distribution of Taxable Estates: An Analysis, by Steven Maguire. Assets counted as business include closely held stock, real estate partnerships, other limited partnerships, farm assets, and other noncorporate business assets. If real estate and limited partnerships are excluded, the share is 14%. Congressional Research Service 11 Nelson 16

19 SECTION I - EXHIBIT 1 Estate Tax Options reflects total estate tax, and thus includes tax on business and non-business assets.) However, the effective tax rates (taxes paid as a percentage of the assets of all estates of $1 million or more) are somewhat lower for these small business returns, suggesting the use of discounts may be important. Table 9. Taxes Paid on Small Business Estates, 2011 Exemption/Rate Estate Tax Liability ($billions) Share of Estate Tax Liability Effective Tax Rate, Business Estates Effective Tax Rates, All Estates $1 million, 55% $3.5 million, 45% $5 million, 35% Source: Based on data from Urban Brookings Tax Policy Center. Data on Taxable Estates of with Half of More of the Estate in Business Assets from Tables T , T09-oi98, and T numbers/displayatab.cfm?docid=2270&topic2id=60&topic3id=66&doctypeid= Although the Urban Brookings Tax Policy Center did not separately estimate farmer estates or consider questions of whether these estates had adequate liquid assets to pay the tax, a study done by the Congressional Budget Office (CBO) did examine these issues. This CBO study likely defined farmers more broadly than the Tax Policy Center criterion. At the same time, it examined the subset of estates that took the QFOBI exemption, which would be both small business and farm estates where the heirs expected to continue the business and where more than half of the estate was in the family business. The analysis was for Column 2 of Table 10 reports those values at an average annual growth rate of 3.5% for 11 years (for 2000 to 2011), to project the distribution across estate sizes for (This measure increases the value by the average annual growth rate of the economy minus growth in the labor force for , applied over 11 years, thus taking into account real wealth growth as well as inflation). Table 10 indicates that the number of farm estates, using their measure of farms subject to the tax, would be less than 123 estates at the $3.5 million exemption and about 65 at the $5 million exemption. These estates are about 2% of all estates owing tax. The number of returns claiming QFOBI are also small, accounting for 2% to 2.5% of all taxable estate returns. Table 10. Number of Farm Estates or Estates Claiming QFOBI Deductions with Estate Tax Liability at Different Exemption Levels 2000 Exemption Level ($millions) Level Adjusted for 2011 ($ millions) Number of Farm Estates Percentage of Total Estates Number of QFOBI Estates Percentage of Total Estates Source: Congressional Budget Office, Effects of the Federal Estate Tax on Farms and Small Businesses, July Congressional Research Service 12 Nelson 17

20 SECTION I - EXHIBIT 1 Estate Tax Options Table 11 shows results the study found for a second question: how many estates of these types are likely to have insufficient liquid assets in the estate to pay the tax liability? While there were 138 farm estates in these circumstances for the $1 million exemption, there were only about 15 for the larger exemptions. These returns account for 0.2% and 0.4% of returns paying estate tax. For estates claiming the QFOBI deduction there were 62 at the $3.5 million exemption and 41 at the $5 million exemption. These returns accounted for about 1% of taxable estates. Table 11. Number of Farm Estates or Estates Claiming QFOBI with Insufficient Liquid Assets to Pay the Tax 2000 Exemption ($millions) Level Adjusted for 2011 ($millions) Number of Farm Estates with Insufficient Liquidity Percentage of Total Estates Number of QFOBI Estates with Insufficient Liquidity Percentage of Total Estates Source: Congressional Budget Office, Effects of the Federal Estate Tax on Farms and Small Businesses, July A different survey of farmers performed by the Department of Agriculture estimated that farm estates would pay $683 million in estate taxes in 2009, which would be just under 4% of total estate tax liability, and that 1.6% of farms decedents would pay the estate tax under the 2009 provisions. 12 This share is much larger than the share for businesses overall reported by the Tax Policy Center and is also about twice as large as the estimates implied by the CBO study. 13 Regardless of the data source used, the evidence suggests two important characteristics of businesses and the estate tax: businesses pay a small fraction of the estate tax and a tiny fraction of total estates of businesses and farmers are liable for the tax. If estate tax policy decisions are driven by these concerns, a more target-efficient alternative would be to provide additional benefits for business assets, such as an expanded QFBOBI deduction. 14 Effects on Savings and Output Some claims have been made that the estate tax causes a significant reduction in savings. This effect may be alleged to be so damaging that it justifies eliminating the tax. However, there is no clear basis for this claim. Economic theory does not provide a clear guide. If the bequest motive is primarily to leave a bequest to one s heirs because of concerns about their welfare, the estate 12 Ron Durst, Federal Tax Policies and Farm Households, U.S. Department of Agriculture, Economic Information Bulletin 54, Mau 2009, 13 The number of farms reported in the USDA study are million, and if the average death to population ratio (about 0.008) were applied, the number of total farm decedents would be about 17,000. The 123 returns reported by CBO are about 0.7% of this number. 14 See CRS Report RL33070, Estate Taxes and Family Businesses: Economic Issues, by Jane G. Gravelle and Steven Maguire for a discussion of business deduction options. Congressional Research Service 13 Nelson 18

21 SECTION I - EXHIBIT 1 Estate Tax Options tax could lead to less saving (because a gift to one s children is made more costly relative to one s own consumption, the substitution effect), or it could lead to more savings to retain a larger amount after the estate tax is paid (the income effect). These offsetting income and substitution effects create an ambiguous theoretical prediction about the effect of the estate tax on savings. If the main purpose of accumulating assets is to provide a precautionary savings amount (to account for catastrophic illness, for example), the estate tax does not matter, since it is irrelevant to that purpose. With theoretical uncertainty, the issue becomes an empirical one. Here, however, there is virtually no empirical evidence. In the single study of the wealth elasticity of estates (the percentage change in wealth divided by the percentage change in taxes), Kopczuk and Slemrod characterized their results as fragile, meaning that the results depended on model specification. 15 A study by Holtz-Eakin and Smith used an elasticity from one of the specifications in the Kopczuk and Slemrod study to estimate that the estate tax caused a decrease in wealth of $1.6 trillion. 16 Although this estimate was based on total projected wealth associated with those filing estate tax returns (in 2004), the report indicated the increase in capital was an increase in small business capital (although, as noted above small businesses account for only a fraction, about 16%, of the estate tax). That estimate was, in turn, used to project increases in hiring by small businesses. The effect projected in the Holtz-Eakin and Smith study appears quite large. 17 As a simple illustration, consider that the effect of estate taxes on savings should be similar to the effect of capital income taxes in general. In 2007, the last year for which data on sources of income in the income tax were available, the estate tax accounted for only 4% of capital income tax revenue at the Federal level. 18 This ratio implies that eliminating capital income taxes would increase wealth by $40 trillion ($1.6 trillion dividend by 0.04). This amount would be an approximate doubling of the total U.S. capital stock. 19 Even the most generous model with infinitely elastic savings responses tends to produce an increase of about a third that size, and estimates based on the higher end of empirically estimated time-series savings rates would suggest a result only a tenth of that size. Some effects from dynamic models, depending on how the revenue loss is offset, are negative or negligible Wojciech Kopczuk and Joel Slemrod, The Impact of the Estate Tax on the Wealth Accumulation and Avoidance Behavior of Donors, Working Paper 7960, National Bureau of Economic Research, October Douglas Holtz-Eakin and Cameron T. Smith. Changing Views of the Estate Tax: Implications for Legislative Options, American Family Business Foundation, February Unfortunately, the study did not spell out the methodology used in detail, including not identifying precisely what elasticity was used or how the price and income effects were measured. 18 Based on CBO data the estate tax collected $26 billion in that year, while the corporate tax collected $370 billion and capital gains $126 billion (Congressional Budget Office, The Budget and Economic Outlook for FY2010-FY2019, January 2010, From individual tax return data an additional $121 billion is estimated from the individual income tax (a 15% tax on qualified dividends, a 20% tax on other income including interest, rent, and business income). The estimate assumes that 25% of business income is a return to capital. Data from Internal Revenue Service, Statistics of Income, Individual Income Tax Returns, located at 19 Based on a typical rule of thumb that the capital stock is 3.5 times output, the capital stock would be around $40 billion. Note that a different functional form, such as a constant elasticity function, could alter the projection but not the general magnitude. 20 See Eric Engen, Jane Gravelle, and Kent Smetters, Dynamic Tax Models: Why They Do the Things They Do National Tax Journal, vol. 50, September 1997, pp Results from eliminating capital income taxes ranged (continued...) Congressional Research Service 14 Nelson 19

22 SECTION I - EXHIBIT 1 Estate Tax Options One problem with the estimate in the estate tax study is that it did not take account of feedback effects from the economy, particularly the decline in pre-tax return when the capital stock expands. 21 That feedback effect is the reason that an infinitely elastic response leads to a limited effect: the capital stock expands only enough to drive the after tax return back to its original value. Given lack of theoretical and empirical evidence it is not possible to precisely determine what the effect of repealing the estate tax on savings, but it is likely to be small, simply because the yield of the tax is small. Any effect on the stock of capital in small business should only be a fraction of that amount. The tax rate is more important than the exemption in determining any positive effects of reducing the estate tax on savings, since that rate is more important for the marginal rate that drives the substitution effect. Exemptions affect the substitution effect by pushing some income into a zero marginal tax rate, but are more important for the average rates that determine the income effect, so that higher exemptions are less likely to increase savings than higher rates. Effect on Charitable Contributions Unlike the effect of the estate tax on savings, there is an extensive empirical literature on the response of charitable bequests in the estate tax, and the evidence indicates a significant response of bequests. Nevertheless, according to a recent CRS study, the effect on overall charitable giving is likely to be small: moving from the $1 million exemption with a 55% tax rate to the $3.5 million exemption with a 45% tax rate would be projected to lower charitable giving by 1%; moving to the $5 million exemption with a 35% rate would be projected to reduce giving by 2%. 22 These relatively small effects occur largely because only 4% to 6% of giving is affected by the estate tax. The effects would be larger for foundations and certain types of organizations (such as higher education) that are more likely to receive bequests. Administrative and Compliance Cost Another issue is the degree to which the estate tax causes excessive compliance and planning costs for taxpayers, and administrative costs for the IRS. Some arguments have been made that these costs, particularly for estate planning, are as large as the estate tax itself. Gale and Slemrod, however, review the limited evidence and conclude that the cost of administration and (...continued) from a 1% fall in the capital stock to a 34% rise. 21 In technical terms, the estimate appears to have been made solely from looking at the supply curve and did not take account of the demand curve. The elasticity of the demand curve for capital with respect to the rate of return is the factor substitution elasticity divided by the labor income share of output, and multiplied by the rate of return, divided by the rate of return plus depreciation. The factor substitution elasticity is generally one or less in absolute value (the elasticity is negative), the labor share about two thirds, and the ratio of return to return plus depreciation about 0.7 making the absolute value of the demand elasticity of capital 1.05 or less. Since the total elasticity is the demand elasticity times the supply elasticity, all divided by the sum of the absolute value of the two elasticities, and the calculations imply that the supply elasticity is about 2.22, the inclusion of demand effects would have reduced the projection by over two thirds. 22 CRS Report R40518, Charitable Contributions: The Itemized Deduction Cap and Other FY2011 Budget Options, by Jane G. Gravelle and Donald J. Marples. Congressional Research Service 15 Nelson 20

23 SECTION I - EXHIBIT 1 Estate Tax Options compliance is probably in the neighborhood of 7% of revenues, with almost all of that cost due to planning and compliance. 23 Other Design Issues This section briefly discusses proposals to revise certain features of the estate tax. These include portability of the spousal exemption, changing the rules on certain trusts, restricting minority discounts, and conforming definitions of fair market value for estates and heirs. 24 Portability of the Spousal Exemption Because transfers between spouses are exempt from the estate tax, the estate exemption is of no value to a person who transfers all of his or her estate to a spouse. For example, if the estate tax exemption is $3.5 million and a couple jointly owns assets of $8 million ($4 million each), if the first spouse to die leaves $4 million to the second spouse, and the second spouse then leaves $8 million to children, $4.5 million of the estate will be subject to tax. If the first spouse to die left $3.5 million to the children directly, then the second spouse would have an estate of $4.5 million, with only $1 million subject to the estate tax. There are estate planning options (such as credit shelter trusts) that can address this issue. However, these options (which may also require an initial transfer of assets between spouses) not only require complicated estate tax planning but also may cause taxpayers to dispose of their assets in a way that they would not prefer. Simply allowing a spouse to inherit any unused portion of the exemption is an alternative. In the example above, all of the assets could be left to the remaining spouse on the death of the first spouse, and the second spouse to die would be able to claim a total exemption of $7 million (the sum of both exemptions). Portability can also be valuable with assets, such as pension rights, that cannot be transferred. Although there are some advantages to this provision in both equity and simplified planning, there are problems as well. First, the portability provision will cost increasing amounts of revenue in the future. The JCT provided estimates suggesting that the number of estates benefitting from portability will increase by 14 times over ten years. 25 Thus, allowing portability is likely to substantially decrease revenues in the long run. However, it may be more likely to benefit smaller estates where it may be more difficult to engage in the types of transfers and planning needed to absorb the credits. There are some complications as well for designing and administering this provision, some of which are detailed in the JCT study. 26 Second (and more) marriages raise an issue. Should the 23 William G. Gale and Joel Slemrod, Rhetoric and Economics in the Estate Tax Debate, National Tax Journal, vol. 54, September 2001, pp These issues do not exhaust the possible reforms that might be considered. See CRS Report RL30600, Estate and Gift Taxes: Economic Issues, by Donald J. Marples and Jane G. Gravelle, pp Joint Committee on Taxation, Taxation of Wealth Transfers Within A Family: A Discussion of Selected Areas for Possible Reform, JCX-23-08, 26 See also William J. Turnier, Three Equitable Taxpayer-Friendly Reforms of Estate and Gift Taxation, Tax Notes, April 10, 2000, pp Congressional Research Service 16 Nelson 21

24 SECTION I - EXHIBIT 1 Estate Tax Options inheritance be allowed for future marriages or should it be inherited only once? That is, suppose a widow remarries, and then dies leaving all her assets to a second spouse: does the second spouse inherit two exemptions or one? Is there a possibility for deathbed marriages to terminally ill low income individuals to generate an additional deduction (and how can that be distinguished from legitimate marriages with a tragic early death)? Another question is: should the value of the inherited exemption be limited to the value of the spouse s estate. That seems to be a reasonable rule. Otherwise, if the second spouse continues to accumulate wealth, the portability would effectively increase the exemption over the amount available had each spouse absorbed the exemption in their own estate. Such a rule, however, would require the filing of estate tax returns and valuation of the estate when they would not otherwise be subject to tax. There would also be issues about how to reconstruct fair market value, if the portability were allowed if the first estate tax return were not filed. As with many solutions that seem simple, complications remain. Grantor Retained Annuity Trusts A Grantor Retained Annuity Trust (GRAT) is a trust that allows the grantor to receive an annuity, with any remaining assets transferred to the trust recipient. The value of the gift is reduced by the value of the assets used to fund the annuity. If the assets in the trust appreciate substantially, then virtually all of the gift can be reduced by the value of the annuity, while still providing a substantial ultimate gift to the recipient. If the grantor dies during the annuity period the remaining value of the annuity is included in the estate. Thus for this trust approach to be a method of transferring assets roughly tax free, the assets must appreciate at a rate faster than the discount rate used to value the annuity, and the grantor needs to survive over the period of the annuity. To assure the latter will be likely to occur, many of these trusts have very short annuity periods, as short as two years. The GRAT proposal contained in H.R and in the President s budget proposals 27 would impose a minimum annuity term of ten years, disallow any decline in the annuity, and require a non-zero remainder interest. The Administration estimates this proposal would raise $3 billion over 10 years. Minority Discounts There are existing restrictions to keep estates from engaging in artificial actions designed to reduce the value of estates (such as freezes on assets). As discussed above, courts sometimes allow estates to reduce the fair market value when assets are left in family partnerships where no one has a majority control. These discounts have even been allowed when assets are in cash and readily marketable securities, and the setting up of these family partnerships has become an estate tax avoidance tool. A provision in the Administration s proposal would set up a category of disregarded actions that could not be used to allow discounts. The estimated revenue gain is $18.7 billion over 10 years. 27 For a discussion of these and other proposals, see the Green Book : General Explanations of the Administrations Fiscal Year 2011 Revenue Proposals. February 2010, Congressional Research Service 17 Nelson 22

25 SECTION I - EXHIBIT 1 Estate Tax Options Consistent Valuation There is no explicit rule preventing a low valuation of fair market value for an estate and a high valuation of the asset for purposes of stepped up basis in the hands of the heir. A provision in the Administration s budget proposals would require this value to be the same and is projected to raise $3 billion over ten years. Conclusion The analysis indicates that the estate tax is relatively small, in revenues, in coverage, and in its effects on family businesses, savings, charitable contributions, and tax administration and compliance. One-fourth of 1% or less of all estates and of family businesses are expected to be subject to tax under an exemption of $3.5 million or $5 million. This share would grow slightly over the 10-year budget horizon, but indexing the exemption would not be very important over this short time period. The estate tax is a small, but highly progressive, element of the tax system. Under the proposals under consideration (the $3.5 million exemption and the $5 million exemption), the majority of the tax falls on estates of $20 million or more, which in turn constitute only three-hundredths of 1% of decedents. For the $3.5 million exemption, 45% rate effective in 2009 and under consideration as a permanent treatment, 96% of the tax falls on the top quintile of the income distribution, 72% falls in the top 1%, and 42% in the top 0.1%. Effects on savings are uncertain in direction but likely small. Based on empirical evidence, a decline of 1% to 2% in charitable contributions from increasing the estate tax relative to the current law baseline of a $1 million exemption with a 55% rate would be expected. Costs of estate planning and administration are relatively small as a percent of estate tax revenue. Because transfers between spouses are exempt, allowing spouses to inherit the exemption can increase the combined couples exemption, and simplify estate planning. This change could cost increasing amounts of revenue over time, however, and lead to certain administrative complications. Several provisions to deal with perceived abuses might be considered, with the most important one relating to the use of discounts when assets are left to a family partnership and no one heir controls the property. Author Contact Information Jane G. Gravelle Senior Specialist in Economic Policy jgravelle@crs.loc.gov, Congressional Research Service 18 Nelson 23

26 SECTION I - EXHIBIT 2 Scroggin Sample Client Letter Describing Estate Tax Legislation and Repeal Steve Leimberg's Estate Planning Newsletter - Archive Message #1605 Date: 16-Feb-10 From: Steve Leimberg's Estate Planning Newsletter Subject: Sample Client Letter Explains Estate Tax Changes & Encourages Action "Planning in Chaos" is a good description of planning in the legislative uncertainty of 2010 and Jeff Scroggin recently developed a letter for the members of the National Association of Estate Planners and Councils (NAEPC) that informs clients about what has happened and underscores the importance of updating estate planning documents. NAEPC has made this form letter available to LISI members. John J. ("Jeff") Scroggin has practiced as a business, tax and estate planning attorney in Atlanta for over 30 years. Jeff serves as Founding Editor of the NAEPC Journal of Estate and Tax Planning and is a prior Co-Editor of Commerce Clearing House's Journal of Practical Estate Planning. Mr. Scroggin is the author of over 250 published articles and columns. Jeff is a nationally recognized speaker on estate, business and tax planning issues and has been quoted extensively, including in the Wall Street Journal (1999, 2004, 2005, 2006, 2007 & 2009), CHH Headline News, National Public Radio Marketplace Radio, National Public Radio Talk of the Town, Fortune Magazine, Forbes Magazine, Kiplinger's, Money Magazine, Worth Magazine, Financial Advisor, National Underwriter, Bloomberg Wealth Management, Smart Money Magazine, Journal of Financial Services Professionals, Wall Street Magazine, BNA Estates Gifts & Trusts Journal, Financial Planning, the New York Times, the Chicago Tribune, the South China Post, the LA Times, the Miami Herald and Newsday. Here is Jeff's commentary: EXECUTIVE SUMMARY: Neither the estate planning community nor the Internal Revenue Service anticipated that the 2010 provisions of Economic Growth and Tax Relief Reconciliation Act of 2001's (EGTRRA) would ever see the light of day. There is minimal available guidance from the IRS and given the short duration of any 2010 changes and the possibility of Congressional action in 2010, the IRS may decide that there is little need for more guidance. Most estate plans will need to be reexamined in light of both the 2010 changes and the looming 2011 income tax and transfer tax changes. For the 2.3 million Americans who are expected to die in 2010 the need to have proper planning in place is paramount. Moreover, what responsibility and liability do advisors carry for not informing their clients of the need to update their estate plans? The purpose of the client letter set out below is to provide a format for informing clients of the changes and to encourage clients to contact their advisors to discuss what steps they should consider adopting. FACTS: In August of 2009 LISI, the Wall Street Journal, New York Times, National Underwriter and a Nelson 24

27 SECTION I - EXHIBIT 2 number of other publications noted that Representative Rangel (Chair of the House Ways and Means Committee) and Senator Baucus (Chair of the Senate Finance Committee) had both indicated that Congress would avoid a one year elimination of estate and generation skipping taxes in 2010 by carrying the 2009 rules across Any permanent solutions would be dealt with at a later time. Inexplicably, in early December the House voted in favor of a permanent estate tax exemption of $3.5 million and a flat estate tax rate of 45% and sent the bill to the Senate. Every House Republican and 26 Democrats voted against the bill. Because of its focus on health care and disagreements among Senators on permanent transfer tax changes, the Senate did not enact the House's bill before they adjourned in Thus on January 1, 2010, the federal estate tax and generation skipping tax were eliminated for one year. The step-up in basis rules were replaced with an adjusted carryover basis regime. Unless Congress acts before January 1, 2011, the transfer tax rules will again radically change when the EGTRRA's transfer tax provisions are automatically repealed. This time of chaos is a great time to reconnect with clients, inform them of the changes, discuss how the changes will adversely impact their families and impress upon them the importance of updating their estate plans to account for changes in both 2010 and By informing clients of the changes, advisors may also effectively shifting the burden of responsibility to them. COMMENT: Some initial thoughts on using the letter. The NAEPC produced the letter as an informational form for the clients of members of Estate Planning Councils. Advisors should adjust the form to meet particular client needs as well as any local issues which should be addressed. Fax, and/or mail the letter to your clients. Post the letter on your website. Maintain a list of who you sent this letter to and do follow-up calls and s to your clients. Please note that the NAEPC and its author waive any copyright protections to the letter. Getting more Information: For a greater depth of information on planning in 2010 and 2011, go to the NAEPC Journal of Estate and Tax Planning at The Journal's February 2010 edition will include additional information. Dear [client]: As you may have heard, the federal estate tax rules changed radically in 2010, and could change radically again in 2011 unless Congress passes new legislation. This letter is intended to advise you of what has happened and encourage you to reevaluate your estate plan as soon as possible Tax Act. In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) which provided for significant phased-in increases in the federal estate, gift and generation skipping tax (GST) exemptions and lower tax rates. EGTRRA provisions included: In 2009, the estate and GST exemptions increased to $3.5 million per decedent, with a flat 45% estate and GST tax rate on any excess. The gift tax exemption was $1.0 million, with tax rates from 41% to 45%. In 2010, the federal estate and GST taxes were repealed for one year. The gift tax $1.0 million exemption remained, with a lower flat tax rate of 35%. Thus, you have to die or pay Nelson 25

28 SECTION I - EXHIBIT 2 gift tax to get the benefit of the change. The step-up in basis rules (which gave a "freshstart" fair market basis for most assets of a decedent) was replaced with an adjusted carryover basis. These new basis rules permit a step-up in basis of up to $1.3 million, plus an additional $3.0 million for certain spousal transfers at death. On January 1, 2011, EGTRRA was automatically repealed, resulting in an odd situation: A $3.5 million estate and GST exemption and flat 45% estate tax rate in 2009, no estate or GST tax in 2010, and a $1.0 million estate exemption and tax rate of up to 60% in What Happened in 2009? Estate planning practitioners almost universally expected Congress to carry the 2009 estate tax rules across 2010 (both Representative Rangel as Chair of the House Ways and Means and Senator Baucus as Chair of the Senate Finance Committee said it would happen earlier last fall). However, unexpectedly in December the House failed to act on a one year extension and instead sent the Senate a bill to make the 2009 rules permanent. Because the Senate was focused on health care and there was broad disagreement in the Senate on what to do with estate taxes, Congress enacted no changes to EGTRRA's 2010 rules. Thus, effective as of January 1, 2010, there is no federal estate or GST tax. Planning in Chaos. Congress's failure to adopt estate tax legislation in 2009 and the possibility that changes will not be adopted during 2010, radically change the estate planning considerations of many clients. For example, Congress has indicated that in 2010 about 6,000 decedents will benefit from the elimination of estate taxes, but over 70,000 heirs will pay higher income taxes because of the change in the income tax basis rules for assets received from decedents Changes. The U.S. has an unpredictable planning environment in which any number of radically different changes may occur in 2010: Congress may do nothing in 2010, in which case there is an adjusted carryover basis, and no federal estate or GST tax for people who die in While you probably will not die in 2010, you still need to consider planning for that possibility, because not planning for these changes, if death occurs, can be disastrous. For example: Formula clauses (e.g. terms that allocated your estate exemption to a "by-pass trust") in your planning documents could inadvertently disinherit some heirs and/or your surviving spouse and/or create conflicts among family members on how your documents should be properly interpreted. Conflicts could arise among your heirs and fiduciaries on asset basis issues. Inadvertent GST taxes could be incurred after Passing assets directly to your surviving spouse may result in higher estate taxes after Inadvertent state taxes could be incurred from out of date terms in your documents. Congress may adopt legislation to carry the 2009 rules over 2010, retroactive to January 1, There is broad disagreement on whether a retroactive tax bill would be constitutional. If a retroactive law it adopted, it will be challenged as unconstitutional and it could take years for the Supreme Court to rule on the issue. Until such a ruling, uncertainty will prevail. Those dying after any enactment should not have that uncertainty. In any event, your estate plan should contemplate dying both before or after a potential retroactive enactment, which may or may not be constitutional. If Congress acts in 2010 to address the estate tax issues, it could: Adopt permanent estate tax exemption, beginning in 2010 or If so, most commentators anticipate estate tax exemptions to fall between $2-5.0 million and tax Nelson 26

29 SECTION I - EXHIBIT 2 rates 35% to 45%. Adopt a temporary higher estate exemption. Adopt rules to limit or eliminate valuation discounts Changes. Unless Congress enacts new legislation in 2010, then on January 1, 2011, a number of automatic changes occur to the federal tax code, including: The estate tax exemption drops to $1.0 million per decedent. The estate tax rate increases (e.g., 55% above $3.0 million and 60% above $10 million). States which remain "coupled" to the federal estate tax will have their state death taxes restored. Thus, if you own property in one of these coupled states, you could have new exposure to a state estate tax. The fair market value step up in basis returns for assets passing from a decedent. The top income tax rates go up by at least 4.6%, capital gain tax rates go up by up to 5% and dividend tax rates go up by up to 24.6%. Higher Taxes. No matter what happens to the estate tax, substantial tax increases are looming. A $12 trillion deficit is projected for the next decade. The Congressional Budget Office indicates that the social security trust fund will pay out more then it receives starting in 2011 or Taxes will have to increase across a broad range of Americans. Both the Washington Post and the New York Times have stated that the President will have to abandon his pledge to only increase taxes on taxpayers earning over $250,000. Given slow economic recovery and the fact that we are in a midterm election year, the federal government will probably not increase taxes until sometime in While substantial tax increases are likely, we just don't know any details. ROTH IRAs. In 2010, taxpayers can convert traditional IRAs to ROTH IRAs and can pay the income taxes due on such conversion in 2010 or equally in 2011 and There are significant benefits and traps for the unwary in making these decisions. Effectively, unless Congress adopts new legislation, in 2010 the estate tax rules rotate 180 degrees from where they were in 2009, and then rotate 180 degrees again in 2011 only the estate tax and income tax rules could be even worse than what we had in Uncertainty makes it difficult to plan, but waiting to see what happens next is not a good idea. The earlier you can implement flexible tax and estate planning to respond to these changes the better. Please call us to schedule a time to go over your current estate plan and determine what changes need to be made to your current plan to minimize taxes and to reduce the possibility of future family conflicts in these chaotic times. Unless we otherwise hear that you want to engage us to review your existing plan, we will not begin that process. Sincerely, HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Jeff Scroggin CITE AS: LISI Estate Planning Newsletter #1605 (February 16, 2010) at Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. Nelson 27

30 SECTION I - EXHIBIT 3 Barry A. Nelson Fellow, American College of Trust and Estate Counsel Master of Laws in Taxation Board Certified Taxation & Wills, Trusts & Estates Judith S. Nelson Former Judge of Compensation Claims Mirlene E. Dubreuze Office Manager «Full_Name» «Mailing_Address» Nelson & Nelson: Tax Update March 9, 2010 LAW OFFICES OF NELSON & NELSON, P.A Sunny Isles Boulevard, Suite 118 North Miami Beach, Florida info@estatetaxlawyers.com Telephone: TeleFax: March 9, 2010 ASSOCIATES Jennifer E. Okcular Master of Laws in Taxation Jennifer D. Sharpe Master of Laws in Taxation OF COUNSEL Richard B. Comiter Fellow, American College of Trust and Estate Counsel Master of Laws in Taxation Board Certified Taxation RE: Update on Federal Estate Tax Legislation: Inaction by Congress Creates Planning Opportunities and Pitfalls Dear «Nickname», The last paragraph of this letter has been prepared in accordance with Circular 230. Please review the last paragraph before reading this letter. Many of you already know that as of January 1, 2010 the federal estate and generation skipping transfer (GST) taxes are repealed, and the gift tax rate is 35% (down from 45% in 2009). When we wrote our year end planning letter in 2009, few practitioners, including myself, believed that Congress would allow the 2010 tax changes to take effect. Those who have a close connection to Washington politics believe that Congress will act to reinstate the 2009 tax rates. However, the longer Congress waits to act, the possibility that some changes will be prospective rather than retroactive back to January 1, 2010 increases. Thus, while there can be no certainty, it may be possible to take advantage of the current tax rates by implementing certain planning techniques. For example, now may be an ideal time to make gifts to family members or create and fund outright gifts or gifts in trust for grandchildren taking advantage of the 35% gift tax rate and more importantly, current repeal of the GST tax. In other words, a GST transfer while there is no GST tax is a window of opportunity you should consider. In addition, if you made any intra-family loans, and the loan cannot be repaid, now may be a good time to forgive or renegotiate the debt. If you have a Will and/or Revocable Trust, it is more than likely that these documents include references to the unified credit, federal estate tax, and other formulas using tax terms. Depending on your net worth and family relationships, your documents may no longer reflect your wishes. We recommend that you schedule a conference to ensure that your documents still reflect your wishes in light of the changes in the estate tax laws and to take advantage of potential planning opportunities. The possibilities of potential planning are diverse and, as one practitioner said, It s not one size fits all. Nelson 28

31 SECTION I - EXHIBIT 3 I have waited until now to update you to see if there may be any indication that Congress would address estate, gift, and GST issues early in 2010 to resolve the chaos the existing uncertainty causes, and as of the date of this letter, there is no clear current indication when Congress will take action on this matter. You are probably aware of the apparent inability of the existing Congress to make progress in many vital issues. The consensus of tax attorneys who follow the estate, gift, and GST tax issues is that, if action is not taken shortly, there is a greater likelihood that Congress will wait until after the November 2010 elections. In such event, there is some possibility that, if legislation is enacted in November of 2010 or later, it could be prospective and not retroactive or it may allow the taxpayer to elect whether the current law or the subsequently enacted laws would apply for In certain circumstances, taxpayers would be better off if estate taxes are reenacted effective January 1, 2010 because such reenactment would provide taxpayers whose deaths occur in 2010 with a step up in income tax basis. For taxpayers with estates of $3.5 million or less or a spouse with $7 million or less for those who benefit from the estate tax marital deduction, a stepped up income tax basis may be preferred over estate tax repeal since the $3.5 million exemption or marital deduction would generally offset any estate taxes and the step up in income tax basis provides an immediate potential benefit. You should also consider whether a Roth IRA conversion may be beneficial for you. New rules that became effective January 1, 2010 provide opportunities for those with IRAs or 401(k) Plans that could result in significant future income tax benefits. We suggest that you review the Roth conversion issues with your CPA, financial planner, or us. We want to ensure you do not neglect your estate tax planning needs, especially in light of the changes we have described herein. If you have any questions regarding your current estate plan or would like to review current potential estate planning opportunities, please contact Victoria at our office and schedule an appointment, if you are currently a client of ours. No one, without our express prior written permission, may use any part of this letter in promoting, marketing or recommending an arrangement relating to any federal tax issue. Furthermore, it may not be shared with any other person without our prior written consent other than as required by law or by ethical rules. However, this prohibition on sharing this letter does not preclude you from sharing with others the nature of this transaction or the fact that you consummate it. Should you have any questions, please feel free to contact me. Very truly yours, BARRY A. NELSON For the Firm G:\MEDIA\Mailings & Announcements\ Update Letter\ Estate Tax Legislation Planning MERGE.doc Nelson 29

32 SECTION I - EXHIBIT 4 Nelson & Nelson: Tax Update December 21, 2009 Year-End Estate and Gift Tax Planning for 2009 December 21, 2009 VIEW AS A WEB PAGE VIEW OR PRINT PDF... This information has been prepared in accordance with Circular 230. Please review the last paragraph of this message before reading this or it's attachments.... Dear, We wish you a happy and healthy new year and holiday season. We have prepared this year-end letter for your consideration. With best regards from all of us at Nelson & Nelson PA. As we approach the end of 2009, I wanted to take a moment to reach out to you and remind you that now is a great time to take advantage of certain gift and estate tax planning techniques as well as update you on recent developments in estate and gift tax legislation. Extension of $3.5 Million Unified Credit On December 3, 2009, the U.S. House of Representatives passed a bill that would permanently extend the current $3.5 Million Unified Credit (the amount of money that can pass estate tax free upon death) and top estate tax rate of 45%. This bill needs to be voted on in the Senate before it becomes law and, as of December 20th, no such action has been taken. Unless a law is enacted, estate taxes would disappear for 2010 and return in 2011 at pre-2001 levels of a $1 Million Unified Credit and estate tax rates as high as 60% for larger estates. Almost all commentators believed that Congress would act before 2010; yet it now is extremely questionable whether such action will be taken. If not, most believe that any legislation in 2010 will be retroactive to January 1, Yet there could be challenges to retroactive legislation, especially to retroactively increase the 35% gift tax rate that becomes effective on January 1, If legislation is enacted it will resolve the most pressing issue relating to estate taxes (i.e., rates and exemptions); however, there are other estate and gift tax proposals in the works (see below for further discussion). Use of Gift Tax Exemptions to Reduce Estate and Gift Tax Any estate exceeding the Unified Credit (currently $3.5 Million) will be subject to a 45% tax on the excess amount. Lifetime gifts (once the $1 Million gift tax exemption is exceeded) are also subject to a 45% gift tax; however, certain types of lifetime transfers are exempt from gift tax, and the end of the year is a good time to make Nelson 30

33 SECTION I - EXHIBIT 4 these tax-free gifts. These gifts include utilizing your annual exclusion amount (currently $13,000 per donee). These gifts can be made outright, in trust (if the trust provides certain withdrawal rights also referred to as Crummey Powers), or via a 529 college savings plan. 529 plans also allow you to make 5 years worth of annual exclusion gifts up front (therefore, assuming no other anticipated gifts to the 529 plan beneficiary, a donor can gift $65,000 in one year to a 529 plan) for that beneficiary if an election is made on a timely filed gift tax return. Charitable contributions are also tax free if made to a qualified exempt organization and can be made in the form of an IRA rollover up to $100,000 (subject to certain limitations). Review of Estate Planning Documents The Unified Credit was increased from $2 Million to $3.5 Million on January 1, We recommended at the end of last year that our clients schedule a conference to review their estate plans to ensure they are taking full advantage of the amount that can pass tax free upon their death and to determine if any formula gift using the prior Unified Credit to children and/or grandchildren is excessive as a result of the increased $3.5 Million exemption. Many Wills and Trusts have formula gifts that provide for the Unified Credit amount applicable in the year of death to pass to specified beneficiaries. Thus, it is possible for the unanticipated consequence of a disproportionately large gift to children and an insufficient gift to a surviving spouse. Planning is also important so that a husband and wife will both take advantage of their Unified Credits without creating potential creditor protection exposure. Failure to take advantage of both spouse's Unified Credit for a couple with a net worth of $7 Million could cause unnecessary additional estate taxes of as much as $1,575,000 (i.e., 45% of $3.5 Million). If asset protection is a concern, extreme care is necessary before restructuring assets to take advantage of the Unified Credit. Accordingly, these issues should be reviewed so you can make informed decisions to take advantage of your Unified Credit without subjecting yourself to additional asset protection exposure. Easy Planning for Intra-Family Loans Intra-Family Loans are another technique for shifting wealth between family members. The transaction is premised on the assumption that the funds loaned will appreciate at a greater rate than the interest the IRS requires to be charged on the loan. The required interest rate is updated monthly by the IRS and is referred to as the Applicable Federal Rate ("AFR"). The December 2009 AFR for loans with a duration of three (3) years or less is 0.69% and for loans of more than 3 years but not greater than 9 years the interest rate is approximately 2.64% in December Loans of greater than 9 years for December 2009 require interest of 4.17%. These rates assume annual compounding and remain at record lows. To see how easily this transaction can work, consider a loan of $1 million to your children or a trust for your children. If the money grows by 7% annually, your children or the trust for their benefit will earn $70,000 per year and yet only owe $ 6,900 in interest (assuming a 3 year loan in December of 2009). The additional growth of $ $63,100 is a tax-free gift to your children (or to their trust). This rate is locked in, even if interest rates increase during the term of the loan. This may also be an opportunity to consider refinancing intra-family loans made in the Nelson 31

34 SECTION I - EXHIBIT 4 past at significantly higher interest rates. Any such negotiation should be at arm's length and if the interest rate is reduced, taxpayers should consider having the borrower give the lender consideration, such as a prepayment of a portion of the principal or a reduction of loan duration, in exchange for the reduction of interest rates to the current AFRs. Possible Changes in Estate Tax Laws While it looks like the Unified Credit will remain at $3.5 Million, there are other changes to estate tax laws that Congress is still considering. Various Congressional proposals include eliminating discounts in intra-family transactions, mandating a minimum term of 10 years for GRATS, unifying the estate and gift tax exemption (allowing taxpayers to use their Unified Credits during their lifetime), and portability of the estate tax exemption (i.e., allowing a surviving spouse to use any unused exemption of their deceased spouse). Roth IRA Conversions Beginning on January 1, 2010 there will be no income cap on Roth IRA conversions. When you convert your traditional IRA to a Roth IRA, you will be required to pay taxes on the income now (or elect to split the tax in 2011 and 2012). By recognizing the income now, you are hedging against the anticipated increase in future tax rates. In addition, unlike traditional IRAs, Roth IRAs do not require minimum distributions, so if you do not need the additional income and would like to leave your IRA to your children or grandchildren, a Roth IRA may be a good option. However, not everyone will benefit from a Roth conversion. If you are about to retire or do not have funds outside of your IRA to pay the taxes now, you may not be a good candidate for a Roth conversion. We recommend scheduling a meeting with your CPA, your financial advisor or our office to determine whether or not you will benefit from this planning technique. * * * In conclusion, we hope that the information in this letter is useful in your year-end planning. If you wish to take advantage of any of the planning techniques that we have described, please feel free to call our office. I hope that the remainder of 2009 will be happy and healthy for you and your family. Regards, Barry A. Nelson Nelson & Nelson, P.A. barry@estatetaxlawyers.com... No one, without our express prior written permission, may use any part of this letter in promoting, marketing or recommending an arrangement relating to any federal tax issue. Furthermore, it may not be shared with any other person without our prior written consent other than as required by law or by ethical rules. However, this prohibition on sharing this letter does not preclude you from sharing with others the nature of this transaction or the fact that you consummate it. Nelson 32

35 SECTION I - EXHIBIT 5 Scroggin & Douglas: Should Clients Consider Gifting Before the End of 2010? Steve Leimberg's Estate Planning Newsletter - Archive Message #1668 Date: 01-Jul-10 From: Steve Leimberg's Estate Planning Newsletter Subject: Scroggin & Douglas: Should Clients Consider Gifting Before the End of 2010? "Most of our caucus is very concerned about what will happen on the estate tax, and I think there are some who would probably be with Sen. Kyl, but I think it's a small number." Sen. Bob Casey (D-PA) in May 2010 There is no agreement on the estate tax either in substance or process. None whatsoever. Senate Finance Committee Chairman Max Baucus in May 2010 "We no longer have an agreement, because the Democratic side has decided that unless a matter has a guaranteed majority of Democratic votes going in, they're not going to allow it on the floor, at least not voluntarily," Minority Whip, Senator Jon Kyl in May 2010 Jeff Scroggin and Charlie Douglas provide members with a comprehensive look at the many factors that can and should be evaluated when the question presented is whether clients should consider gifting before 2010 comes to a close. John J. ( Jeff ) Scroggin has practiced as a business, tax and estate planning attorney in Atlanta for over 31 years. He holds a BSBA in accounting, J.D., and LL.M (Tax) from the University of Florida. Jeff serves as Founding Editor of the NAEPC Journal of Estate and Tax Planning and is a prior Co-Editor of Commerce Clearing House s Journal of Practical Estate Planning. He has been a member of the Board of the National Association of Estate Planners and Councils since Mr. Scroggin is the author of over 230 published articles and columns. He has been named as a 2009 and 2010 Georgia Super-Lawyer and as a 2009 and 2010 Five Star Wealth Advisor. He is an Accredited Estate Planner. Jeff is a nationally recognized speaker on estate, business and tax planning issues and has been quoted extensively, including in the Wall Street Journal, CNN Headline News, MSNBC, National Public Radio, Fortune Magazine, Forbes Magazine, Kiplinger s, Money Magazine, Worth Magazine, Financial Advisor, National Underwriter, Bloomberg Wealth Management, Smart Money Magazine, Journal of Financial Services Professionals, Wall Street Magazine, BNA Estates Gifts & Trusts Journal, Financial Planning, the New York Times, the Chicago Tribune, the South China Post, the LA Times, the Miami Herald and Newsday. Jeff owns one of the largest private collections of tax memorabilia in the US. Charlie Douglas has practiced in the business, tax, estate and financial planning areas for over 25 years. He holds a J.D. from Case Western Reserve School of Law and possesses the Certified Financial Planner and an Accredited Estate Planner designations. He currently serves as Co-editor of the NAEPC Journal of Estate and Tax Planning and is a Senior Vice President with Wells Fargo's Private Bank, where he specializes in providing comprehensive and customized planning solutions for business Nelson 33

36 SECTION I - EXHIBIT 5 owners, high net-worth individuals and their families. Charlie is a speaker and author on the subject of values-based planning and has published numerous articles and books on the topic. The authors gratefully acknowledge the help of Michael Van Cise in reviewing and improving this article. Now, here is their commentary: EXECUTIVE SUMMARY: Wealth planning advisors have been impatiently waiting for years for Congress to restore clarity to the transfer tax rules. Given the recent demise of a Baucus/Kyl sponsored changes in the Senate, it appears that transfer tax reform is dead for this year. With an effective transfer tax rate as low as 25.93% (if the donor survives the gift by three years), every affluent client needs to consider the idea of gifting in Transfer tax rates are only going up in future years. COMMENT: Our commentary will examine some of the gift planning opportunities that exist for the remainder of The tax issues surrounding the computation of federal gift taxes, particularly their inclusion in the computation of federal estate taxes, are quite complex. We have not attempted to show every nuance of the computations and have purposely simplified and rounded computations used in the examples. As Howard Zaritsky noted in RIA Federal Tax Update on April 1, 2010: Serious planning for generation skipping transfers is virtually impossible in The only thing we know is that outright generation-skipping transfers in 2010 are not taxable. Therefore, we have not provided any significant discussion of the GST issues in gift planning for Perspectives on Transfer Tax Rates The Chance for Reform in 2010? While the chance for any transfer tax reform in 2010 is rapidly diminishing, it is not yet completely dead (but the pulse is pretty faint). While many articles have been written on the chances for permanent transfer tax reform (See: Scroggin, A Smaller Estate Exemption or a Return to 2001? A Contrarian View, LISI Estate Planning Newsletter #1521, September 17, 2009), there are a few lessmentioned reasons why reform is probably not going to occur this year: Is it politically feasible to concurrently grant the rich an estate tax break when their income taxes are going up significantly? Senator Bob Casey (D-PA) put it this way after the mid-may bipartisan estate tax discussions in the Senate broke down, I think it would be a big mistake when everybody is yelling about spending and deficits to have the very wealthy people get off the hook. The idea that we re going to give an incredible economic advantage to less than 1% of the population is really offensive to me, to Nelson 34

37 SECTION I - EXHIBIT 5 understate it dramatically. Senator Casey has indicated that 80% of the Senate Democrats are opposed to the proposal of a $5.0 million exemption and 35% estate tax rate. Congress may actually embrace the new-found gift tax revenue from clients who decide to make significant gifts in This sounds remarkably similar to Congress offering future tax benefits to taxpayers who convert their traditional IRAs to ROTH IRAs in When the Tax Reform Act of 1976 raised the maximum gift tax rate from 57.5% to 70%, gift tax receipts quadrupled in the months between the law s enactment and its effective date. The Congressional Budget Office estimates a dramatic surge in gift tax receipts to more than $14 billion for more than double the amount of gift tax receipts collected in 1976 and by far the most in our nation s history. With the elimination of date of death fair market value basis for decedents passing in 2010, estimates are that the sale of estate assets by heirs will generate significant new tax revenue in future years possibly more than was lost to the one year repeal of estate taxes in At least that was the expectation until the Texas oilman died on March 28th leaving a $9.0 billion estate. The vast majority of states have reported budget deficits the last two years. Many minimized significant cut-backs last year by using federal stimulus dollars. That option will not be available in 2010 and future years. However, over half the states remain coupled to the federal state estate tax credit provided for in IRC section If the 2001 tax rules return in 2011, not only would the federal government receive a revenue boost, but the coupled states would also see automatic increases in revenue from their restored estate taxes, without having had to enact an unpalatable tax increase. However much they may gripe, even Republicans recognize that new sources of federal revenue are an absolute necessity. If Republicans gain control of either side of Congress in the midterm elections, they may thank the Democrats for their 2010 inactivity: Republicans may get to claim credit for reductions in the federal deficit which are funded by higher estate taxes, while campaigning (and obtaining campaign contributions) to reduce the federal estate tax. Consider the 2011 Rates. In 2009 the effective gift tax rate ranged from 41-45%, once the $1.0 million gift exemption was utilized. Estate tax rates in 2009 were a flat 45%. The gift tax rate for 2010 is a flat 35% for gift amounts above the $1.0 million gift tax exemption. In 2011 the top transfer tax rate (on gifts and bequests over $3.0 million) will be 55%, with an additional 5% surtax is imposed on transfers from $10.0 million to $17,184,000. The surtax was designed to eliminate the benefit of the lower marginal tax rates and raise the effective transfer tax rate on larger wealth transfers to a 55% rate. Higher Transfer Tax Rates in the Future? But will the maximum transfer tax rate of 60% in 2011 necessarily be the highest rate in future years? Consider that in 1977 the newly unified gift and estate tax rate maxed out at 70%. More onerous transfer taxes are possible as a necessary source of increasing revenue. We are facing a long term public Nelson 35

38 SECTION I - EXHIBIT 5 financial crisis. The U.S. is now in its 3rd consecutive year of trillion-dollar-plus annual deficits and it has tens of trillions of dollars of unfunded and off balance sheet liabilities for entitlement programs. Its debt to GDP ratio is already an alarming 96.5% and that percentage is sure to skyrocket as baby-boomers continue to strain the entitlement systems in the years to come. Transfer tax rates stand a far better chance of going up, not down, and there is historical precedent during unprecedented times for an increase in transfer tax rates, particularly if Congress fails to bring long term deficits under control. It s always easier to take money from dead taxpayers they complain less than the live ones Offers a Unique Opportunity. We enter the second half of 2010 without a hint of a legislation from Congress to modify the transfer tax rules in 2010 or deal with the sun-setting of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) in With a 71% increase in the top transfer tax rate (i.e., from 35% for gift taxes in 2010 to 60% in 2011) automatically taking effect in six months and with the additional benefits of no GST Taxes in 2010, clients need to understand the benefit of pre-paying transfer taxes before the end of It s time to start considering the options now, even if the plans are implemented later in the year. The delay of planning until the end of 2010 could be a profound and costly mistake. Understanding Gift Taxes Ever since the passage of EGTRRA, most estate planners have not given significant attention to the gift tax planning opportunities available from pre-paying gift taxes. That perspective will radically change in Tax Exclusion Planning. Since 2001, most estate planning advisors have discouraged clients from making taxable gifts because permanent higher estate exemptions might make the payment of gift taxes an unnecessary reduction of an inheritance. However, as we recognize the possibility of a long term reduction in estate exemptions and increases in estate tax rates, paying gift taxes may trump waiting to pay estate taxes, particularly in 2010 when the gift tax rate is a flat 35%. If the donor survives the gift by three years, the effective rate (compared to an estate tax) is 25.93%. Planning Example: If the donor pays the gift tax, the donor effectively transfers $1.35 of value for each dollar gifted, but is only subject to tax on one dollar. Therefore, the true rate of the tax (if the donor survives by three years) as compared to a transfer on death where the entire $1.35 would be subject to tax is determined by the following formula: $1.35 multiplied by rate X = $0.35. By solving for X, you determine that the true rate of tax when one considers the full benefit to the donee of the transfer is approximately 25.93%. With a valuation discount on intra-family transfers (e.g., minority interest and lack of marketability discounts), the effective transfer tax rate is even lower. Pre-payment of gift taxes can have a decisive advantage over the payment of estate taxes. The principal reason is that gift tax is calculated on a tax-exclusive basis (on the Nelson 36

39 SECTION I - EXHIBIT 5 value of the property transferred) while the estate tax is calculated on a tax-inclusive basis (on the value of property transferred plus any amount used to pay the estate tax). This striking difference in how these taxes are calculated allows families to preserve more of their wealth by paying gift tax on a taxable lifetime transfer instead of paying an estate tax on a bequest. Planning Example: Assume a donor has $6,000,000 available to make a lifetime gift and pay the resulting gift tax. Assume further that the full amount of the gift is taxable and that a 55% marginal estate tax rate (i.e., assuming death occurs after 2010) and 35% gift tax rate applies. The donor can make a $4,444,444 gift and pay the resulting gift tax liability of $1,555,556 (i.e., $4,444,444 x 35%). If on the other hand, the donor bequeathed the entire $6,000,000, then the Donor could only transfer $2,700,000 (i.e., $6,000,000 less a 55% tax). The net result is that the donor transferred an additional $1,744,444 (i.e., $4,444,444-$2,700,000) - 64% more - by making a taxable gift as opposed to a bequest. The Gross-up Rule. One of the biggest risks of incurring a gift tax is that the gift tax can become a tax-inclusive tax if the donor/payor of the gift tax fails to survive the gift by three years. IRC section 2035(b) provides: The amount of the gross estate... shall be increased by the amount of any tax paid under [the gift tax rules] by the decedent or his estate on any gift made by the decedent or his spouse during the 3-year period ending on the date of the decedent's death. Note that the date of the gift, not the date of the payment of the gift tax or the filing of the gift tax return begins the running of the three year statute. If the payor of the gift tax dies within three years of the gift, any federal gift tax the decedent paid is included in the taxable estate, even if the asset subject to the gift tax is not included in computing the decedent s estate taxes (e.g., in gift-splitting when the other spouse was the sole donor, but the decedent paid the gift tax). IRC section 2035(b) does not include gift tax payments in the donor s estate to the extent the gift tax was paid by the decedent s spouse pursuant to a gift-splitting arrangement. The relevant tax policy is that there is no incentive to restore the decedent s estate under IRC 2035 because no amounts were removed from the estate by the gift tax payment. Prepaying transfer taxes not only provides for a lower effective transfer tax rate, it also moves future appreciation on the asset outside the donor s taxable estate. Part of any analysis on making taxable gifts include the expected income tax cost of a loss of fair market value basis at death (or the partial step-up permitted in 2010) and the estate taxes payable at the time of death. Planning Example: Even if the donor is not expected to survive for three years, making a taxable gift may still make sense, particularly with a rapidly appreciating asset. For example, assume a taxpayer has an asset worth $1.0 million which grows at 25% per year. Assume further that the taxpayer is in a 55% transfer tax bracket. If taxpayer has a life expectancy of two years, the gift would remove almost $563,000 (i.e., $1,000,000 at an annual rate of 25% grows to almost $1,563,000) in appreciation from the taxable Nelson 37

40 SECTION I - EXHIBIT 5 estate, saving up to $310,000 in transfer taxes. Moreover, the payment of a gift tax of $350,000 removes the increase which might have come from those assets from the taxable estate (e.g., if the $350,000 tax would have generated an after-tax 10% return, an additional $73,500 is removed from the taxable estate). State gift taxes are not pulled back into the taxable estate. See: Revenue Ruling , CB 170. Even though state gift tax rates are normally low and few states impose them, there may still be some benefit from reducing the estate by paying state gift taxes and not having to be concerned about the three year rule. Transferee Liability. The donor is primarily liable for the gift tax imposed on the gift pursuant to IRC section 6324(b) and Treasury Regulation section (a). However, if the donor does not pay the tax, section 6324(b) places a lien on the gifted asset, which effectively means that the donee is liable for unpaid taxes, penalties and interest of any gift received by the donee, not to exceed the value of the gift. Thus, if the gift is determined to be larger than that reported on the gift tax return, the donee may have personal liability for the increase to the extent of the value of the gift. See also Armstrong discussed below. Generally, unless the donee has assumed primary liability (e.g., by contract pursuant to a net gift arrangement), the donor or the donor s estate will still have primary liability. IRC section 6324(a)(2) provides that donees may also be liable for the estate tax when gifts are pulled back into the taxable estate (e.g., pursuant to IRC section 2035(a) for an insurance policy transferred within three years, or pursuant to 2035(b) for a gift tax added to the taxable estate). Basis Issues. In general, the donee of a gifted asset takes over the tax basis of the donor. IRC section 1015(a) provides: If the property was acquired by gift..., the basis shall be the same as it would be in the hands of the donor... except that if such basis... is greater than the fair market value of the property at the time of the gift, then for the purpose of determining loss the basis shall be such fair market value. If the donor s basis in the asset exceeds its fair market value, the rules get a little more complicated for the donee. If the donee subsequently sells the asset for a gain, the donee uses the donor s basis in the property. If the donee sells the asset for a loss, the fair market value of the donated assets is used as the basis. Thus, if the donee sells for a price between the fair market value and the donor s basis, neither a loss nor a gain is incurred. Planning Example: If a low basis asset is transferred to the donee, the value of the gift is effectively reduced by the income tax or capital gain tax the donee will ultimately pay upon the sale of the asset. For example, if a zero basis stock worth $10,000 is transferred to a child, the real value of the gift may only be $8,000 (e.g., $10,000 less a 20% federal capital gains tax in 2011). Instead, consider selling the asset and gifting cash of $10,000 to the child. Not only is a higher value transferred out of the estate, but the payment of the capital gains tax reduces the donor s estate. IRC section 1015(d)(6) provides: In the case of any gift made after December 31, 1976, Nelson 38

41 SECTION I - EXHIBIT 5 the increase in basis provided by this subsection with respect to any gift for the gift tax paid under chapter 12 shall be an amount (not in excess of the amount of tax so paid) which bears the same ratio to the amount of tax so paid as (i) the net appreciation in value of the gift, bears to (ii) the amount of the gift. Net appreciation in value of any gift is the amount by which the fair market value of the gift exceeds the donor's adjusted basis immediately before the gift. At least two issues should be noted in dealing with 1015(d)(6). First, only the gift tax on the net appreciation in gain is taken into account. Second, the Code would appear to differ from the regulations on what is the amount of the gift. Treasury Regulation section (c)(2) reads: In general, for purposes of section 1015(d)(6)(A)(ii), the amount of the gift is determined in conformance with the provisions of paragraph(b) of this section. Thus, the amount of the gift is the amount included with respect to the gift in determining (for purposes of section 2503(a)) the total amount of gifts made during the calendar year (or calendar quarter in the case of a gift made on or before December 31, 1981), reduced by the amount of any annual exclusion allowable with respect to the gift under section 2503(b) Although there is no similar language in IRC section 1015(d)(6), the above regulation reduces the amount of the gift by any applicable annual exclusions. Bottom line: when annual exclusions are available, consider using them to both reduce the taxable gift and provide a greater basis adjustment for the donee. Planning Example: Assume in 2010 that a married client who has previously used all of her gift exemption transfers an asset worth $1.0 million (with a basis of $300,000) to 15 heirs. Gift splitting is elected for the gift, with the result that $390,000 of the gift are excluded as annual exclusion gifts. The gift tax is $213,500 (i.e., $610,000 times 35%). What is the basis addition pursuant to IRC section 1015(d)(6)? If the annual exclusions are not treated as a part of the amount of the gift, the addition to basis is $149,450 (i.e., $213,500 times the sum of appreciation of $700,000 divided by the $1.0 million gift). But if we follow the regulations, the amount of the gift is reduced by $390,000 and the addition to basis in increased to $213,500 (i.e., $213,500 times the sum of the appreciation of $700,000 divided by the revised amount of the gift of $610,000, but with the basis adjustment not being in excess of the gift tax paid). Normally, one of the major detriments to lifetime gifting is the application of the carryover basis rules provided for in IRC section 1015 in lieu of a fair market value basis if the transfer occurred at death. However, for gifts by persons who die in 2010, this detriment is reduced somewhat. In 2010, IRC section 1022 provides that the basis of assets of decedent estates will be an adjusted step-up of up to $1.3 million, with an additional step up of up to $3.0 million on certain types of spousal bequests. Additional step up is permitted for certain losses carried over from the decedent. Three limits on the step up rules in 2010 have not received much attention: Nelson 39

42 SECTION I - EXHIBIT 5 Section 1022(d)(2) provides that any step-up cannot exceed the fair market value of the asset. Therefore, appraisals will still be necessary. Section 1022(d)(1)(c)(i) provides that if assets are gifted to the decedent within three years of the decedent s death the decedent s personal representative may not allocate basis adjustment to the gifted asset. There is an exception for certain gifts received by the decedent from a spouse. Section 1022(d)(1)(B)(iii) provides that a decedent will not be treated as owning any property by reason of holding a power of appointment over the property. Therefore, even though a general power of appointment might have pulled an asset into the estate of the decedent, there is no basis adjustment permitted pursuant to section Clients should consider the tax basis benefits of exercising a power of appointment before death. Planning Example: If a client is expected to pass in 2010 and owns assets which might be discounted in value, consider the idea of eliminating the minority ownership discount to obtain a higher basis at the time of death. For example, assume a married client owns 40% of an LLC which owns several real properties. If the estate s total appreciated value (i.e., the difference between fair market value and the client s basis) after the redemption is less than $4.3 million, consider (before death occurs) redeeming the client s LLC interest for one or more of the underlying pieces of real estate. In the alternative, another LLC member (e.g., a spouse) could gift or sell an 11% LLC interest to the client, permitting the application of a control premium to the LLC value in the decedent s estate. Obviously, there are other factors which may adversely impact such a plan (e.g., maintaining family control of the asset). GST Taxes. The rules and issues governing gifts to GST trusts in 2010 are confused and beyond the scope of this article. With the elimination of the GST tax for 2010 and the uncertainty over the GST tax treatment of post-2010 distributions from GST trusts, clients who are considering making gifts to GST trusts should consider the benefit of making such gifts directly (as opposed to using GST trusts) to grandchildren and other skip persons. If the client wants to reduce the control of the donee, consider using manager managed FLPs and LLCs or non-voting stock. In any case, the client is well advised to have provisions allowing the company a right to repurchase the gifted interest for its fair market value (e.g., as part of a right of first refusal). Holding Period. IRC section 1223(2) provides that the donee s holding period is tacked to the holding period of the donor. Therefore, the donee can more easily qualify for long term capital gain treatment. Gift Planning in the 2010 Environment. Estate Planning in The conditions for 2010 wealth transfer planning are uniquely favorable due to a number of factors, including: Nelson 40

43 SECTION I - EXHIBIT 5 Historically low federal interest rates, Low asset values, particularly in real estate and family businesses, Significant intra-family transfer discounts could be curtailed or eliminated by Congress or the IRS in the near future, As noted in this article, planning now can position clients to take advantage of bargain transfer tax rates through the end of 2010, The increasing possibility of restoration of the 2001 transfer tax rules in 2011 increases the tax benefit of making gifts in 2010, There is a possibility of even higher transfer tax rates in the future, and The benefit of income shifting, given the expectation of significant increases in state and federal income tax rates in the coming years and the resulting spread in income tax rates at the upper and lower ends of taxation. Timing. Except in the case of a client facing imminent death, advisors should consider putting the plan in place and then waiting to complete the gift until the end of the year, because: If the client died before the end of 2010, not only would the gift have created an unnecessary gift tax, but the partial step up in basis provided in IRC section 1022 is lost. However, to the extent that annual exclusions and gift exemptions protect the gift from taxation, delay for this reason may be unnecessary. Congress might still act before the end of Retroactive changes may sabotage the plan. Other legislative changes might create new and unexpected planning opportunities or traps. Other family changes might occur before January 1, 2011 and reduce the benefit of the proposed plan (e.g., divorce of a child). Clients could complete the appraisals, sign the documents, and then leave everything in escrow with an independent party who is directed to deliver the relevant documents to the donees before the end of the year if (1) the donor has not died, (2) Congress has not adopted legislation that negates the benefit of the 2010 gifting program and (3) no other restrictions on the release of the documents have occurred (e.g., divorce of a child). To assure that the gifts are deemed completed gifts, the escrow should leave sufficient time for actual delivery to the donees (or their designated agents), not just a release from escrow. It might be important at year end to know where the donees may be vacationing to make sure delivery occurs. However, timing of gifts is a critical issue in starting the three year statute of limitations running pursuant to section 2035(b). The statute is triggered by the completion of the gift, not the payment of the gift tax. Therefore, the earlier the gift can be completed, the less gift-tax-inclusion risk is absorbed by the decedent s estate. One alternative is the creation of an inter vivos QTIP trust. The donor can Nelson 41

44 SECTION I - EXHIBIT 5 create the trust now, but defer the decision on electing QTIP status as long as October 15, 2011 (assuming the return is extended). But if the decision creates a taxable gift (i.e., deciding not to elect QTIP status), the decision should be made by April 15, 2011 in order to avoid penalties and interest on the gift tax that was due April 15, One concern with this approach is that even if donor does not elect to treat a part of the QTIP trust as a marital deduction trust, the only beneficiary of the trust can be the donor s spouse. To get around this issue, the trust instrument could provide that if the spouse disclaimed all or any portion of the trust, it passes to a By-Pass type trust or designated individuals (e.g., GST skip persons). The spouse would have nine months after the funding of the trust to make the decision to disclaim, but should not receive any benefits from the trust during the pre-disclaimer period. However, the use of the Clayton regulation for gift tax marital deduction purposes is not entirely clear. For more information on this issue, see Steve R. Akers, Estate Planning in Light of One-Year Repeal of Estate and GST Tax in 2010, at page 35, published by Bessemer Trust. Transferring FLP/LLC Interests & the Step Transaction Doctrine. Delaying the funding of an FLP or LLC to the end of 2010 and making a quick transfer before year s end could prove to be problematic if the IRS raises the step-transaction doctrine. Essentially, the step-transaction doctrine treats a series of separate steps as a single transaction if such steps are in substance integrated and focused toward a predetermined result. If the funding of the LLC or FLP and the gifts of interests were collapsed into a single transaction, the result can be a gift of the entity's underlying assets instead of a gift of the ownership interests. As a result, no valuation discounts are applicable for the ownership in the LLC or FLP (e.g., lack of marketability or minority interest). See: Heckerman v. United States., 104 AFTR 2d (W.D. Wash, 2009); Pierre v. Comm r, 133 T.C. No. 2 (2009); Pierre v. Commissioner, T.C. Memo (2010); It is critically important to document the non-tax purposes of the transaction and to put as much time as possible between the funding of the entity and the gifting of the ownership interests. Arguably, the less volatile the value of the asset (e.g., cash, bonds, real estate), the more time required to realize a real economic risk and avoid having the gift of ownership in the entity treated as an indirect gift of the underlying assets of the entity. Hoarding Cash. One of the reasons that planning should start early is the need for many clients to start hoarding cash or obtaining liquidity to pay for the gift taxes which will be due on April 15, The amount of cash the client can accumulate by April 15, 2011 will directly determine how much can be gifted in Planning Example: Assume an unmarried client owns a family business worth $40 million. He wants to pass 49% of the business to children working in the company. Assume a 40% discount is applied to gift. If the client has all of his gift exemption Nelson 42

45 SECTION I - EXHIBIT 5 available, he would need to hoard about $3.77 million to pay the gift taxes the less cash he expects to be able to accumulate by April 15, 2011, the less he can gift before the end of Assuming no growth in the value of the company and 100% transferred at death, the estate tax on the 49% transfer would be over $10 million (i.e., $40 million multiplied times 49% times a 55% tax rate, with no discount applied since the decedent still owns 100% of the business). If the donor survives the gift by three years, there is a tax savings of at least $6.0 million to the family. Annual Exclusion Gifting. In this environment, the continued funding of annual exclusion gifts should be an easy choice. The annual exclusion is one of the most effective, but most under-utilized parts of an estate plan. In 2010, the Code permits taxpayers to make gifts of $13,000 each to as many different donees as the donor desires. In looking at the more sophisticated planning ideas, do not overlook the annual exclusion, including pre-payment of section 529 plans and payment of tuition and medical costs for others pursuant to IRC section 2503(e). Planning Example: Assume a married client with a $20 million estate is seriously ill. The estate assets have a basis of $8.0 million. Assume the dispositional documents use a standard ByPass/QTIP trust arrangement. The client has four married children, fifteen grandchildren (six of whom are married) and five great-grandchildren a total of 34 heirs. Assume in 2010 the client made annual exclusion direct gifts (i.e., not in trust) and elected gift splitting. Total annual exclusion gifts would total $884,000. If the client died in 2010, the gifting would not adversely impact the estate tax costs, or the partial step-up in basis rules (i.e., allocation of basis to the remaining assets would use the $4.3 million partial step-up allowed in 2010). If the client and his spouse both die after 2010, the 2010 gifts could reduce the federal estate taxes by up to $486,200 (i.e., 55% times $884,000). Transferring FLP/LLC Interests & Annual Exclusion Gifting. The IRS has maintained that, due to the restrictions on distributions and transferability of FLP interests which are often contained in FLP agreements, the transferees of FLP interests derive no present economic benefit from the transfer. As a result transfers of FLP interests have been treated as gifts of a future interest which are not eligible for the gift tax annual exclusion. See: Walter M. Price, et ux v. Comm r, T.C. Memo (January 4, 2010); Hackl v. Comm r, 188 T.C. 279 (2002), aff d, 335 F. 3d 664 (7th Cir. 2003); and John W. Fisher et ux. v. United States; No. 1:08-cv Practitioners need to consider the impact of transfer and sale restrictions in their agreements which prevent transferees from the present use and enjoyment of their interests and terms which limit distributions. For example, instead of having a restriction against transferring an interest to anyone other than existing partners without the written consent of the general partner, provide that the transferee will be subject to a right of first refusal, with reasonable limits on exercise. Nelson 43

46 SECTION I - EXHIBIT 5 Purposely Creating a Gift Tax. As noted previously, making taxable gifts in 2010 may reduce the overall transfer tax cost of the transfer. Planning Example: If the client gifts $1.0 million to her heirs in 2010, the heirs receive $1.0 million and the donor pays the $350,000 gift tax, further reducing the donor s taxable estate if she survives the gift by three years. Thus, a $1.0 million gift requires $1,350,000 in assets. If the taxpayer at death wanted to transfer $1.0 million to family (and is in a 55% estate tax bracket), she would need to have $2,222,222 in assets, from which an estate tax of $1,222,222 would be taken before transferring the $1.0 million to family. The difference in tax cost is $872,222. Net Gifts. A net gift is a gift in which the donor, as a condition of the gift, requires the donee to pay the gift tax. The gift s value is reduced by the gift tax to be paid by the donee because the donee s payment of the gift tax is considered a sale, not a gift, by the donor. The amount of the gift tax (and the reduction in the value of the gift) is determined by a formula of: the tentative gift tax divided by the sum of one plus the rate of tax. In Revenue Ruling ( CB 208), the IRS noted that any state gift taxes which were assumed by the donee can also be taken into account to reduce the gift. See: Revenue Ruling 75-72, CB 310 which supercedes Revenue Ruling , CB 275. Planning Example: Assume the donor makes a $10 million gift in 2010 to a donee, and the donee is obligated to pay the gift tax on the transfer. Assume further that the transfer is fully subject to gift tax at the rate of 35%. The gift tax on the net gift is $2,592,593 - an effective transfer tax rate of 25.93%. Because part of the net gift transaction is treated as a sale transaction the donor may recognize taxable income from sale portion of the transaction. What taxable income does the donor recognize from the sale? Treasury Regulation section (e)(1) provides that Where a transfer of property is part a sale and in part a gift, the transferor has gain to the extent that the amount realized by him exceeds his adjusted basis in the property. As confirmed by the examples in the above regulation, the entire basis (not a just an amount proportionate to the sale part of the transaction) is used to compute the donor s gain, effectively reducing the gain to zero, unless the gift taxes paid by the donee exceed the donor s total adjusted basis in the property. The nature of a net gift is a part sale/part gift transaction. This creates some interesting basis issues for net gifts, including: Pursuant to IRC section 1015(d)(6), to the extent that gift tax is paid on the donor s appreciated value in the gift (i.e., not the entire gift tax paid), the donee s basis in the gifted asset is increased to a value which does not exceed the property s fair market value. See the prior discussion. But if the donee pays the gift tax, what happens? Logically, you would think that the donee s payment of the donor s tax could not be taken into account because the donee s payment is considered a sale and to permit a second basis adjustment would effectively be Nelson 44

47 SECTION I - EXHIBIT 5 double-dipping. However, IRC section 1015(d)(6) reads: In the case of any gift made after December 31, 1976, the increase in basis provided by this subsection with respect to any gift for the gift tax paid under chapter 12 shall be (emphasis added). Does this mean that the increase in basis is still permitted? Treasury Regulation section reads: Where a transfer of property is in part a sale and in part a gift, the unadjusted basis of the property in the hands of the transferee is the sum of (1)Whichever of the following is the greater: (i) The amount paid by the transferee for the property, or (ii) The transferor's adjusted basis for the property at the time of the transfer, and (2) the amount of increase, if any, in basis authorized by section 1015(d) for gift tax paid On the sale portion of the transaction, there is an increase in the donee s basis to the extent the donee purchased a part of the transferred asset. Thus, the donee may obtain a higher basis then would have been obtained from a straight gift when there is an unrecognized appreciation in the asset s value. But what happens if the gift tax is pulled back into the donor s taxable estate because the donor died within three years of the gift or the IRS audits the return and the gift taxes are increased and the agreement with the donee holds them liable for the tax increase? Is the donee s basis in the transferred asset adjusted for the additional increase in the sale portion of the transaction? What if, during the period from the initial transfer to the payment of the gift tax, the donee has sold the transferred asset? The Armstrong decisions held that both any gift tax increase from an audit and the 2035(b) inclusion were so contingent and speculative that they cannot be taken into account in determining the amount of the gift tax. (See: Armstrong, Frank Jr, Est v. U.S., 2002 WL (4th Cir 2002), aff g 132 F Supp 2d 421(D Va 2001); Estate of Armstrong, 119 TC 220 (2002)) Logically, if the potential additional gift taxes cannot be taken into account to adjust the value of the net gift at the time of the gift, they also cannot be taken into account to adjust the basis of the gifted asset. However, it can be argued that Armstrong was the result of a narrow fact pattern including the fact that additional gift taxes were illusory because the donor s estate (not the donees) actually paid the applicable taxes. The Fourth Circuit noted: Because the donees obligation to pay the additional gift taxes was premised solely on undervaluation, a probability no one expected to arise, the obligation was contingent and too speculative to justify application of the net gift principles the children s obligation to pay additional gift taxes was illusory. Basically, the advisors did such a good job of protecting the donees that any liability for future gift tax claims was not expected to occur and did not occur, even when the gift taxes were increased and the donor died within three years of the gift. But see: McCord v. Commissioner, 461 F3d 614 (5th Cir 2006) and Arlein & Frazier, The Net, Net Gift, Trusts and Estates, August 2008, where the authors rely upon the 5th Circuit opinion in McCord to argue that the 2035(b) potential inclusion may create an additional reduction in the computed gift tax if the donees assume that liability. For a detailed Nelson 45

48 SECTION I - EXHIBIT 5 discussion of McCord, see Steve Akers Revisits McCord, LISI Estate Planning Newsletter #1016, September 5, 2006; Paul Hood, McCord Fifth Circuit Reverses Tax Court, LISI Estate Planning Newsletter #1010, August 23, There are a number of other issues with net gifts, including: Many clients will object to the economic cost of pre-paying the gift tax even if the effective gift tax rate is substantially less than the potential estate tax rate in the future. It is always easier to part with cash when you are dead. The IRS ruled in Revenue Ruling , C.B. 189 that the gift tax is only due after the donor has exhausted his or her unified credit (i.e., the donor cannot elect to not use the unified credit and have the donee pay the gift tax). Moreover, if gift-splitting is used, it appears that the donor and the donor s spouse s unified credits are used first to the extent gift splitting applies. The U.S. Supreme Court ruled in V. Diedrich v. Comm r, 226 US 628 (1982) that the donor has taxable gain to the extent the gift tax exceeds the donor s basis in the gifted property. The income is taxable to the donor in the year the gift tax is paid, not in the year the gift was made. See also: Estate of Weedon v. Comm r, 685 F2d 1160 (9th Cir. 1982) and Revenue Ruling 75-72, CB 310. Thus, any taxable income from the net gift will ordinarily occur in the year following the gift. This could be problematic for gifts in 2010 because of the increased ordinary income and capital gain tax rates in The Eighth Circuit ruled in S. Sachs Estate, 856 F2d 1158 (8th Cir. 1988) that if the donor dies within three years of the net gift, the gift taxes paid by the donee are includable in the donor s taxable estate. Advisors need to make sure that the obligation of the donee to pay the gift tax is not a conditional or speculative obligation. A written net gift agreement should clearly state that the donee is obligated to pay the gift tax shown on the filed gift tax return. The larger issue is whether that indemnity should extend to higher gift taxes after an audit and/or the inclusion of gift taxes in the donor s taxable estate pursuant to 2035(b). If Armstrong is correct (see above), there would appear to be no benefit in having the donee increase his or her liability from secondary (i.e., transferee liability behind the estate s liability) to primary (i.e., by agreeing to be the primary obligor for such claims). But review the Arlein & Frazier article discussed above. Pursuant to IRC section 677(a)(1), if a trust is the donee of a net gift, any income earned by the trust from the date of contribution to the date the grantor s gift tax liability is satisfied may be taxable to the grantor under the grantor trust rules (i.e., the trust is satisfying the legal obligation of the grantor). See Treasury Regulation 1.677(a)-1(d); Estate of Sheaffer v. Comm r, 37 TC 99 (1961), aff d Nelson 46

49 SECTION I - EXHIBIT F.2d 738 (8th Cir. 1963); Revenue Ruling , CB 328. Income from trust assets should be minimized during this period. Discounting Family Debt. As a consequence of estate planning and other family planning, many clients have created intra-family debt (e.g., an installment sale of a family business interest to an income defective trust). Rather than leaving the debt in the estate of the older generation, clients should consider a forgiveness of the debt on a net gift basis effectively treating a net gift arrangement as a discounted pay-off of the note. Here s the basic question to ask the reluctant client: If you could satisfy a debt for 26% of its face value, while eliminating an estate tax of up to 55% of the debt, why would you NOT act? Planning Example: Assume a client has completed a sale of a real estate LLC using a $10 million note to an income defective trust for his children. The client agrees to forgive the note if the trust will pay the gift tax. Assuming the client has used all of his gift exemption to fund the seed money for the transaction, the gift tax on the net gift value would be roughly $2.6 million. The trusts could borrow the funds to pay the taxes by obtaining a bank loan against the real estate before the due date of the gift tax on April 15, But what if the trust is a GST trust? Because of the uncertainties surrounding gifts to GST trusts in 2010, the client s advisors may not want to make a significant gift to the trust. However, the client could make the gift of the IDIT note to his children (or even grandchildren as a direct skip). The trust could obtain a loan from a commercial lender and prepay $2.6 million of the note to the donee/family members who then pay the gift tax liability of the donor. The net effect is the removal of the note from the donor s estate on a substantially discounted basis, while providing an income stream that is payable to family members, who may be in a lower income tax bracket than the donor/client. The most interesting aspect of such a plan is that even though the $10 million dollar note has been removed from the client s estate, the amount of debt on the trust has not increased, because the gift tax liability obligation funded by the commercial loan effectively reduced the principal of the note. Caution: The gift of an installment sale note can create the immediate recognition of the taxable gain in the note. See: See IRC section 453B and Revenue Ruling , C.B Of course, this is a problem only to the extent there is deferred taxable gain in the unpaid balance of the note. Discounting Gifts. The recession has reduced the value of many assets. There is an increasing chance that Congress or the IRS will constrict the discounting on intra-family gifts. These trends should encourage clients to make gifts in The use of FLPS, LLCs, fractional interests and charitable lead trusts (among other discounting techniques) should be considered in any gift tax planning in Financed Net Gifts Present an Attractive Alternative. Instead of effectively reducing Nelson 47

50 SECTION I - EXHIBIT 5 the gift to the donee by the cost of the gift tax in a net gift transaction, the donor could loan the donee the amount for the gift taxes due using the current low AFR rates. Life Insurance. Many clients have created Irrevocable Life Insurance Trusts (ILIT) to hold life insurance outside the taxable estate. Many ILITs have GST provisions. As noted in this article, the rules governing the funding of GST trusts in 2010 are confused at best. To minimize the risk of creating an inadvertent GST taxable distribution or termination in future years, clients should consider either borrowing against trust assets or making loans to ILITs at the low AFR rates to fund 2010 life insurance premiums. It is amazing how many clients still own large life insurance policies in their own name or indirectly through their business entities. Many of these policies have large cash values. With the possibility of significant increases in estate taxes in 2011 and IRC section 2035(a) that includes gratuitous transfers of life insurance in the taxable estate of the insured/donor if they die within three years of the gift, clients should consider moving the life insurance out of their taxable estate as soon as possible. Moving large cash value policies out at a 35% gift tax rate in 2010 may make significant sense for clients who have retained ownership of policies Transfers to a Terminally Ill Spouse. Roughly 2.3 million Americans will die this year provides some planning opportunities for a terminally ill spouse. The healthier spouse can transfer assets to the terminally ill spouse who redrafts dispositive documents to establish a testamentary bypass and/or QTIP trust for the healthy spouse. If the ill spouse dies in 2010 no portion of the QTIP Trust will be included in the healthy spouse s estate under IRC section Why not? Because IRC section 2044 includes the assets of a QTIP trust in the surviving spouse s gross estate only if an election is made to obtain an estate tax marital deduction for the QTIP trust. Because of the estate tax repeal in 2010, no marital deduction is available or needed and therefore the QTIP trust avoids estate inclusion in the healthy spouse s estate. Use of both a bypass trust and a QTIP trust gives the advantage of allocating income from the bypass trust to more than just the surviving spouse, while taking advantage of the larger basis adjustment (i.e., $3.0 million) permitted under IRC section 1022 for transfers for the benefit of surviving spouses. However, unlike the standard A-B trust arrangement in which any excess over the estate exemption is solely allocated to the marital share, in this case, once the $4.3 million basis adjustment is reached, assets should again be allocated to the by-pass trust to permit more flexibility in allocating later trust distributions. But what happens to the basis of the assets bequeathed by the spouse? For 2010, IRC section 1022(d)(1)(c)(i) provides that if assets were gifted to the decedent within three years of the decedent s death, no basis adjustment may be allocated to the assets. However, there is an interesting exception to this rule in IRC section 1022(d)(1)(c)(ii), which reads: Clause (i) shall not apply to property acquired by the decedent from the decedent's spouse unless, during such 3-year period, such spouse acquired the property in whole or in part by gift or by inter vivos transfer for less than adequate and full Nelson 48

51 SECTION I - EXHIBIT 5 consideration in money or money's worth. Thus, unless the asset being gifted was acquired by the gifting spouse by gift or by inter vivos transfer for less than adequate and full consideration in money or money's worth, the asset can still receive a partial basis adjustment pursuant to IRC section IRC section 1014(e) which eliminates a step up in basis on assets gifted within a year of demise is revoked for See IRC section 1014(f). Planning for Gift Splitting. As noted earlier, IRC section 2035(b) only applies if the payor of the gift tax dies within three years of the gift. This offers a planning opportunity. If one spouse is in poorer health than the other, consider making a gift splitting election and have the healthier spouse (assuming they have the available funds from their own resources) pay the total gift tax (See: PLR ). This eliminates the chance that the gift tax will be included in the unhealthy spouse s taxable estate. What if neither spouses is in great health? Consider gift splitting and having each spouse pay half the gift tax, increasing the chance that at least one of them will survive beyond the three years. If the couple were in a second marriage and had different beneficiaries, the unhealthy spouse could revise his or her dispositive documents and make a special bequest to the surviving spouse to compensate for the payment of gift tax just do not tie it directly to the gift tax paid. Funds used to pay the gift tax should not originate from a donor spouse with an implicit understanding that the non-donor spouse use the funds to pay the donor spouse s gift taxes. Where such funds have originated from the donor spouse with an implied understanding that they be used to cover donor s taxable gifts, the IRS has applied form-over-substance principles and ruled that all of the gift tax paid was in essence paid by the donor spouse (See: Brown v. United States, 329 F 3d 664 (9th Cir 2003) and TAM ). Gifts from Existing Marital Trusts. Normally, deferral of transfer taxes makes sense. But 2010 has turned many of our planning perspectives on their head. What happens if a spouse has passed before 2010 and created a QTIP trust for the surviving spouse? Pursuant to IRC section 2044 the QTIP trust assets will be subject to estate tax at the death of the surviving spouse at an effective tax rate of up to 55% versus a 35% tax rate in If permitted by the trust instrument, clients who have QTIPs for their benefit should consider taking a principal distribution from the trust and then gifting the assets to heirs at the lower gift tax rate. Net gifting could increase the benefit of this planning technique. Planning Example: A client s deceased spouse created a QTIP which holds $10 million growing at 5% per year. The surviving spouse is comfortable and is willing to make a net gift of $6.0 million to their heirs and the trust permits discretionary principal distributions. Assuming the spouse has used her gift exemption, the net gift tax is approximately $1.5 million, making a net passage to heirs of $4.5 million. If the client dies in five years, the $6.0 million asset would have been worth approximately $7.66 million and the estate tax (at 55%) would have been up to $4.2 million a net after-tax bequest of $3.4 million. If the client made the net gift five years earlier, after Nelson 49

52 SECTION I - EXHIBIT 5 appreciation, the heirs would own an asset that has appreciated to $5.7 million a tax savings of up to $2.3 million Purchases or gifts of lifetime or remainder interests in the QTIP should also be considered. The merger of lifetime and remainder interests in a QTIP is normally treated as a gift transaction, generally as net gift transaction. See: Revenue Ruling 98-8, C.B. 541; Treasury Regulation sections A-1(a)(2), A-1(b), (c)(1), (C)(4), (G); Lawrence M. Lipoff, Revisiting Purchases of Remainder Interests in QTIP Trusts, Estate Planning, March See also: Morgens, 133 TC 17 (2010) for the result when the surviving spouse dies within three years of the deemed gift (covered by Paul Hood in LISI Estate Planning Newsletter #1599). Gifting to Unhealthy Non-Spouses. In considering a taxable gift to a non-spouse, one of the considerations should be the impact of the donee dying within a few years of the transfer. While IRC section 2013 provides an estate tax credit for estate taxes paid by a previous decedent/owner, there is no comparable benefit for gift taxes paid. Potentially, the combination of the gift tax on the initial gift coupled with the estate tax liability upon the donee s death could eliminate the tax benefits of the planning opportunities discussed in this article. If there are no 2010 GST issues, it may make sense to gift to a trust in lieu of a direct gift (particularly to an heir with significant health issues) and give the intended initial donee a lifetime interest in the trust. The trust could provide potential estate tax savings to the donee s heirs and asset protection to the donee. Charitable Gifting in Charitable gifting in 2010 offers some unique opportunities. Planning Example: Many clients make charitable bequests in their wills. But if a client is expected to die in 2010, there is effectively no 2010 estate or income tax benefits from making the charitable bequest. To obtain the benefits, make the gift before the client s death and take advantage of the charitable income tax deduction for the grantor to reduce the grantor s income taxes. For example, moving a $50,000 charitable gift into the last year of the client s life could save the family up to $17,500 in federal income taxes (i.e., $50,000 times the 35% top federal income tax rate in 2010). Make sure the dispositive documents are changed to remove the charitable bequests, or the charity might have the right to claim the transfer a second time. Planning Example: As an alternative to the above example, the will could be changed to make the bequest of $50,000 to the an heir in 2010 and request that the heir make the charitable contribution. If the $50,000 gift is an asset with a low basis in the hands of the decedent, funding it through the estate could allow for an increase in the basis using the 2010 basis adjustment rules and therefore provide for a larger charitable deduction for the heir who makes the charitable contribution. Planning Example: Consider a charitably inclined client who is willing to forego current benefits to his family. Assume that in June 2010 she places $10 million of real estate generating an annual income of $700,000 (and appreciating at 5% per year) into a Nelson 50

53 SECTION I - EXHIBIT 5 Charitable Lead Annuity Trust having a 10 year charitable payout of $700,000 per year (paid quarterly), with the remainder interest passing to children. The value of the noncharitable remainder interest at the time of gift is approximately $4.0 million, with a total gift tax due of no more than $1.4 million (i.e., 35% of the $4.0 million, assuming the gift exemption has already been used). However, at the end of 10 years, the estimated value of the real estate passing to family is over $18 million. Assume the client made the same $700,000 gift to charity herself and retained ownership of the asset until she died 10 years later. The estate tax (at 55%) on the passage of the $18 million in real estate could be as much as $9.9 million a tax savings of up to $8.5 million. Basis Planning. Normally, basis planning issues are secondary to the estate tax issues because of the relative tax rates and the step-up in basis for assets in an estate. Basis planning will be an important part of planning in Some of those planning aspects are discussed in other parts of this article. Planning Example: A terminally ill married client has a currently unmarketable asset which has substantially depreciated in value (e.g., the basis is $500,000 and the value is $200,000). If the client dies in 2010, the asset s basis will step-down to its fair market value, resulting in the family losing the tax benefit of the inherent loss in the asset. Instead, have the terminally ill client gift the asset to his spouse or another heir. If the donee subsequently sells the asset for a value from $200,000 to $500,000, no taxable gain will be reported on the sale. The gift to the spouse creates no gift tax issues and a gift tax return does not need to be filed if it is a direct gift. Planning Example: There is another 2010 planning opportunity in the above example. Except in 2010, any capital loss carryovers vanish upon the death of the taxpayer. Assuming the client dies in 2010, selling the asset before death may create a capital loss which, pursuant to IRC section 1022(b)(2)(C), can then be used to increase the basis of assets held in the estate. If the client dies after 2010, this strategy will not provide any additional tax benefits. Planning Example: The client has marketable stock she purchased for $14,000 which now has a value of only $10,000. If the stock is gifted to a child and the child sells it for $10,000, the capital loss in value is effectively lost. Instead, have the client sell the asset for $10,000 and take a $4,000 capital loss. The $10,000 in cash could then be gifted to the child. Gifting to Qualify for Estate Tax Benefits. If the sunsetting of EGTRRA occurs on January 1, 2011, estate taxes will increase significantly and estate-tax-driven planning will increase. Although beyond the scope of this article, gifting may allow taxpayers to qualify for estate benefits which are available only if qualified assets meet certain percentage tests. The taxpayer may make gifts which allow his or her estate to take advantage of the special estate tax benefits, such as: the estate business deduction contained in IRC section 2057 (automatically restored in 2011), special use valuation, IRC section 303 redemption and the installment payment of estate taxes pursuant to IRC section Nelson 51

54 SECTION I - EXHIBIT 5 Comparison of Gifting to Other Planning The tax rules governing estate planning in 2010 are a radical change from prior years and, as a result, have changed the relative benefits of previous planning techniques. Short-Term and Zeroed-Out GRATs are Endangered Species. Superior to paying estate and/or gift taxes is paying no transfer taxes at all. In recent years, as long as a wealthy client had liquid assets and at least several years to engage in wealth transfer, rolling short-term grantor retained annuity trusts (GRATs) were the superstar of freeze techniques which offered the opportunity to pass on a substantial amount of wealth to the next generation on a transfer tax-free basis. But short term zeroed-out GRATs and GRATS with a duration of 10 years or less are now on the endangered species list. This past March the House of Representatives passed the Small Business and Infrastructure Jobs Tax Act of Among its revenue offsets were proposals to substantially alter the rules for creating and funding GRATs. Specifically, the bill required that: (1) GRATs have a minimum 10-year term; (2) Annuity payments not decline during the first 10 years of the trust; and (3) A GRAT s design at inception envisions a remainder interest (i.e., the GRAT cannot have a zero remainder value). It used to be said that the worst that could happen with a GRAT was that the investments could underperform the 7520 hurdle rate, in which case the annuity payments coming back to the grantor would completely deplete the GRAT and no gift would be made. But, if legislation is passed by Congress which is similar to the House bill, longer term GRATS may be less attractive as a wealth transfer tool because of gift taxes may be due at the time of creation and there is an increased possibility of estate inclusion should the grantor die during the enlarged GRAT term. IDGTs Still Appealing but Come with Baggage. Another popular freeze technique is an Intentionally Defective Grantor Trust (IDGT). A gift is often made through seeding the irrevocable grantor trust (normally 10% of the discounted value of the property to be transferred) and then creating an installment note from the trust for the purchase of assets from the grantor using low AFR rates. The trust is defective for income tax purposes, but is effective for estate tax purposes, effectively removing the trust assets from the donor s taxable estate. The IDGT essentially allows the grantor to: Avoid capital gains on the sale to the trust, Make indirect gift-tax free transfers to the trust by making the income tax payments for the income earned by the trust, allowing the trust assets to compound on a tax favorable basis, and Transfer appreciation in the grantor trust to multiple generations over and above the applicable federal rate (AFR) due on the installment note. Nelson 52

55 SECTION I - EXHIBIT 5 One downside to the IDGT is that if the trust s assets fail to outperform the applicable AFR rate on the note then the grantor s initial seeding of the trust through gifting will have been wasted. Compare a net gift to a sale to an intentionally income defective trust: Assuming the donor survives the gift by 3 years, the effective tax rate is 25.93% versus a tax rate of up to 60% beginning in Techniques which merely freeze the value of the estate (e.g., IGIT sales) are at a significant tax rate disadvantage. The cash flow needed to finance a net gift is less than the cost of financing a note equal to the sales portion of a comparable IDGT transfer. Because no payments are due on a net-gift until April 15th of the year following the gift, the donee can receive up to 15½ months of the use of the asset before having to pay the gift tax. In the end the IDGT like the GRAT is essentially a freeze technique designed to remove from the estate appreciation over and above a federal rate of interest. Freeze techniques are generally not going to be as an effective a tax savings tool as reducing a client s taxable estate using taxable gifts at the current low gift tax rates. Other Issues in 2010 Gifting. IRS Gift Tax Audits. Anytime a client is pre-paying gift taxes on assets which are being discounted or which otherwise do not have a readily determinable fair market value, the client runs the risk that the IRS will challenge the gift s value and ask for more gift taxes. Although a discussion of methods of minimizing such risks is beyond the scope of this article, advisors and their clients are well advised to adopt approaches designed to minimize such risks (e.g., avoiding radical discounts and other red flags on the return). One way to minimize the risk of higher gift taxes is to use a lifetime trust with a formula QTIP election, effectively capping the value of the gift. If the IRS argues that the gift is understated, the excess flows to the marital share. See: Steve Akers commentary in Petter: Defined Value Clause Upheld; One-Two Punch to IRS's Fight Against Defined Value Clauses, LISI Estate Planning Newsletter #1578, January 14, IRS section 6501 provides that if there is adequate disclosure of the gift a three year statute of limitations from the date of gift tax filing applies to an IRS challenge of the return. Advisors should thoroughly review the disclosure requirements contained in Treasury Regulation section (c) before filing a gift tax return. Compliance. Effective for gifts in 2010, IRC section 6019(b) provides that within thirty days of the filing of a gift tax return, each recipient of a gift must receive a copy of certain information included on the return. IRC section 6716(b) imposes a $50 penalty Nelson 53

56 SECTION I - EXHIBIT 5 for each instance of non-compliance. State Gift Taxes. Even when a gift is covered by a federal gift tax exclusion or exemption, state gift taxes may still result and (unlike the federal estate tax after 2010), no federal gift tax credit is given for state gift taxes. The following jurisdictions impose a gift tax: Connecticut, Louisiana, North Carolina, Puerto Rico, and Tennessee. Local tax issues can create other tax problems. For example, gifts in Tennessee which would be covered by the federal gift exemption may still result in the imposition of a Tennessee gift tax. What Assets should be Gifted? In choosing assets to be gifted, a number of issues should be considered (in no particular order): Make gifts of assets which are increasing in value first. If an appreciating asset is held in the estate it may produce greater estate taxes, while a diminishing asset (e.g., a retirement plan which passes to a surviving spouse) may reduce the value of the estate over time. All things being equal, the donor should generally gift assets which have the highest basis first. Because the value of the gift is effectively reduced by the income taxes which the donee may ultimately pay, higher basis gifts reduce the benefit less. Whenever possible, make a gift for which a valuation discount in value may apply. But the discounting of values may be counterproductive for clients who die in 2010 if it results in an estate not fully utilizing the basis adjustment in IRC section 1022because of the reduced fair market value of the gifted assets. Caution: Be wary of gifts of assets with secured debt. In general, the value of a gifted asset which is collateral for a debt is the difference between its fair market value and the amount of the debt. Thus, a piece of real estate worth $100,000 with a $90,000 mortgage is only valued at $10,000. However, if the secured debt exceeds the donor s basis, the donor may incur taxable income from the transaction. For example, if the donor s basis in the above real estate was $70,000, the gift could create $20,000 in taxable income or capital gains to the donor. Donee Spouse not a US Citizen. If the donee is not a U.S. citizen, a gift tax marital deduction is not allowed. Moreover, gifts cannot be made to a Qualified Domestic Trust as allowed for estates. Instead, pursuant to IRC section 2523(i), the annual exclusion for gifts to non-u.s. citizen spouses is $100,000 and is adjusted for inflation. Effective in 2010 the exclusion has increased to $134,000. Where a client is married to a non-us citizen, the transfer of $134,000 each year to the non-citizen spouse may provide significant tax savings. However, if the spouse is a US resident, the assets may still be subject to a federal estate tax. Moreover, the spouse s home country may also impose a tax on the assets at the spouse s death. Nelson 54

57 SECTION I - EXHIBIT 5 Deathbed Transfers. Deathbed annual exclusion gifts are a significant planning tool. However, in Revenue Ruling ( C.B. 161) the IRS ruled that if the donor dies before the check clears his or her account, the gift is not removed from the estate. In general, charitable death bed checks do not have to clear the decedent s accounts before death, while non-charitable gifts do have to clear the account to be deductible. Planning Example: A terminally ill client has no descendants, but does have a taxable estate in In her will she has made 20 special bequests each under $5,000 to friends, with the balance going to nieces and nephews. The will provides that the residue pays any estate tax. Have the client make the $100,000 in transfers during life as annual exclusion gifts and revise the will to eliminate those bequests. Converting the bequests to annual exclusion gifts saves the nieces and nephews $41,000 to $60,000 in estate taxes (i.e., the range due to the effective estate tax rates in 2011). Powers of Attorney. The IRS takes the position that an annual exclusion gift cannot be made unless the power of attorney or state law specifically allows such gifts. See Goldman v. Comm r., T.C. Memo But see: Estate of Ridenour v. Comm r, 65 TCM 1850 (1993) and Estate of Casey v. Comm r, 58 T.C.M. 176 (1989), rev'd, 948 F.2d 895 (4th Cir. 1991). Sunset Provisions. Section 901(b) of EGTRRA reads: The Internal Revenue Code of 1986 shall be applied and administered to years, estates, gifts and transfers described in subsection (a) as if the provisions and amendments described in section (a) has never been enacted. Section 901(a) reads: All provisions of, and amendments made by, this Act shall not apply to (2) in the case of title V [the transfer tax changes] to estates, of decedents dying, gifts made or generation skipping transfers, after December 31, Some commentators have wondered whether this section of EGTRRA effectively reinstates the pre-egtrra rules retroactively to all transfers which were governed by EGTRRA For example: Is date of death fair market value basis retroactively restored for assets sold after 2010, when the owner died in 2010? CONCLUSION: Lifetime gifting of assets in 2010 offers both transfer tax and income tax advantages. However, as this article illustrates, the issues can be quite complex and the planner must review all of the tax, legal, dispositional, and family implications before recommending and implementing any gifting program. While this article has focused on gift planning for 2010, let s not forget about the even greater risks facing taxpayers on January 1, 2011, including (but certainly not limited to): the return of lower GST and estate exemptions, higher transfer tax rates the reinstatement of expired provisions of EGTRRA (e.g., the family business deduction), confusion over the meaning of EGTRRA s statement (in section 901 of the Nelson 55

58 SECTION I - EXHIBIT 5 Act) that [t]he Internal Revenue Code shall be applied and administered as if the [2001 Act] had never been enacted, and the return of higher income, dividend and capital gain rates. Although the tax benefits of gifting will not be as beneficial after 2010 (e.g., because of the higher gift tax rates), the tax-exclusive nature of gifts and net gift strategies could still offer significant transfer tax savings even after Virtually all estate planning advisors need to start preparing their clients for the looming 2011 transfer tax and income tax changes. Congress s decision or inability to deal with EGTRRA s sun-setting provisions in 2010 is going to keep the estate and tax planning industry busy for some time. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Jeff Scroggin Charlie Douglas CITE AS: LISI Estate Planning Newsletter #1668 (July 1, 2010) at LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. Copyright 2010 Jeff Scroggin & Charlie Douglas. All rights reserved. Copyright 2010 Leimberg Information Services Inc. Nelson 56

59 SECTION I - EXHIBIT 6 [JOINT COMMITTEE PRINT] DESCRIPTION OF REVENUE PROVISIONS CONTAINED IN THE PRESIDENT S FISCAL YEAR 2011 BUDGET PROPOSAL Prepared by the Staff of the JOINT COMMITTEE ON TAXATION August 16, 2010 U.S. Government Printing Office Washington: 2010 JCS-2-10 Nelson 57

60 SECTION I - EXHIBIT 6 CONTENTS INTRODUCTION... 1 Page I. INDEX THE INDIVIDUAL ALTERNATIVE MINIMUM TAX AMOUNTS FOR INFLATION... 2 II. MAKE PERMANENT AND MODIFY CERTAIN TAX CUTS ENACTED IN 2001 AND A. Dividends and Capital Gains Tax Rate Structure... 4 B. Extend Temporary Increase in Expensing for Small Business C. Marginal Individual Income Tax Rate Reductions D. Child Tax Credit E. Increase of Refundable Portion of the Child Credit F. Marriage Penalty Relief and Earned Income Tax Credit Simplification G. Education Incentives H. Modify and Make Permanent the Estate, Gift, and Generation Skipping Transfer Taxes After I. Other Incentives for Families and Children (includes extension of the adoption tax credit, employer-provided child care tax credit, and dependent care tax credit).. 69 J. Reinstate the Overall Limitation on Itemized Deductions and the Personal Exemption Phase-out III. TEMPORARY RECOVERY MEASURES A. Extend the Making Work Pay Credit for One Year B. Provide $250 Economic Recovery Payment and Special Tax Credit C. Extend COBRA Health Insurance Premium Assistance D. Provide Additional Tax Credits for Investment in Qualified Property Used in a Qualifying Advanced Energy Manufacturing Project E. Extend Temporary Bonus Depreciation for Certain Property F. Extend Option for Cash Assistance to States in Lieu of Low-Income Housing Tax Credit for IV. TAX CUTS FOR FAMILIES AND INDIVIDUALS A. Increase in the Earned Income Tax Credit B. Expand the Child and Dependent Care Tax Credit C. Automatic Enrollment in Individual Retirement Arrangements D. Saver s Credit E. Extend American Opportunity Tax Credit V. TAX CUTS FOR BUSINESSES A. Increase Exclusion of Gain on Sale of Qualified Small Business Stock i Nelson 58

61 SECTION I - EXHIBIT 6 H. Modify and Make Permanent the Estate, Gift, and Generation Skipping Transfer Taxes After 2009 Present and Prior Law In general In general, a gift tax is imposed on certain lifetime transfers and an estate tax is imposed on certain transfers at death. A generation skipping transfer tax generally is imposed on certain transfers, either directly or in trust or similar arrangement, to a skip person (i.e., a beneficiary in a generation more than one generation younger than that of the transferor). Transfers subject to the generation skipping transfer tax include direct skips, taxable terminations, and taxable distributions. The estate and generation skipping transfers taxes are repealed for decedents dying and gifts made during 2010, but are reinstated for decedents dying and gifts made after Exemption equivalent amounts and applicable tax rates In general Under present law in effect through 2009 and after 2010, a unified credit is available with respect to taxable transfers by gift and at death. 46 The unified credit offsets tax computed at the lowest estate and gift tax rates. Before 2004, the estate and gift taxes were fully unified, such that a single graduated rate schedule and a single effective exemption amount of the unified credit applied for purposes of determining the tax on cumulative taxable transfers made by a taxpayer during his or her lifetime and at death. For years 2004 through 2009, the gift tax and the estate tax continued to be determined using a single graduated rate schedule, but the effective exemption amount allowed for estate tax purposes was higher than the effective exemption amount allowed for gift tax purposes. In 2009, the highest estate and gift tax rate was 45 percent. The unified credit effective exemption amount was $3.5 million for estate tax purposes and $1 million for gift tax purposes. For 2009 and after 2010, the generation skipping transfer tax is imposed using a flat rate equal to the highest estate tax rate on cumulative generation skipping transfers in excess of the exemption amount in effect at the time of the transfer. The generation skipping transfer tax exemption for a given year (prior to and after repeal, discussed below) is equal to the unified credit effective exemption amount for estate tax purposes. 46 Sec Nelson 59

62 SECTION I - EXHIBIT 6 Repeal of estate and generation skipping transfer taxes in 2010; modifications to gift tax Under EGTRRA, the estate and generation skipping transfer taxes are repealed for decedents dying and generation skipping transfers made during The gift tax remains in effect during 2010, with a $1 million exemption amount and a gift tax rate of 35 percent. Also in 2010, except as provided in regulations, certain transfers in trust are treated as transfers of property by gift, unless the trust is treated as wholly owned by the donor or the donor s spouse under the grantor trust provisions of the Code. Reinstatement of the estate and generation skipping transfer taxes for decedents dying and generation skipping transfers made after December 31, 2010 The estate, gift, and generation skipping transfer tax provisions of EGTRRA sunset at the end of 2010, such that those provisions (including repeal of the estate and generation skipping transfer taxes) will not apply to estates of decedents dying, gifts made, or generation skipping transfers made after December 31, As a result, in general, the estate, gift, and generation skipping transfer tax rates and exemption amounts that would have been in effect had EGTRRA not been enacted will apply for estates of decedents dying, gifts made, or generation skipping transfers made in 2011 or later years. A single graduated rate schedule with a top rate of 55 percent and a single effective exemption amount of $1 million indexed for inflation for generation skipping transfer tax purposes will apply for purposes of determining the tax on cumulative taxable transfers by lifetime gift or bequest. Basis in property received In general Gain or loss, if any, on the disposition of property is measured by the taxpayer s amount realized (i.e., gross proceeds received) on the disposition, less the taxpayer s basis in such property. 47 Basis generally represents a taxpayer s investment in property, with certain adjustments required after acquisition. For example, basis is increased by the cost of capital improvements made to the property and decreased by depreciation deductions taken with respect to the property. Basis in property received by lifetime gift Property received from a donor of a lifetime gift generally takes a carryover basis. 48 Carryover basis means that the basis in the hands of the donee is the same as it was in the hands of the donor. The basis of property transferred by lifetime gift also is increased, but not above fair market value, by any gift tax paid by the donor. The basis of a lifetime gift, however, generally cannot exceed the property s fair market value on the date of the gift. If the basis of 47 Sec Sec Nelson 60

63 SECTION I - EXHIBIT 6 property is greater than the fair market value of the property on the date of the gift, then, for purposes of determining loss, the basis is the property s fair market value on the date of the gift. Basis in property received from a decedent who died in 2009 Property passing from a decedent who died during 2009 generally takes a stepped-up basis. 49 In other words, the basis of property passing from such a decedent s estate generally is the fair market value on the date of the decedent s death (or, if the alternate valuation date is elected, the earlier of six months after the decedent s death or the date the property is sold or distributed by the estate). This step up in basis generally eliminates the recognition of income on any appreciation of the property that occurred prior to the decedent s death. If the value of property on the date of the decedent s death was less than its adjusted basis, the property takes a stepped-down basis when it passes from a decedent s estate. This stepped-down basis eliminates the tax benefit from any unrealized loss. 50 Basis in property received from a decedent who dies during 2010 The rules providing for date-of-death fair market value ( stepped-up ) basis in property acquired from a decedent are repealed for assets acquired from decedents dying in 2010, and a modified carryover basis regime applies. 51 Under this regime, recipients of property acquired from a decedent at the decedent s death receive a basis equal to the lesser of the decedent s adjusted basis or the fair market value of the property on the date of the decedent s death. The modified carryover basis rules apply to property acquired by bequest, devise, or inheritance, or property acquired by the decedent s estate from the decedent, property passing from the decedent to the extent such property passed without consideration, and certain other property to which the prior law rules apply, other than property that is income in respect of a decedent. Property acquired from a decedent is treated as if the property had been acquired by gift. Thus, the character of gain on the sale of property received from a decedent s estate is carried over to the heir. For example, real estate that has been depreciated and would be subject to recapture if sold by the decedent will be subject to recapture if sold by the heir. 49 Sec There is an exception to the rule that assets subject to the Federal estate tax receive stepped-up basis in the case of income in respect of a decedent. Sec. 1014(c). The basis of assets that are income in respect of a decedent is a carryover basis (i.e., the basis of such assets to the estate or heir is the same as it was in the hands of the decedent) increased by estate tax paid on that asset. Income in respect of a decedent includes rights to income that has been earned, but not recognized, by the date of death (e.g., wages that were earned, but not paid, before death), individual retirement accounts (IRAs), and assets held in accounts governed by section 401(k). In community property states, a surviving spouse s one-half share of community property held by the decedent and the surviving spouse generally is treated as having passed from the decedent and, thus, is eligible for stepped-up basis. Under 2009 law, this rule applies if at least one-half of the whole of the community interest is includible in the decedent s gross estate. 51 Sec Nelson 61

64 SECTION I - EXHIBIT 6 An executor generally may increase (i.e., step up) the basis in assets owned by the decedent and acquired by the beneficiaries at death, subject to certain special rules and exceptions. Under these rules, each decedent s estate generally is permitted to increase the basis of assets transferred by up to a total of $1.3 million. The $1.3 million is increased by the amount of unused capital losses, net operating losses, and certain built-in losses of the decedent. In addition, the basis of property transferred to a surviving spouse may be increased by an additional $3 million. Thus, the basis of property transferred to surviving spouses generally may be increased by up to $4.3 million. Nonresidents who are not U.S. citizens may be allowed to increase the basis of property by up to $60,000. Repeal of modified carryover basis regime for determining basis in property received from a decedent who dies after December 31, 2010 As described above, the estate, gift, and generation skipping transfer tax provisions of EGTRRA sunset at the end of 2010, such that those provisions will not apply to estates of decedents dying, gifts made, or generation skipping transfers made after December 31, As a result, the modified carryover basis regime in effect for determining basis in property passing from a decedent who dies during 2010 does not apply for purposes of determining basis in property received from a decedent who dies after December 31, Instead, the law in effect prior to 2010, which generally provides for date-of-death fair market value ( stepped-up ) basis in property passing from a decedent, will apply. State death tax credit; deduction for State death taxes paid State death tax credit under prior law Before 2005, a credit was allowed against the Federal estate tax for any estate, inheritance, legacy, or succession taxes ( death taxes ) actually paid to any State or the District of Columbia with respect to any property included in the decedent s gross estate. 52 The maximum amount of credit allowable for State death taxes was determined under a graduated rate table, the top rate of which was 16 percent, based on the size of the decedent s adjusted taxable estate. Most States imposed a pick-up or soak-up estate tax, which served to impose a State tax equal to the maximum Federal credit allowed. Phase-out of State death tax credit; deduction for State death taxes paid Under EGTRRA, the amount of allowable State death tax credit was reduced from 2002 through For decedents dying after 2004, the State death tax credit was repealed and replaced with a deduction for death taxes actually paid to any State or the District of Columbia, in respect of property included in the gross estate of the decedent. 53 Such State taxes must have been paid and claimed before the later of: (1) four years after the filing of the estate tax return; or (2) (a) 60 days after a decision of the U.S. Tax Court determining the estate tax liability 52 Sec Sec Nelson 62

65 SECTION I - EXHIBIT 6 becomes final, (b) the expiration of the period of extension to pay estate taxes over time under section 6166, or (c) the expiration of the period of limitations in which to file a claim for refund or 60 days after a decision of a court in which such refund suit has become final. Reinstatement of State death tax credit for decedents dying after December 31, 2010 As described above, the estate, gift, and generation skipping transfer tax provisions of EGTRRA sunset at the end of 2010, such that those provisions will not apply to estates of decedents dying, gifts made, or generation skipping transfers made after December 31, As a result, neither the EGTRRA modifications to the State death tax credit nor the replacement of the credit with a deduction applies for decedents dying after December 31, Instead, the State death tax credit as in effect for decedents who died prior to 2002 will apply. Exclusions and deductions Gift tax annual exclusion Donors of lifetime gifts are provided an annual exclusion of $13,000 (for 2010) on transfers of present interests in property to any one donee during the taxable year. 54 If the nondonor spouse consents to split the gift with the donor spouse, then the annual exclusion is $26,000 for The dollar amounts are indexed for inflation. Transfers to a surviving spouse In general. A 100-percent marital deduction generally is permitted for estate and gift tax purposes for the value of property transferred between spouses. 55 In addition, transfers of qualified terminable interest property also are eligible for the marital deduction. Qualified terminable interest property is property: (1) that passes from the decedent; (2) in which the surviving spouse has a qualifying income interest for life ; and (3) to which an election applies. A qualifying income interest for life exists if: (1) the surviving spouse is entitled to all the income from the property (payable annually or at more frequent intervals) or has the right to use the property during the spouse s life; and (2) no person has the power to appoint any part of the property to any person other than the surviving spouse to be effective during the life of the surviving spouse. Transfers to surviving spouses who are not U.S. citizens. A marital deduction generally is denied for property passing to a surviving spouse who is not a citizen of the United States. 56 A marital deduction is permitted, however, for property passing to a qualified domestic trust of which the noncitizen surviving spouse is a beneficiary. A qualified domestic trust is a trust that has as its trustee at least one U.S. citizen or U.S. corporation. No corpus may be distributed from 54 Sec. 2503(b). 55 Secs & Secs. 2056(d)(1) and 2523(i)(1). 47 Nelson 63

66 SECTION I - EXHIBIT 6 a qualified domestic trust unless the U.S. trustee has the right to withhold any estate tax imposed on the distribution. For years when the estate tax is in effect, there is an estate tax imposed on (1) any distribution from a qualified domestic trust before the date of the death of the noncitizen surviving spouse and (2) the value of the property remaining in a qualified domestic trust on the date of death of the noncitizen surviving spouse. The tax is computed as an additional estate tax on the estate of the first spouse to die. Conservation easements For years when an estate tax is in effect, an executor generally may elect to exclude from the taxable estate 40 percent of the value of any land subject to a qualified conservation easement, up to a maximum exclusion of $500, The exclusion percentage is reduced by two percentage points for each percentage point (or fraction thereof) by which the value of the qualified conservation easement is less than 30 percent of the value of the land (determined without regard to the value of such easement and reduced by the value of any retained development right). Before 2001, a qualified conservation easement generally was one that met the following requirements: (1) the land was located within 25 miles of a metropolitan area (as defined by the Office of Management and Budget) or a national park or wilderness area, or within 10 miles of an Urban National Forest (as designated by the Forest Service of the U.S. Department of Agriculture); (2) the land had been owned by the decedent or a member of the decedent s family at all times during the three-year period ending on the date of the decedent s death; and (3) a qualified conservation contribution (within the meaning of sec. 170(h)) of a qualified real property interest (as generally defined in sec. 170(h)(2)(C)) was granted by the decedent or a member of his or her family. Preservation of a historically important land area or a certified historic structure does not qualify as a conservation purpose. Effective for estates of decedents dying after December 31, 2000, EGTRRA expanded the availability of qualified conservation easements by eliminating the requirement that the land be located within a certain distance of a metropolitan area, national park, wilderness area, or Urban National Forest. A qualified conservation easement may be claimed with respect to any land that is located in the United States or its possessions. EGTRRA also clarifies that the date for determining easement compliance is the date on which the donation is made. As described above, the estate, gift, and generation skipping transfer tax provisions of EGTRRA sunset at the end of 2010, such that those provisions will not apply to estates of decedents dying, gifts made, or generation skipping transfers made after December 31, As a result, the EGTRRA modifications to expand the availability of qualified conservation contributions do not apply for decedents dying after December 31, Sec. 2031(c). 48 Nelson 64

67 SECTION I - EXHIBIT 6 Provisions affecting small and family-owned businesses and farms Special-use valuation For years when an estate tax is in effect, an executor may elect to value for estate tax purposes certain qualified real property used in farming or another qualifying closely-held trade or business at its current-use value, rather than its fair market value. 58 The maximum reduction in value for such real property was $1 million for Real property generally can qualify for special-use valuation if at least 50 percent of the adjusted value of the decedent s gross estate consists of a farm or closely-held business assets in the decedent s estate (including both real and personal property) and at least 25 percent of the adjusted value of the gross estate consists of farm or closely-held business real property. In addition, the property must be used in a qualified use (e.g., farming) by the decedent or a member of the decedent s family for five of the eight years immediately preceding the decedent s death. If, after a special-use valuation election is made, the heir who acquired the real property ceases to use it in its qualified use within 10 years of the decedent s death, an additional estate tax is imposed in order to recapture the entire estate-tax benefit of the special-use valuation. Family-owned business deduction Prior to 2004, an estate was permitted to deduct the adjusted value of a qualified familyowned business interest of the decedent, up to $675, A qualified family-owned business interest generally is defined as any interest in a trade or business (regardless of the form in which it is held) with a principal place of business in the United States if the decedent s family owns at least 50 percent of the trade or business, two families own 70 percent, or three families own 90 percent, as long as the decedent s family owns, in the case of the 70-percent and 90-percent rules, at least 30 percent of the trade or business. To qualify for the deduction, the decedent (or a member of the decedent s family) must have owned and materially participated in the trade or business for at least five of the eight years preceding the decedent s date of death. In addition, at least one qualified heir (or member of the qualified heir s family) is required to materially participate in the trade or business for at least 10 years following the decedent s death. The qualified family-owned business rules provide a graduated recapture based on the number of years after the decedent s death within which a disqualifying event occurred. 58 Sec. 2032A. 59 Sec The qualified family-owned business deduction and the unified credit effective exemption amount are coordinated. If the maximum deduction amount of $675,000 is elected, then the unified credit effective exemption amount is $625,000, for a total of $1.3 million. Because of the coordination between the qualified family-owned business deduction and the unified credit effective exemption amount, the qualified family-owned business deduction would not provide a benefit in any year in which the applicable exclusion amount exceeds $1.3 million. 49 Nelson 65

68 SECTION I - EXHIBIT 6 In general, there is no requirement that the qualified heir (or members of his or her family) continue to hold or participate in the trade or business more than 10 years after the decedent s death. However, the 10-year recapture period can be extended for a period of up to two years if the qualified heir does not begin to use the property for a period of up to two years after the decedent s death. EGTRRA repealed the qualified family-owned business deduction for estates of decedents dying after December 31, As described above, the estate, gift, and generation skipping transfer tax provisions of EGTRRA sunset at the end of 2010, such that those provisions will not apply to estates of decedents dying, gifts made, or generation skipping transfers made after December 31, As a result, the qualified family-owned business deduction will apply to estates of decedents dying after December 31, Installment payment of estate tax for closely held businesses Estate tax generally is due within nine months of a decedent s death. However, an executor generally may elect to pay estate tax attributable to an interest in a closely held business in two or more installments (but no more than 10). 60 An estate is eligible for payment of estate tax in installments if the value of the decedent s interest in a closely held business exceeds 35 percent of the decedent s adjusted gross estate (i.e., the gross estate less certain deductions). If the election is made, the estate may defer payment of principal and pay only interest for the first five years, followed by up to 10 annual installments of principal and interest. This provision effectively extends the time for paying estate tax by 14 years from the original due date of the estate tax. A special two-percent interest rate applies to the amount of deferred estate tax attributable to the first $1.34 million 61 (as adjusted annually for inflation occurring after 1998; the original amount for 1998 was $1 million) in taxable value of a closely held business. The interest rate applicable to the amount of estate tax attributable to the taxable value of the closely held business in excess of $1.34 million is equal to 45 percent of the rate applicable to underpayments of tax under section 6621 of the Code (i.e., 45 percent of the Federal short-term rate plus two percentage points). Interest paid on deferred estate taxes is not deductible for estate or income tax purposes. Under pre-egtrra law, for purposes of these rules an interest in a closely held business was: (1) an interest as a proprietor in a sole proprietorship; (2) an interest as a partner in a partnership carrying on a trade or business if 20 percent or more of the total capital interest of such partnership was included in the decedent s gross estate or the partnership had 15 or fewer partners; and (3) stock in a corporation carrying on a trade or business if 20 percent or more of the value of the voting stock of the corporation was included in the decedent s gross estate or such corporation had 15 or fewer shareholders. Under present and pre-egtrra law, the decedent may own the interest directly or, in certain cases, indirectly through a holding company. If ownership is through a holding company, 60 Sec Rev. Proc , I.R.B (Nov. 9, 2009). 50 Nelson 66

69 SECTION I - EXHIBIT 6 the stock must be non-readily tradable. If stock in a holding company is treated as business company stock for purposes of the installment payment provisions, the five-year deferral for principal and the two-percent interest rate do not apply. The value of any interest in a closely held business does not include the value of that portion of such interest attributable to passive assets held by such business. Effective for estates of decedents dying after December 31, 2001, EGTRRA expands the definition of a closely held business for purposes of installment payment of estate tax. EGTRRA increases from 15 to 45 the maximum number of partners in a partnership and shareholders in a corporation that may be treated as a closely held business in which a decedent held an interest, and thus will qualify the estate for installment payment of estate tax. EGTRRA also expands availability of the installment payment provisions by providing that an estate of a decedent with an interest in a qualifying lending and financing business is eligible for installment payment of the estate tax. EGTRRA provides that an estate with an interest in a qualifying lending and financing business that claims installment payment of estate tax must make installment payments of estate tax (which will include both principal and interest) relating to the interest in a qualifying lending and financing business over five years. EGTRRA clarifies that the installment payment provisions require that only the stock of holding companies, not the stock of operating subsidiaries, must be non-readily tradable to qualify for installment payment of the estate tax. EGTRRA provides that an estate with a qualifying property interest held through holding companies that claims installment payment of estate tax must make all installment payments of estate tax (which will include both principal and interest) relating to a qualifying property interest held through holding companies over five years. As described above, the estate, gift, and generation skipping transfer tax provisions of EGTRRA sunset at the end of 2010, such that those provisions will not apply to estates of decedents dying, gifts made, or generation skipping transfers made after December 31, As a result, the EGTRRA modifications to the estate tax installment payment rules described above do not apply for estates of decedents dying after December 31, Generation-skipping transfer tax rules In general For years before and after 2010, a generation skipping transfer tax generally is imposed on transfers, either directly or in trust or similar arrangement, to a skip person (as defined above). 62 Transfers subject to the generation skipping transfer tax include direct skips, taxable terminations, and taxable distributions. 63 An exemption generally equal to the estate tax 62 Sec Sec Nelson 67

70 SECTION I - EXHIBIT 6 exemption amount is provided for each person making generation skipping transfers. The exemption may be allocated by a transferor (or his or her executor) to transferred property. A direct skip is any transfer subject to estate or gift tax of an interest in property to a skip person. 64 Natural persons or certain trusts may be skip persons. All persons assigned to the second or more remote generation below the transferor are skip persons (e.g., grandchildren and great-grandchildren). Trusts are skip persons if (1) all interests in the trust are held by skip persons, or (2) no person holds an interest in the trust and at no time after the transfer may a distribution (including distributions and terminations) be made to a non-skip person. A taxable termination is a termination (by death, lapse of time, release of power, or otherwise) of an interest in property held in trust unless, immediately after such termination, a non-skip person has an interest in the property, or unless at no time after the termination may a distribution (including a distribution upon termination) be made from the trust to a skip person. 65 A taxable distribution is a distribution from a trust to a skip person (other than a taxable termination or direct skip). 66 If a transferor allocates generation skipping transfer tax exemption to a trust prior to the taxable distribution, generation skipping transfer tax may be avoided. The tax rate on generation skipping transfers is a flat rate of tax equal to the maximum estate tax rate in effect at the time of the transfer multiplied by the inclusion ratio. The inclusion ratio with respect to any property transferred in a generation skipping transfer indicates the amount of generation skipping transfer tax exemption allocated to a trust. The allocation of generation skipping transfer tax exemption effectively reduces the tax rate on a generation skipping transfer. If an individual makes a direct skip during his or her lifetime, any unused generationskipping transfer tax exemption is automatically allocated to a direct skip to the extent necessary to make the inclusion ratio for such property equal to zero. An individual can elect out of the automatic allocation for lifetime direct skips. Under pre-egtrra law, for lifetime transfers made to a trust that were not direct skips, the transferor had to make an affirmative allocation of generation skipping transfer tax exemption; the allocation was not automatic. If generation skipping transfer tax exemption was allocated on a timely filed gift tax return, then the portion of the trust that was exempt from generation skipping transfer tax was based on the value of the property at the time of the transfer. If, however, the allocation was not made on a timely filed gift tax return, then the portion of the trust that was exempt from generation skipping transfer tax was based on the value of the property at the time the allocation of generation skipping transfer tax exemption was made. An election to allocate generation skipping transfer tax to a specific transfer generally may be made at any time up to the time for filing the transferor s estate tax return. 64 Sec. 2612(c). 65 Sec. 2612(a). 66 Sec. 2612(b). 52 Nelson 68

71 SECTION I - EXHIBIT 6 Modifications to the generation skipping transfer tax rules under EGTRRA Generally effective after 2000, EGTRRA modifies and adds certain mechanical rules related to the generation skipping transfer tax. First, EGTRRA generally provides that generation skipping transfer tax exemption will be allocated automatically to transfers made during life that are indirect skips. An indirect skip is any transfer of property (that is not a direct skip) subject to the gift tax that is made to a generation skipping transfer trust, as defined in the Code. If any individual makes an indirect skip during the individual s lifetime, then any unused portion of such individual s generation skipping transfer tax exemption is allocated to the property transferred to the extent necessary to produce the lowest possible inclusion ratio for such property. Second, EGTRRA provides that, under certain circumstances, generation skipping transfer tax exemption can be allocated retroactively when there is an unnatural order of death. In general, if a lineal descendant of the transferor predeceases the transferor, then the transferor can allocate any unused generation skipping transfer exemption to any previous transfer or transfers to the trust on a chronological basis. Third, EGTRRA provides that a trust that is only partially subject to generation skipping transfer tax because its inclusion ratio is less than one can be severed in a qualified severance. A qualified severance generally is defined as the division of a single trust and the creation of two or more trusts, one of which would be exempt from generation skipping transfer tax and another of which would be fully subject to generation skipping transfer tax, if (1) the single trust was divided on a fractional basis, and (2) the terms of the new trusts, in the aggregate, provide for the same succession of interests of beneficiaries as are provided in the original trust. Fourth, EGTRRA provides that in connection with timely and automatic allocations of generation skipping transfer tax exemption, the value of the property for purposes of determining the inclusion ratio shall be its finally determined gift tax value or estate tax value depending on the circumstances of the transfer. In the case of a generation skipping transfer tax exemption allocation deemed to be made at the conclusion of an estate tax inclusion period, the value for purposes of determining the inclusion ratio shall be its value at that time. Fifth, under EGTRRA, the Secretary of the Treasury generally is authorized and directed to grant extensions of time to make the election to allocate generation skipping transfer tax exemption and to grant exceptions to the time requirement, without regard to whether any period of limitations has expired. If such relief is granted, then the gift tax or estate tax value of the transfer to trust would be used for determining generation skipping transfer tax exemption allocation, and the relief would be retroactive to the date of the transfer. Sixth, EGTRRA provides that substantial compliance with the statutory and regulatory requirements for allocating generation skipping transfer tax exemption will suffice to establish that generation skipping transfer tax exemption was allocated to a particular transfer or a particular trust. If a taxpayer demonstrates substantial compliance, then so much of the transferor s unused generation skipping transfer tax exemption will be allocated as produces the lowest possible inclusion ratio. 53 Nelson 69

72 SECTION I - EXHIBIT 6 Sunset of EGTRRA modifications to the generation skipping transfer tax rules As described above, the estate and generation skipping transfer taxes are repealed for decedents dying and gifts made in The estate, gift, and generation skipping transfer tax provisions of EGTRRA sunset at the end of 2010, such that those provisions will not apply to estates of decedents dying, gifts made, or generation skipping transfers made after December 31, As a result, the generation skipping transfer tax again will apply after December 31, However, the EGTRRA modifications to the generation skipping transfer tax rules described above will not apply to generation skipping transfers made after December 31, Instead, in general, the rules as in effect prior to 2001 will apply. Description of Proposal The proposal generally makes permanent the estate, gift, and generation skipping transfer tax laws in effect for 2009, retroactive to the beginning of Under the proposal, the applicable exclusion amount for estate tax purposes generally is $3.5 million for decedents dying during 2010 and later years. The applicable exclusion amount for gift tax purposes is $1 million for 2010 and later years. The highest estate and gift tax rate under the proposal is 45 percent, as under 2009 law. 67 As under present law, the generation skipping transfer tax exemption for a given year is equal to the applicable exclusion amount for estate tax purposes ($3.5 million for 2010 and later years), and the generation skipping transfer tax rate for a given year will be determined using the highest estate tax rate in effect for such year. The proposal makes permanent the repeal of the State death tax credit; as under 2009 law, the proposal allows a deduction for certain death taxes paid to any State or the District of Columbia. In addition, the proposal makes permanent the repeal of the qualified family-owned business deduction. The proposal also repeals the modified carryover basis rules that, under EGTRRA, would apply for purposes of determining basis in property acquired from a decedent who dies in Under the proposal, a recipient of property acquired from a decedent who dies after December 31, 2009, generally will receive date-of-death fair market value basis (i.e., stepped up basis) under the basis rules that applied to assets acquired from decedents who died in Under the proposal, the sunset of the EGTRRA estate, gift, and generation skipping transfer tax provisions scheduled to occur at the end of 2010, is repealed. As a result, the proposal makes permanent the above-described EGTRRA modifications to the rules regarding 67 As under present law, the tax on taxable transfers for a year is determined by computing a tentative tax on the cumulative value of current year transfers and all gifts made by a decedent after December 31, 1976, and subtracting from the tentative tax the amount of gift tax that would have been paid by the decedent on taxable gifts after December 31, 1976, if the tax rate schedule in effect for that year had been in effect on the date of the prioryear gifts. 54 Nelson 70

73 SECTION I - EXHIBIT 6 (1) qualified conservation easements, (2) installment payment of estate taxes, and (3) various technical aspects of the generation skipping transfer tax. Effective date. The proposal is effective for estates of decedents dying, generation skipping transfers made, and gifts made after December 31, Transfer tax planning issues Stability and consistency in the law Analysis As described above, under EGTRRA the estate tax exemption amount and the estate and gift tax rates changed on an almost annual basis between 2002 and The estate and generation skipping taxes are repealed temporarily in 2010, followed by reinstatement of the taxes in 2011 with a lower exemption amount and a higher top marginal tax rate. Present law provides for two distinct sets of rules for determining basis of assets received from a decedent, depending on whether the decedent dies in 2010 or in a different year. The credit for succession taxes paid to a State was phased out and replaced with a deduction. In addition, increases in the estate tax exemption amount resulted in a phase-out and effective repeal of the deduction for qualified family-owned business interests under section 2057, but section 2057 again will be operative for 2011 and later years. Certain other modifications to the estate and gift tax laws under EGTRRA are scheduled to expire at the end of Commentators have advocated a stable and more predictable estate and gift tax system -- without constantly changing parameters, phase-outs, or sunsets -- arguing that the complexity of current law has made estate planning difficult and costly. The American Bar Association s Task Force on Federal Wealth Transfer Taxes argued that, because of the complexity of current law, [a] significant number of individuals likely will have estate plans with provisions that are inappropriate. 68 This could arise, for example, because estate planners fail to plan properly for changes in law, taxpayers are reluctant to incur the transaction costs associated with repeatedly modifying estate plans, or taxpayers choose to delay further planning in the hope that they will not die before the estate tax is permanently repealed or substantially reduced. As another example, the ABA Task Force notes that some taxpayers wish to maintain life insurance only if they will have an estate tax liability, but this is difficult to determine when the estate tax laws are unsettled and changing. 69 Differences in estate and gift tax exemption amounts Under the budget proposal, the gift tax exemption amount remains $1 million, while the estate tax exemption amount is $3.5 million. Commentators have argued that this decoupling of 68 American Bar Association, Task Force on Federal Wealth Transfer Taxes, Report on Reform of Federal Wealth Transfer Taxes (2004) (hereinafter ABA Task Force ), p Ibid., pp Nelson 71

74 SECTION I - EXHIBIT 6 the estate and gift tax exemption amounts complicates wealth transfer tax planning and raises administrability issues, and that the exemption amounts, therefore, should be reunified. For example, some commentators argue that, as a result of the lower gift tax exemption amount, taxpayers are likely to engage in complicated and costly planning to avoid gift tax. 70 They argue that the lower gift tax exemption (and resulting higher cost of the gift tax) could encourage taxpayers to create complicated long-term trusts at death designed to avoid gift tax on transfers to successive generations. They further argue that the lower gift tax exemption will encourage taxpayers to delay transfers until death, encouraging family wealth to remain locked in older generations. 71 The extent to which such practices have increased in use since the exemption amounts were decoupled in 2004 is uncertain. In addition, the effect of the lower gift tax exemption amount from 2004 through 2009 is partially mitigated by a structural difference between the estate tax and the gift tax that generally benefits taxpayers who make inter vivos gifts: the gift tax is tax exclusive, whereas the estate tax is tax inclusive. In other words, under the estate tax, the assets used to pay the tax are included in the estate tax base. Thus, if the estate and gift taxes were fully reunified, the gift tax would be a less costly tax. Furthermore, the gift tax often is viewed as being necessary to protect the income tax base. In the absence of a gift tax, it may be possible for a taxpayer to transfer an asset with builtin gain or that produces income to a taxpayer who is in a lower tax bracket, where the gain or income would be realized and taxed at a lower rate before the asset is gifted back to the original holder. Therefore, if the gift tax effective exemption amount were increased to equal the higher estate tax exemption amount, the effectiveness of the gift tax as a tool to protect the income tax base may be diminished. Treatment of State death taxes for Federal estate tax purposes Prior to 2002, Federal law allowed for a credit against the Federal estate tax for any estate, inheritance, legacy or succession taxes (referred to as State death taxes ) actually paid to any State or the District of Columbia. 72 The credit was determined under a graduated rate table set forth in section 2011(b), which ties the maximum credit amount to the adjusted taxable estate, which is the taxable estate reduced by $60,000. Under EGTRRA, the amount of the allowable credit was reduced from 2002 through For decedents dying after 2004, the credit is replaced with a deduction from the gross estate for State death taxes actually paid to any State or the District of Columbia. 73 The budget proposal reinstates and makes permanent the State death tax deduction. 70 Ibid., p Ibid., pp Sec Sec Nelson 72

75 SECTION I - EXHIBIT 6 Before the credit was repealed, many States imposed soak-up or pick-up taxes, i.e., State taxes designed to impose a tax equal to the maximum amount of the Federal credit allowed to a decedent. Such taxes had the effect of shifting revenue to States from the Federal government, without changing the overall amount of estate tax liability (Federal and State) of a taxpayer. Under prior law, all of the States imposed a tax at a level at least equal to the amount of the State death tax credit allowed under section As of July 1, 2009, however, 27 States imposed no State death taxes. 75 Some argue that the State death tax credit should be reinstated rather than retaining the present-law deduction. They argue, for example, that the credit served as a powerful funding mechanism for States; because States are struggling financially in the current economy, the States are in critical need of such funding. Furthermore, because it is politically difficult to enact new taxes in many States, some State legislatures have been unable or unwilling to replace existing soak-up taxes (which in some cases now lie dormant because such laws operate only to the extent Federal law allows a credit for State death taxes) with new estate or inheritance taxes, leaving such States without an annual stream of revenue. Some advocates of reinstating the State death tax credit also argue that the absence of Federal credit increases the disparity in estate taxes imposed by the various States, which can (1) lead to competition between States to attract wealthy residents and (2) result in disparate tax treatment of similarly situated individuals, depending only on an individual s State of residence at the time of death. 76 Others argue that the State death tax credit should not be reinstated. Some argue, for example, that estate or other succession taxes, whether Federal or State, are undesirable and that the allowance of a Federal credit for State death taxes is a subsidy to States that encourages the enactment or retention of State-level death taxes. Some might also argue that if the intended policy is to provide a funding mechanism for State governments, it would be more direct and efficient to provide a direct Federal government subsidy instead of making a tax expenditure through the tax system. Federal estate tax and basis of transferred assets Present law includes two sets of rules for determining the basis of property acquired from a decedent s estate. The basis of property acquired from estates of decedents dying anytime before or after 2010 generally is the property s fair market value at the time of the decedent s death. As a result of this basis step-up (or step-down if property declined in value while owned by the decedent) when a taxpayer sells inherited property, the taxpayer generally does not recognize gain or loss attributable to appreciation or depreciation in the property that occurred during the decedent s holding period. Present law provides a different rule for property acquired from estates of decedents dying in For this property, there is no Federal estate tax, but 74 ABA Task Force, p See McGuire Woods LLP, 2009 State Death Tax Chart (Revised July 1, 2009), available at 76 See, e.g., Jeffrey A. Cooper, Interstate Competition and State Death Taxes: A Modern Crisis in Historical Perspective, 33 Pepperdine Law Review 835 (2006). 57 Nelson 73

76 SECTION I - EXHIBIT 6 heirs generally take a carryover basis. This carryover basis preserves in the hands of an heir taxable gain or loss attributable to increases or decreases in the value of property during the decedent s holding period. The one-year change from an estate tax coupled with basis step-up (or step-down) to estate tax repeal with carryover basis raises several behavioral and administrative issues. A few significant issues are described below. Carryover basis may affect a taxpayer s willingness to sell an appreciated asset. In general, a realization-based tax system creates lock-in, a behavioral distortion that may be described as the reluctance of an individual to sell property and thereby incur tax on the recognition of accrued appreciation in the property. This lock-in reduces the mobility of capital to potentially higher return investments. Proponents of carryover basis argue that allowing inherited property to receive a basis step-up accentuates lock-in. Because income taxes on accrued appreciation can be avoided entirely if the basis of property that passes at death is stepped up to its fair market value at the time of death, an individual may choose not to sell appreciated property before death. Under this argument, carryover basis would reduce lock-in because holding assets until death would not permit avoidance of income tax liability on predeath appreciation when assets eventually are sold by heirs. Conversely, opponents of carryover basis argue that it perpetuates lock-in because income tax liability for pre-death gains carries over to the heir. Thus, under carryover basis the decedent s beneficiary also may refrain from selling an asset because of the adverse income tax consequences from sale. Opponents of carryover basis argue that the stepped-up basis rule removes the lock-in effect once each generation. Under carryover basis, taxpayers will be required to establish a decedent s historical cost basis in inherited assets. Commentators have argued that establishing this historical cost basis may be difficult in many cases. 77 The difficulty may be acute in part because the decedent is no longer available to remember the history of assets and where records of transactions affecting basis might be located. This problem may be especially troublesome in the case of personal residences for which there may be many transactions that affect basis; personal effects such as jewelry; assets such as classic cars that appreciate in value and to which many improvements may be made; and unique assets such as paintings and stamp collections. It may be possible to use presumptions to ameliorate the difficulty of establishing historical cost basis. For example, a rule that presumed the decedent purchased an asset at its value on the date of its acquisition would in some cases limit the necessary knowledge to the date the decedent acquired the asset. In the absence of statutory presumptions, if an heir is unable to establish a decedent s basis in property, a question is whether the IRS will consider the heir to have a zero basis in the property. 77 Nonna A. Noto, Step-Up vs. Carryover Basis for Capital Gains: Implications for Estate Tax Repeal, CRS Report for Congress RL30875, p. 9 (updated Apr. 20, 2001). The report notes that practitioners raised this concern when a previous attempt to institute carryover basis was enacted (and repealed before taking effect) by the Tax Reform Act of See also AICPA Tax Division, Reform of the Estate and Gift Tax System, Tax Notes (Apr. 9, 2001), p Nelson 74

77 SECTION I - EXHIBIT 6 A related issue under a carryover basis regime is the role of the executor of an estate in determining the decedent s basis in the assets over which the executor has control. 78 When carryover basis rules were adopted in 1976, the executor was required to obtain information about basis and to provide that information to heirs. No such requirement was included in the carryover basis rules adopted in If rules required executors to provide basis information to beneficiaries or if executors provided information in the absence of a requirement, a question would be whether beneficiaries would be permitted to rely on the information and whether executors would be subject to penalties for failure to report correct or complete information. Although the 2001 rules do not require an executor to provide basis information to beneficiaries, they do provide that an executor must allocate the permitted basis increases (the $1.3 million and $3 million amounts described previously) among estate assets, and they permit broad discretion in making the allocation (subject to a prohibition on using basis additions to create a built-in loss in any single asset). This broad discretion may create difficulties for executors concerned about fiduciary obligations and may create uncertainty for beneficiaries if an executor fails to make an allocation. Change from a step-up basis rule to a carryover basis regime raises a question whether the change should be accompanied by transition rules. Some individuals may have purchased and held appreciating or depreciable property with the expectation that the basis of the property would be stepped-up upon the individuals deaths. These individuals may argue that it would be unfair to repeal the stepped-up basis rule at least with respect to amounts of appreciation that have occurred before the time of the rule change. The carryover basis rules adopted in 1976 provided a grandfather rule under which the basis of an inherited asset could not be less than its value on December 31, Establishing the value of all assets that could be inherited proved to be a difficult and time consuming exercise. EGTRRA s carryover basis rules do not provide a grandfather for pre-carryover basis appreciation. Retroactive application of the estate and generation skipping transfer taxes The proposal makes permanent the estate, gift and generation skipping tax laws that were in effect in 2009, effective for decedents dying and gifts made after December 31, The estate and generation skipping taxes thus would be reinstated for all estates of decedents dying and gifts made during 2010, even with respect to transfers that occurred prior to the enactment of the proposal. Similarly, the modified carryover basis rules for assets acquired from a decedent who dies in 2010 would be repealed retroactively and replaced with the 2009 step-up in basis rules. Some may argue that retroactive imposition of the estate and generation skipping taxes is inappropriate, because such retroactivity may be unconstitutional or is simply unfair. Although the outcome of any constitutional challenge is uncertain, some believe that a constitutional challenge itself is a virtual certainty, calling the tax law into question while litigation and 78 AICPA Tax Division, supra note 82, p. 326; Task Force on Federal Wealth Transfer Tax, Report on Reform of Federal Wealth Transfer Taxes 72 (2004); Karen C. Burke and Grayson M.P. McCouch, Estate Tax Repeal: Through the Looking Glass, 22 Virginia Tax Review 187, 220 (2002). 59 Nelson 75

78 SECTION I - EXHIBIT 6 appeals, maybe all the way to the Supreme Court, are ongoing. 79 In other words, the likelihood of litigation, even if ultimately unsuccessful, could result in years of uncertainty for taxpayers, heirs, and fiduciaries. With regard to fairness, some may argue that taxpayers rely on the law that is in effect when planning wealth transfers, and that it is inappropriate for Congress to change the applicable rules after the fact. A taxpayer, for example, may choose to make an outright gift to a greatgrandchild in early 2010, when there is no generation skipping transfer tax. Had the taxpayer known that the generation skipping transfer tax would apply to the transfer, it is possible that he or she would not have made the outright gift or would have structured the gift in a different way. On the other hand, some may argue that retroactive application of the 2009 transfer tax and basis rules is both appropriate and fair. First, lawmakers widely discussed the prospect of retroactivity prior to the end of 2009, such that taxpayers and estate planners had some prior knowledge that the transfer tax and basis rules could be retroactively modified. Furthermore, some may argue that a greater number of taxpayers will be affected negatively by the law currently in effect for 2010; in other words, a smaller number of taxpayers would face an increased tax liability if the 2009 rules were extended retroactively. Specifically, under 2010 law, assets acquired from a decedent do not receive a full step up in basis. As a result, many heirs will incur capital gains tax liability upon a sale or other disposition of an inherited asset. If the 2009 rules instead applied, the same asset would receive a full step up in basis as of the decedent s death, such that the heir would not incur capital gains tax liability upon a subsequent disposition of the asset with respect to appreciation that occurred before the decedent s death. The number of heirs who have the potential for greater capital gains tax liability under 2010 law likely far exceeds the number of decedents estates that will benefit from the absence of an estate tax under 2010 law. Economic issues Wealth taxes, saving, and investment Some may argue that a reduction in the estate tax for years after 2010, as under the proposal, would affect taxpayers saving and investment behavior. Taxes on accumulated wealth are taxes on the stock of capital held by the taxpayer. As a tax on capital, issues similar to those that arise in analyzing any tax on the income from capital arise. In particular, there is no consensus among economists on the extent to which the incidence of taxes on the income from capital is borne by owners of capital in the form of reduced returns or whether reduced returns cause investors to save less and provide less capital to workers, thereby reducing wages in the long run. A related issue is to what extent individuals respond to increases (or decreases) in the after-tax return to investments by decreasing (or increasing) their saving. Again, there is no consensus in either the empirical or theoretical economics literature regarding the responsiveness of saving to after-tax returns on investment. 79 Ronald D. Aucutt, Milford B. Hatcher, Jr., Charles D. Fox IV, and Diana S.C. Zeydel, The Impact of Estate Tax Repeal -- Going Blindly Where No One Else Has Gone, American Law Institute - American Bar Association Continuing Legal Education (Feb , 2010). 60 Nelson 76

79 SECTION I - EXHIBIT 6 Some economists believe that an individual s bequest motives are important to understanding saving behavior and aggregate capital accumulation. If estate and gift taxes alter the bequest motive, they may change the tax burdens of taxpayers other than the decedent and his or her heirs. 80 It is an open question whether the bequest motive is an economically important explanation of taxpayer saving behavior and level of the capital stock. For example, theoretical analysis suggests that the bequest motive may account for between 15 and 70 percent of the United States capital stock. 81 Others believe the bequest motive is not important in national capital formation, 82 and empirical analysis of the existence of a bequest motive has not led to a consensus. 83 Theoretically, it is an open question whether estate and gift taxes encourage or discourage saving, and there has been limited empirical analysis of this specific issue. 84 By 80 A discussion of why, theoretically, the effect of the estate tax on saving behavior depends upon taxpayers motives for intergenerational transfers and wealth accumulation is provided by William G. Gale and Maria G. Perozek, Do Estate Taxes Reduce Saving? in William G. Gale and Joel B. Slemrod, eds., Rethinking the Estate Tax, (Washington, D.C: The Brookings Institution), For a brief review of how different views of the bequest motive may alter taxpayer bequest behavior, see William G. Gale and Joel B. Slemrod, Death Watch for the Estate Tax, Journal of Economic Perspectives, 15, Winter, 2001, pp See Laurence J. Kotlikoff and Lawrence H. Summers, The Role of Intergenerational Transfers in Aggregate Capital Accumulation, Journal of Political Economy, 89, August, Also see, Laurence J. Kotlikoff, Intergenerational Transfers and Savings, Journal of Economic Perspectives, 2, Spring, For discussion of these issues in the context of wealth transfer taxes see, Henry J. Aaron and Alicia H. Munnell, Reassessing the Role for Wealth Transfer Taxes, National Tax Journal, 45, June, For attempts to calculate the share of the aggregate capital stock attributable to the bequest motive, see Thomas A. Barthold and Takatoshi Ito, Bequest Taxes and Accumulation of Household Wealth: U.S.-Japan Comparison, in Takatoshi Ito and Anne O. Kreuger (eds.), The Political Economy of Tax Reform (Chicago: The University of Chicago Press), 1992; and William G. Gale and John Karl Scholz, Intergenerational Transfers and the Accumulation of Wealth, Journal of Economic Perspectives, 8, Fall 1994, pp Gale and Scholz estimate that 20 percent of the nation s capital stock can be attributed to intentional transfers (including inter vivos transfers, life insurance, and trusts) and another 30 percent can be attributed to bequests, whether planned or unplanned. 82 Franco Modigliani, The Role of Intergenerational Transfers and Life Cycle Saving in the Accumulation of Wealth, Journal of Economic Perspectives, 2, Spring, In this article, Modigliani argues that 15 percent is more likely an upper bound. 83 See B. Douglas Bernheim, How Strong Are Bequest Motives? Evidence Based on Estimates of the Demand for Life Insurance and Annuities, Journal of Political Economy, 99, October 1991, pp Bernheim finds that social security annuity benefits raise life insurance holdings and depress private annuity holdings among elderly individuals. He interprets this as evidence that elderly individuals choose to maintain a positive fraction of their resources in bequeathable forms. For an opposing finding, see Michael D. Hurd, Savings of the Elderly and Desired Bequests, American Economic Review, 77, June 1987, pp Hurd concludes that any bequest motive is not an important determinant of consumption decisions and wealth holdings... Bequests seem to be simply the result of mortality risk combined with a very weak market for private annuities. (p. 308). 84 Wojciech Kopczuk and Joel Slemrod, The Impact of the Estate Tax on the Wealth Accumulation and Avoidance Behavior of Donors, in William G. Gale and Joel B. Slemrod, eds., Rethinking Estate and Gift Taxation, (Washington, D.C.: The Brookings Institution), 2001, use estate tax return data from 1916 to 1996 to investigate the impact of the estate tax on reported estates. They find a negative correlation between measures of the level of estate taxation and reported wealth. This finding may be consistent with the estate tax depressing wealth accumulation (depressing saving) or with the estate tax encouraging successful avoidance activity. 61 Nelson 77

80 SECTION I - EXHIBIT 6 raising the after-tax cost of leaving a bequest, a more expansive estate tax may discourage potential transferors from accumulating the assets necessary to make a bequest. On the other hand, a taxpayer who wants to leave a bequest of a certain net size might save more in response to estate taxation to meet that goal. For example, some individuals purchase additional life insurance to have sufficient funds to pay the estate tax without disposing of other assets in their estate. Wealth taxes and small business Regardless of any potential effect on aggregate saving, the scope and design of the transfer tax system may affect the composition of investment. In particular, some observers note that the transfer tax system may impose special cash flow burdens on small or family-owned businesses. They note that if a family has a substantial proportion of its wealth invested in one enterprise, the need to pay estate taxes may force heirs to liquidate all or part of the enterprise or to encumber the business with debt to meet the estate tax liability. If the business is sold, while the assets generally do not cease to exist and remain a productive part of the economy, the share of business represented by small or family-owned businesses may be diminished by the estate tax. If the business borrows to meet estate tax liability, the business s cash flow may be strained. There is some evidence that many businesses may be constrained in the amount of funds they can borrow. If businesses are constrained, they may reduce the amount of investment in the business and this would be a market inefficiency. 85 One study suggests that reduction in estate taxes may have a positive effect on an entrepreneur s survival. 86 Others argue that potential deleterious effects of the estate tax on investment by small or family-owned businesses are limited. The 2009 (and proposed) exemption value of the unified More recently, David Joulfaian, The Behavioral Response of Wealth Accumulation to Estate Taxation: Time Series Evidence, National Tax Journal, 59, June 2006, pp , examines the size of taxable estates and the structure of the estate tax and its effects on the expected rates of return to saving. While he emphasizes the sensitivity of the analysis to how individuals expectations about future taxes are modeled he concludes that taxable estates are ten percent smaller because of the estate tax. 85 Steven M. Fazzari, R. Glenn Hubbard, and Bruce C. Petersen, Financing Constraints and Corporate Investment, Brookings Papers on Economic Activity, 1988, pp Douglas Holtz-Eakin, David Joulfaian, and Harvey S. Rosen, Sticking It Out: Entrepreneurial Survival and Liquidity Constraints, Journal of Political Economy, 102, February 1994, pp Holtz-Eakin, Joulfaian, and Rosen study the effect of receipt of an inheritance on whether an entrepreneur s business survives rather than whether an on-going business that is taxed as an asset in an individual s estate survives. They find that the effect of inheritance on the probability of surviving as an entrepreneur is small but noticeable: a $150,000 inheritance raises the probability of survival by about 1.3 percentage points, and [i]f enterprises do survive, inheritances have a substantial impact on their performance: the $150,000 inheritance... is associated with a nearly 20-percent increase in an enterprise s receipts (p.74). These results do not necessarily imply that the aggregate economy is made better off by receipt of inheritances. Survival of the entrepreneur may not be the most highly valued investment that could be made with the funds received. For example, Francisco Perez-Gonzalez, Inherited Control and Firm Performance, American Economic Review, 96, December 2006, pp , finds that where the incoming CEO is related to the departing CEO, or to a founder, the firm underperforms in terms of profitability and other financial measures. 62 Nelson 78

81 SECTION I - EXHIBIT 6 credit is $3.5 million per decedent. As a result, small business owners can obtain an effective exemption of up to $7.0 million per married couple, and other legitimate tax planning can further reduce the burden on such enterprises. Also, as described above, Code sections 2031A, 2057, 87 and 6166 are provided to reduce the impingement on small business cash flow that may result from an estate tax liability. Some analysis questions whether, in practice, small businesses need to liquidate operating assets to meet estate tax liabilities. A recent study of 2001 estate returns shows that many estates that claimed benefits under sections 2032A, 2057, or 6166 held liquid assets nearly sufficient to meet all debts against the estate. The study found only 2.4 percent of estates that reported closely held business assets and agricultural assets elected the deferral of tax under section Others have argued that estate tax returns report a small fraction of the value of decedents estates thereby mitigating any special burden that the estate tax may impose on small business. 89 Wealth taxes and labor supply As people become wealthier, they have an incentive to consume more of everything, including leisure time. Some, therefore, suggest that, by reducing the amount of wealth transferrable to heirs, transfer taxes may reduce labor supply of the parent, although it may increase labor supply of the heir. Over 100 years ago, Andrew Carnegie opined that the parent who leaves his son enormous wealth generally deadens the talents and energies of the son, and tempts him to lead a less useful and less worthy life than he otherwise would While, in 87 As discussed above, section 2057 no longer applies for estates of decedents dying after 2003, but will apply to estates of decedents dying after Martha Eller Gangi and Brian G. Raub, Utilization of Special Estate Tax Provisions for Family-Owned Farms and Closely Held Businesses, SOI Bulletin, 26, Summer 2006, pp Gangi and Raub calculate a liquidity ratio, the ratio of liquid assets (cash, cash management accounts, State and local bonds, Federal government bonds, publicly traded stock, and insurance on the life of the decedent) to the sum of the net estate tax plus mortgages and liens. They found that in 2001 this ratio exceeded one for estates of less than $2.5 million claiming benefits of the special deduction for qualified family owned business assets or deferral of tax. Larger such estates had average liquidity ratios of 0.5 or more. Generally all estates claiming special use valuations had an average liquidity ratio of at least one. A liquidity ratio of one implies that the estate has liquid assets sufficient to pay the net estate tax plus pay off all mortgages and liens. 89 See George Cooper, A Voluntary Tax? New Perspectives on Sophisticated Tax Avoidance, (Washington, D.C.: The Brookings Institution), Also, see B. Douglas Bernheim, Does the Estate Tax Raise Revenue? in Lawrence H. Summers (ed.), Tax Policy and the Economy 1 (Cambridge, Mass.: The MIT Press), 1987; and Alicia H. Munnell with Nicole Ernsberger, Wealth Transfer Taxation: The Relative Role for Estate and Income Taxes, New England Economic Review, November/December These studies pre-date the enactment of chapter 14 of the Code. The purpose of chapter 14 is to improve reporting of asset values in certain transfers. Nevertheless, planning opportunities remain whereby small business owners can reduce the cash required to meet an estate tax obligation, see Joint Committee on Taxation, Options to Improve Tax Compliance and Reform Tax Expenditures, JCS-2-05, January 27, The Joint Committee staff discusses the ability to use valuation discounts and lapsing trust powers effectively to shelter business (and other) assets from the estate tax on pages Andrew Carnegie, The Advantages of Poverty, in The Gospel of Wealth and Other Timely Essays, Edward C. Kirkland (ed.), (Cambridge, MA: The Belknap Press of Harvard University Press), 1962, reprint of Carnegie from Nelson 79

82 SECTION I - EXHIBIT 6 theory, increases in wealth should reduce labor supply, empirically economists have found the magnitude of these effects to be small. 91 Conversely, by reducing the amount of wealth transferrable to heirs, the estate tax could increase work effort of heirs as the benefits of the installment payment method, special-use valuation, and the exclusion for qualified family-owned business interests will be lost and recaptured if the assets fail to remain in a qualified use. In addition, the estate tax also could distort, in either direction, the labor supply of the transferor if it distorts his or her decision to make a bequest. Wealth taxes, the distribution of wealth, and fairness Some suggest that, in addition to their role in producing Federal revenue, Federal transfer taxes may help prevent an increase in the concentration of wealth. Overall, there are relatively few analyses of the distribution of wealth holdings in the economic literature. 92 Conventional economic wisdom holds that the Great Depression of the 1930s and World War II substantially reduced the concentration of wealth in the United States, and that there had been no substantial change at least through the 1980s. Most analysts assign no role to tax policy in the reduction in wealth concentration that occurred between 1930 and Nor has any analyst been able to quantify what role tax policy might have played since World War II For a review of this issue, see John Pencavel, Labor Supply of Men: A Survey, in Orley Ashenfelter and Richard Layard (eds.), Handbook of Labor Economics, vol. I, (New York, NY: North-Holland Publishing Co.) For a direct empirical test of what some refer to as the Carnegie Conjecture, see Douglas Holtz-Eakin, David Joulfaian, and Harvey S. Rosen, The Carnegie Conjecture: Some Empirical Evidence, Quarterly Journal of Economics, 108, May 1993, pp Holtz-Eakin, Joulfaian, and Rosen assess the labor force participation of families that receive an inheritance. They find that the likelihood that a person decreases his or her participation in the labor force increases with the size of the inheritance received. For example, families with one or two earners who received inheritances above $150,000 [in constant dollars] were about three times more likely to reduce their labor force participation to zero than families with inheritances below $25,000. Moreover,... high inheritance families experienced lower earnings growth than low inheritance families, which is consistent with the notion that inheritance reduces hours of work (pp ). Theory suggests also that those who choose to remain in the labor force will reduce their hours worked or labor earnings. Holtz-Eakin, Joulfaian, and Rosen find these effects to be small. 92 For some exceptions, see Martin H. David and Paul L. Menchik, Changes in Cohort Wealth Over a Generation, Demography, 25, August 1988; Paul L. Menchik and Martin H. David, The Effect of Income Distribution on Lifetime Savings and Bequests, American Economic Review, 73, September 1983; and Edward N. Wolff, Estimate of Household Wealth Inequality in the U.S., , The Review of Income and Wealth, 33, September See Michael K. Taussig, Les inegalites de patrimoine aux Etats-Unis, in Kessler, Masson, Strauss- Khan (eds.) Accumulation et Repartition des Patrimoines. Taussig estimates shares of wealth held by the top 0.5 percent of wealth holders in the United States for various years between 1922 and Wolff, in Estimate of Household Wealth Inequality in the U.S., , does not attribute any movements in wealth distribution directly to tax policy, but rather to the changes in the relative values of housing and corporate stock. Wojciech Kopczuk and Joel Slemrod, The Impact of the Estate Tax on Wealth Accumulation and Avoidance Behavior, in William G. Gale, James R. Hines Jr., and Joel Slemrod (eds), Rethinking Estate and Gift Taxation, (Washington, D.C.: The Brookings Institution), 2001, find mixed evidence. Using aggregate time series 64 Nelson 80

83 SECTION I - EXHIBIT 6 Income tax does not tax all sources of income. Some suggest that by serving as a backstop for income that escapes income taxation, transfer taxes may help promote overall fairness of the U.S. tax system. Still others counter that to the extent that much wealth was accumulated with after-(income)-tax dollars, as an across-the-board tax on wealth, transfer taxes tax more than just those monies that may have escaped the income tax. In addition, depending upon the incidence of such taxes, it is difficult to make an assessment regarding the contribution of transfer taxes to the overall fairness of the U.S. tax system. Even if transfer taxes are believed to be borne by the owners of the assets subject to tax, an additional conceptual difficulty is whether the tax is borne by the generation of the transferor or the generation of the transferee. The design of the gift tax illustrates this conceptual difficulty. A gift tax is assessed on the transferor of taxable gifts. Assume, for example, a mother makes a gift of $1 million to her son and incurs a gift tax liability of $450,000. From one perspective, the gift tax could be said to have reduced the mother s current economic well-being by $450,000. However, it is possible that, in the absence of the gift tax, the mother would have given her son $2 million, so that the gift tax has reduced the son s economic well-being by $1 million. It also is possible that the economic well-being of both was reduced. Of course, distinctions between the donor and recipient generations may not be important to assessing the fairness of transfer taxes if both the donor and recipient have approximately the same income. 94 Federal estate taxation and charitable bequests The two unlimited exclusions under the Federal estate tax are for bequests to a surviving spouse and for bequests to a charity. Because the proposed marginal tax rate under the estate tax is 45 percent, while marginal income tax rates range from 10 to 35 percent (39.6 percent after 2010), the after-tax cost of a charitable bequest is lower than the after-tax cost of a charitable gift made during one s lifetime. 95 Economists refer to this incentive as the price or substitution data, Kopczuk and Slemrod find a negative correlation between the share of wealth held by top wealth holders and the estate tax rates. That finding would imply that the estate tax may mitigate the concentration of wealth among top wealth holders. Wojciech Kopczuk and Emmanuel Saez, Top Wealth Shares in the United States, : Evidence from Estate Tax Returns, National Tax Journal, 57, September 2004, pp , report a similar result. However, when Kopczuk and Slemrod use pooled cross section analysis to make use of individual estate tax return data, they find at best a weak relationship between estate tax rates and wealth holdings. 94 Researchers have found that the correlation of income between parents and children is less than perfect. For analysis of the correlation of income among family members across generations, see Gary R. Solon, Intergenerational Income Mobility in the United States, American Economic Review, 82, June 1992, and David J. Zimmerman, Regression Toward Mediocrity in Economic Stature, American Economic Review, 82, June These studies, however, examine data relating to a broad range of incomes in the United States and do not directly assess the correlation of income among family members with transferors subject to the estate tax. 95 Economists note that when expenditures on specified items are permitted to be deducted from the tax base, before the computation of tax liability, the price of the deductible item is effectively reduced by a percentage equal to the taxpayer s marginal tax rate. Assume, for example, a decedent has a $1 million taxable estate and that the marginal, and average, estate tax rate were 40 percent. This means that the estate tax liability would be $400,000. A net of $600,000 would be available for distribution to heirs. If, however, the decedent had provided that his estate make a charitable bequest of $100,000, the taxable estate would equal $900,000 and the estate tax liability would be $360,000. By bequeathing $100,000 to charity, the estate s tax liability fell by $40,000. The net 65 Nelson 81

84 SECTION I - EXHIBIT 6 effect. In short, the price effect says that if something is made cheaper, people will do more of it. Some analysts have suggested that the charitable estate tax deduction creates a strong incentive to make charitable bequests and that changes in Federal estate taxation could alter the amount of funds that flow to charitable purposes. The decision to make a charitable bequest arises not only from the incentive effect of a charitable bequest s deductibility, or tax price, but also from what economists call the wealth effect. Generally the wealthier an individual is, the more likely he or she is to make a charitable bequest and the larger the bequest will be. Because the estate tax diminishes the value of wealth to an heir, the wealth effect would suggest repeal of the estate tax could increase charitable bequests. A number of studies have examined the effects of estate taxes on charitable bequests. Most of these studies have concluded that, after controlling for the size of the estate and other factors, deductibility of charitable bequests encourages taxpayers to provide charitable bequests. 96 Some analysts interpret these findings as implying that reductions in estate taxation, as under the budget proposal, could lead to a reduction in funds flowing into the charitable sector. This is not necessarily the case, however. Some charitable bequests may substitute for lifetime giving to charity, in part to take advantage of the greater value of the charitable deduction under the estate tax than under the income tax that results from the lower marginal income tax rates and limitations on annual lifetime giving. If this is the case, reductions in the estate tax could lead to increased charitable giving during the taxpayer s life. On the other hand, some analysts have suggested that a more sophisticated analysis is required recognizing that a taxpayer may choose among bequests to charity, bequests to heirs, lifetime gifts to charity, and lifetime gifts to heirs and recognizing that lifetime gifts reduce the future taxable estate and available for distribution to heirs after payment of the estate tax and payment of the charitable bequest would be $540,000. The $100,000 charitable bequest reduced the amount of funds available to be distributed to heirs by only $60,000. Economists say that the $100,000 charitable bequest cost $60,000, or that the price of the bequest was 60 cents per dollar of bequest. More generally, the price of charitable bequest equals (1 - t), where t is the estate s marginal tax rate. 96 For example, see Charles T. Clotfelter, Federal Tax Policy and Charitable Giving (Chicago: University of Chicago Press), 1985; David Joulfaian, Charitable Bequests and Estate Taxes, National Tax Journal, 44, June 1991, pp ; and Gerald Auten and David Joulfaian, Charitable Contributions and Intergenerational Transfers, Journal of Public Economics, 59, 1996, pp David Joulfaian, Estate Taxes and Charitable Bequests by the Wealthy, National Tax Journal, 53, September 2000, pp , provides a survey of these studies and presents new evidence. Each of these studies estimates a tax price elasticity in excess of 1.6 in absolute value. This implies that for each 10-percent reduction in the tax price, where the tax price is defined as one minus the marginal tax rate, there is a greater than 16-percent increase in the dollar value of charitable bequests. Such a finding implies that charities receive a greater dollar value of bequests than the Treasury loses in forgone tax revenue. In a more recent study, Michael J. Brunetti, The Estate Tax and Charitable Bequests: Elasticity Estimates Using Probate Records, National Tax Journal, 58, June 2005, pp , finds price elasticities in excess of 1.2. Not all studies find such responsiveness of charitable bequests to the marginal estate tax rate. Thomas Barthold and Robert Plotnick, Estate Taxation and Other Determinants of Charitable Bequests, National Tax Journal, 37, June 1984, pp , estimated that marginal tax rates had no effect on charitable bequests. 66 Nelson 82

85 SECTION I - EXHIBIT 6 consumption. In this more complex framework, reductions in estate taxation could reduce lifetime charitable gifts. 97 Federal transfer taxes and complexity Critics of Federal transfer taxes document that these taxes create incentives to engage in avoidance activities. Some of these avoidance activities involve complex legal structures and can be expensive to create. Incurring these costs, while ultimately profitable from the donors and donees perspective, is socially wasteful because time, effort, and financial resources are spent that lead to no increase in productivity. Such costs represent an efficiency loss to the economy in addition to whatever distorting effects Federal transfer taxes may have on other economic choices such as saving and labor supply discussed above. For example, in the case of family-owned businesses, such activities may impose an ongoing cost by creating a business structure to reduce transfer tax burdens that may not be the most efficient business structure for the operation of the business. Reviewing more complex legal arrangements increases the administrative cost of the Internal Revenue Service. There is disagreement among analysts regarding the magnitude of the costs of avoidance activities. 98 It is difficult to measure the extent to which any such costs incurred are undertaken from tax avoidance motives as opposed to succession planning or other motives behind gifts and bequests. Alternatives to the current U.S. estate tax system Some argue that, rather than modifying and making permanent the present U.S. estate tax system, Congress should consider an alternative structure. The choice of one form of wealth transfer tax system over another necessarily will involve tradeoffs among efficiency, equity, administrability, and other factors. A determination whether one system is preferable to another could be made on the basis of each system s relative success in achieving one or a majority of these goals, without sacrificing excessively the achievement of the others. Alternatively, such a determination could be made based on which system provides the best mix of efficiency, equity, and administrability. The United States, State governments, and foreign jurisdictions tax transfers of wealth in many different ways. Some wealth transfer tax systems, for example, impose a tax on the transferor. Such systems include the U.S. estate and gift tax system, which imposes a gift tax on 97 Auten and Joulfaian, Charitable Contributions and Intergenerational Transfers, attempted to estimate this more complex framework. Their findings suggest that reductions in estate taxation would reduce charitable contributions during the taxpayer s life. 98 Joint Economic Committee, The Economics of the Estate Tax, December 1998, has stated the costs of complying with the estate tax laws are roughly the same magnitude as the revenue raised. Richard Schmalbeck, Avoiding Federal Wealth Transfer Taxes, in William G. Gale and Joel B. Slemrod, eds., Rethinking Estate and Gift Taxation, (Washington, D.C.: The Brookings Institution), 2001, disagrees writing [a]bout half of the estate planners consulted in the preparation of this paper reported that they had rather standard packages that they would make available to individuals who would leave estates in the three to ten million range that might be provided for as little as $3000 to $5000. See William G. Gale and Joel B. Slemrod, Life and Death Questions About the Estate and Gift Tax, National Tax Journal, 53, December 2000, pp , for a review of the literature on compliance cost. 67 Nelson 83

86 SECTION I - EXHIBIT 6 certain gratuitous lifetime transfers, an estate tax on a decedent s estate, and a generationskipping transfer tax on certain transfers that skip generations. Another approach that involves imposition of a tax on a transferor is a deemed-realization approach, under which a gratuitous transfer is treated as a realization event and the gain on transferred assets, if any, generally is taxed to the transferor as capital gain. Other wealth transfer tax systems tax the transferee of a gift or bequest. Such systems include inheritance (or accessions ) tax systems, under which a tax is imposed against the recipient of a gratuitous transfer. Some jurisdictions do not impose a separate tax, but instead treat receipts of gifts or bequests as gross income of the recipient (an income inclusion approach ). Regardless of whether the tax is imposed against the transferor or the transferee, some commentators assert that the real economic burden of any approach to taxing transfers of wealth falls on the recipients, because the amount received effectively is reduced by the amount of tax paid by the transferor or realized by the transferee. 99 Some commentators argue that systems that impose a tax based on the circumstances of the transferee such as an inheritance tax or an income inclusion approach are more effective in encouraging dispersal of wealth among a greater number of transferees and potentially to lower-income beneficiaries. Others assert that such systems promote fairness in the tax system. However, the extent to which one form of transfer tax system in practice is more effective than another in achieving these goals is not clear. Wealth transfer tax systems other than an estate tax also may present benefits or additional challenges in administration or compliance. Inheritance taxes or income inclusion systems, for example, may reduce the need for costly tax planning in the case of certain transfers between spouses. At the same time, to the extent such systems are effective in encouraging distributions to multiple recipients in lower tax brackets, they may be susceptible to abuse such as through the use of multiple nominal recipients as conduits for a transfer intended for a single beneficiary. Prior Action The proposal was contained in the President s fiscal year 2010 budget proposal. The President s fiscal year 2002 through 2009 budget proposals included a proposal to make permanent after 2010 the repeal of the estate and generation skipping taxes, as scheduled to be in effect in 2010 under EGTRRA. 99 See, e.g., Lily L. Batchelder, Taxing Privilege More Effectively: Replacing the Estate Tax with an Inheritance Tax, The Hamilton Project, The Brookings Institution, Discussion Paper , at 5 (June 2007); Alternatives to the Current Wealth Transfer Tax System, in American Bar Association, Task Force on Federal Wealth Transfer Taxes, Report on Reform of Federal Wealth Transfer Taxes 171 app. A (2004); Joseph M. Dodge, Comparing a Reformed Estate Tax with an Accessions Tax and an Income-Inclusion System, and Abandoning the Generation-Skipping Tax, SMU Law Review 56 (2003), 551, Nelson 84

87 SECTION I - EXHIBIT 7 111th Congress, 2nd Session IN THE SENATE OF THE UNITED STATES PLACED ON THE CALENDAR IN THE SENATE Tax Hike Prevention Act of 2010 S S. 3773; 111 S SYNOPSIS: A bill to permanently extend the 2001 and 2003 tax relief provisions and to provide permanent AMT relief and estate tax relief, and for other purposes DATE OF INTRODUCTION: September 13, 2010 SPONSOR(S): Sponsor and Cosponsors as of 09/13/2010 McConnell, Mitch (R-KY) - Sponsor Grassley, Charles (R-IA) - Cosponsor Kyl, Jon L. (R-AZ) - Cosponsor McCain, John (R-AZ) - Cosponsor Cochran, Thad (R-MS) - Cosponsor Graham, Lindsey (R-SC) - Cosponsor Roberts, Pat (R-KS) - Cosponsor Cornyn, John (R-TX) - Cosponsor Inhofe, James M. (R-OK) - Cosponsor Ensign, John (R-NV) - Cosponsor Isakson, John (R-GA) - Cosponsor Brownback, Sam (R-KS) - Cosponsor Enzi, Michael B. (R-WY) - Cosponsor Crapo, Michael (R-ID) - Cosponsor Burr, Richard (R-NC) - Cosponsor Vitter, David (R-LA) - Cosponsor Wicker, Roger (R-MS) - Cosponsor Chambliss, Saxby (R-GA) - Cosponsor Bond, Christopher (Kit) (R-MO) - Cosponsor Hutchison, Kay Bailey (R-TX) - Cosponsor Hatch, Orrin G. (R-UT) - Cosponsor Bennett, Robert Foster (R-UT) - Cosponsor Risch, James E. (R-ID) - Cosponsor Shelby, Richard (R-AL) - Cosponsor Thune, John (R-SD) - Cosponsor Murkowski, Lisa (R-AK) - Cosponsor TEXT: S 3773 PCS Calendar No th CONGRESS Nelson 85

88 SECTION I - EXHIBIT 7 2d Session S To permanently extend the 2001 and 2003 tax relief provisions and to provide permanent AMT relief and estate tax relief, and for other purposes. IN THE SENATE OF THE UNITED STATES September 13, 2010 Mr. MCCONNELL (for himself, Mr. GRASSLEY, Mr. KYL, Mr. MCCAIN, Mr. COCHRAN, Mr. GRAHAM, Mr. ROBERTS, Mr. CORNYN, Mr. INHOFE, Mr. ENSIGN, Mr. ISAKSON, Mr. BROWNBACK, Mr. ENZI, Mr. CRAPO, Mr. BURR, Mr. VITTER, Mr. WICKER, Mr. CHAMBLISS, Mr. BOND, Mrs. HUTCHISON, Mr. HATCH, Mr. BENNETT, Mr. RISCH, and Mr. SHELBY) introduced the following bill; which was read the first time September 14, 2010 Read the second time and placed on the calendar A BILL To permanently extend the 2001 and 2003 tax relief provisions and to provide permanent AMT relief and estate tax relief, and for other purposes. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, Nelson 86

89 SECTION I - EXHIBIT 7 TITLE III--PERMANENT ESTATE TAX RELIEF SEC APPLICATION OF ESTATE, GENERATION-SKIPPING TRANSFER, AND GIFT TAXES AFTER (a) In General.--The following provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001, and the amendments made by such provisions, are repealed on and after January 1, 2010, with respect to decedents dying on and after such date, and on and after January 1, 2011, with respect to gifts made and generation-skipping transfers on and after such date: (1) Subtitles A and E of title V. (2) Subsection (d), and so much of subsection (f)(3) as relates to subsection (d), of section 511. (3) Paragraph (2) of subsection (b), and paragraph (2) of subsection (e), of section 521. Except in the case of an election under section 404, the Internal Revenue Code of 1986 shall be applied as if such provisions and amendments had never been enacted. (b) Conforming Amendment.--Subsection (c) of section 2511 of the Internal Revenue Code of 1986 is repealed on and after January 1, 2011, with respect to gifts made on and after such date. SEC TREATMENT OF UNIFIED CREDIT AND MAXIMUM ESTATE TAX RATE AFTER (a) Restoration of Unified Credit Against Gift Tax.--Paragraph (1) of section 2505(a) of the Internal Revenue Code of 1986 (relating to general rule for unified credit against gift tax), after the application of section X01, is amended by striking '(determined as if the applicable exclusion amount were $1,000,000)'. (b) Exclusion Equivalent of Unified Credit Equal to $5,000,000.--Subsection (c) of section 2010 of the Internal Revenue Code of 1986 (relating to unified credit against estate tax) is amended to read as follows: '(c) Applicable Credit Amount.-- '(1) IN GENERAL.--For purposes of this section, the applicable credit amount is the amount of the tentative tax which would be determined under section 2001(c) if the amount with respect to which such tentative tax is to be computed were equal to the applicable exclusion amount. '(2) APPLICABLE EXCLUSION AMOUNT.-- '(A) IN GENERAL.--For purposes of this subsection, the applicable exclusion amount is $5,000,000. '(B) INFLATION ADJUSTMENT.--In the case of any decedent dying in a calendar year after 2010, the dollar amount in subparagraph (A) shall be increased by an amount equal to-- Nelson 87

90 SECTION I - EXHIBIT 7 '(i) such dollar amount, multiplied by '(ii) the cost-of-living adjustment determined under section 1(f)(3) for such calendar year by substituting 'calendar year 2009' for 'calendar year 1992' in subparagraph (B) thereof. (c) Maximum Estate Tax Rate Equal to 35 Percent.-- (1) IN GENERAL.--Subsection (c) of section 2001 of the Internal Revenue Code of 1986 (relating to imposition and rate of tax) is amended-- (A) by striking 'Over $500,000' and all that follows in the table contained in paragraph (1) and insert the following: (B) by striking '(1) IN GENERAL.--', and (C) by striking paragraph (2). Nelson 88

91 SECTION I - EXHIBIT 8 111th Congress, 2nd Session IN THE HOUSE OF REPRESENTATIVES AS INTRODUCED IN THE HOUSE Responsible Estate Tax Act H.R H.R. 5764; 111 H.R SYNOPSIS: A bill to amend the Internal Revenue Code of 1986 to reinstate estate and generationskipping taxes, and for other purposes DATE OF INTRODUCTION: July 15, 2010 SPONSOR(S): Sponsor and Cosponsors as of 07/15/2010 Sanchez, Linda T. (D-CA) - Sponsor Watson, Diane E. (D-CA) - Cosponsor Norton, Eleanor Holmes (D-DC) - Cosponsor Lee, Barbara (D-CA) - Cosponsor McGovern, James P. (D-MA) - Cosponsor TEXT: HR 5764 IH 111th CONGRESS 2d Session H. R To amend the Internal Revenue Code of 1986 to reinstate estate and generation-skipping taxes, and for other purposes. IN THE HOUSE OF REPRESENTATIVES July 15, 2010 Ms. LINDA T. SANCHEZ of California (for herself, Ms. WATSON, Ms. NORTON, Ms. LEE of California, and Mr. MCGOVERN) introduced the following bill; which was referred to the Committee on Ways and Means A BILL To amend the Internal Revenue Code of 1986 to reinstate estate and generation-skipping taxes, and for other purposes. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, Nelson 89

92 SECTION I - EXHIBIT 8 SECTION 1. SHORT TITLE. This Act may be cited as the 'Responsible Estate Tax Act'. SEC. 2. REINSTATEMENT AND EXTENSION OF ESTATE AND GENERATION-SKIPPING TAXES; REPEAL OF CARRYOVER BASIS. (a) In General.--The following provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001, and the amendments made by such provisions, are hereby repealed: (1) Subtitles A and E of title V. (2) Subsection (d), and so much of subsection (f)(3) as relates to subsection (d), of section 511. (3) Paragraph (2) of subsection (b), and paragraph (2) of subsection (e), of section 521. Any provision of the Internal Revenue Code of 1986 amended by such provisions are amended to read as such provisions would read if such sections had never been enacted. (b) Sunset Not to Apply.-- (1) Subsection (a) of section 901 of the Economic Growth and Tax Relief Reconciliation Act of 2001 is amended by striking 'this Act' and all that follows and inserting 'this Act (other than title V) shall not apply to taxable, plan, or limitation years beginning after December 31, 2010.'. (2) Subsection (b) of such section 901 is amended by striking ', estates, gifts, and transfers'. SEC. 3. MODIFICATION OF RATES AND MAINTENANCE OF UNIFIED CREDIT AGAINST THE ESTATE TAX. (a) Modification of Rates.-- (1) IN GENERAL.--The table in paragraph (1) of section 2001(c) of the Internal Revenue Code of 1986 is amended by striking the last 6 rows and inserting the following: 'Over $750,000 but not over $3,500,000 Over $3,500,000 but not over $10,000,000 Over $10,000,000 but not over $50,000,000 Over $50,000,000 (2) SURTAX ON WEALTHY ESTATES.--Paragraph (2) of section 2011(c) of such Code is amended to read as follows: '(2) SURTAX ON ESTATES OVER $500,000,000.--Notwithstanding paragraph (1), if the amount with respect to which the tentative tax to be computed is over $500,000,000, the rate of tax otherwise in effect under this subsection with respect to the amount in excess of Nelson 90

93 SECTION I - EXHIBIT 8 $500,000,000 shall be increased by 10 percent.'. (b) Maintenance of Unified Credit.--The table in subsection (c) of section 2010 of the Internal Revenue Code of 1986 (relating to applicable credit amount) is amended by inserting 'and thereafter' after '2009'. (c) Effective Date.--The amendments made by this section shall apply to estates of decedents dying, and gifts made, after December 31, Nelson 91

94 SECTION I - EXHIBIT 9 Barry A. Nelson Fellow, American College of Trust and Estate Counsel Master of Laws in Taxation Board Certified Taxation & Wills, Trusts & Estates Judith S. Nelson Former Judge of Compensation Claims Mirlene E. Dubreuze Office Manager Nelson & Nelson: Tax Planning Letter for 2010 Planning for Terminally Ill Client Based Upon Repeal LAW OFFICES OF NELSON & NELSON, P.A Sunny Isles Boulevard, Suite 118 North Miami Beach, Florida info@estatetaxlawyers.com Telephone: TeleFax: ASSOCIATES Jennifer E. Okcular Master of Laws in Taxation Jennifer D. Sharpe Master of Laws in Taxation OF COUNSEL Richard B. Comiter Fellow, American College of Trust and Estate Counsel Master of Laws in Taxation Board Certified Taxation Dear Client: May 25, 2010 The last paragraph of this letter has been prepared in accordance with Circular 230. Please review the last paragraph before reading this letter. Since the current status of the law is so uncertain, many of the typical recommendations for clients with diminished life spans under the pre 2010 estate tax repeal are clouded by uncertainty as to: (i) whether there will be an estate tax upon the client s death (if the client passes away during estate tax repeal); and (ii) if there is no estate tax, the consequences of loss of step up in basis for income tax purposes. The discussion below will be in order of relative simplicity and ease of implementation. I have reviewed a significant number of articles addressing planning for those with diminished life expectancy and my comments are as follows: Annual Exclusion Gifts. The client should take advantage of his ability to make gifts of $13,000 to as many persons as he desires (e.g., children, grandchildren, spouses of children, etc.). These transfers must be irrevocably completed while the client is living. For example, if the client makes gifts of $13,000 to 3 children, 3 spouses of children, and 9 grandchildren, then he could gift $195,000, which would be excluded from his estate and his spouse s estate. These gifts should be made immediately as the annual gift tax exclusion is use it or lose it and cannot be used if the client were to pass away before the transfers are completed. If instead of gifting cash, the gift is of a fractional interest in real property or in another discountable asset, there will be even bigger savings. A simple plan may be to have the client invest in a private equity deal. The minute the purchase is made and assuming the asset is illiquid, the asset becomes discountable as there typically is little or no market for private equity investments. Accordingly, it may be possible to create an LLC for the purpose of a private equity investment, have the investment made with funds from the client, and then have the client gift the entire LLC to his children and grandchildren rather than a gift of cash. In such event, the value of assets gifted may be as high as $300,000-$400,000 depending upon the discount for the private equity interest once it is purchased. Nelson 92

95 SECTION I - EXHIBIT 9 Gift of Assets from the Client s Spouse to the Client. As of today, there are no estate taxes if the client were to pass away in 2010 unless Congress retroactively reinstitutes the tax. The longer Congress fails to act, the more likely it is that any legislation in 2010 will be prospective and not retroactive. The client s Revocable Trust provides that if estate tax repeal is in effect, then 50% of his estate passes into long term trusts for his children. If estate tax repeal is in effect, then the more assets that can pass to the client s children, the more that will avoid estate tax upon the death of the surviving spouse. Accordingly, consideration should be given to having all of the surviving spouse s assets added to the client s Revocable Trust so that, should the client pass away when estate tax repeal is in effect, 50% of the surviving spouse s assets (in accordance with the client s existing Revocable Trust), will pass tax free to the children. It should be noted that the cost of no estate tax is the loss of step up in basis for any appreciated assets. However, the total appreciation is about $ and at current capital gains rates, the loss of the step up at 15% is about $. If we can transfer $ of the surviving spouse s assets to the client and if estate tax repeal is in effect and an additional $ passes tax free to the children, then the potential estate tax savings upon the death of the surviving spouse would be well over $. Roth IRA Conversion is the first year a Roth IRA conversion can be made for persons with higher income. If the client elects to convert any of his qualified plans to Roth IRAs, then he creates a debt (the income tax liability on the value of the IRA or other qualified plan on the date of the conversion, which tax would have to be paid next year or over next year and the year after). We could then prepare a beneficiary designation for the Roth IRA stating that the maximum amount that can pass free from estate tax or if estate tax repeal is in effect, the entire IRA will pass to the children with the remainder passing to the surviving spouse. By converting to a Roth IRA, the children will get an asset that will be free from income taxes when the funds are withdrawn and also benefit from the compounding benefits of tax free accumulations as the assets appreciate. Charitable Giving-Creation of Foundation or Donor Advised Fund. If the client s income and his spouse s income are expected to be higher than such income after the client s death (due to loss of his earnings, loss of earnings on assets that will pass to children upon his death, or if he should convert his IRAs and qualified plans to Roth in 2010), then creating a charitable foundation or a donor advised fund in 2010 should be considered as the family will benefit from both estate tax value reduction and an income tax deduction that will partially offset, for example, the income on the Roth conversion. Gifts Using Actuarial Tables. In order to use any technique tied to actuarial tables, the client would have to survive 18 months from the date of transfer using an actuarially valued gift to benefit from a presumption that the tables could be used. Otherwise, there is a possibility that the IRS would reclassify the transaction as a gift. In light of the fact that the gift tax rates may vastly exceed the estate tax rates (should estate tax repeal be in effect at the time of the client s death), I believe the use of actuarial table techniques may be risky. However, I bring this issue to your attention should you wish to explore it further. Income Tax Basis Issues. If estate tax repeal is in effect at the time of the client s death, then a significant amount of his assets will not benefit from the step up in basis that occurs under 2009 law. As a result, the client should take some time to provide his Nelson 93

96 SECTION I - EXHIBIT 9 knowledge as to the income tax basis of his assets so that, to the extent he has information that would not be readily available upon his death, we have such information accumulated with his assistance. Additional Gifts to Grandchildren. We should consider direct transfers to grandchildren upon the client s death to enhance asset protection and decrease potential estate taxes for the client s children. No one, without our express prior written permission, may use any part of this letter in promoting, marketing or recommending an arrangement relating to any federal tax issue. Furthermore, it may not be shared with any other person without our prior written consent other than as required by law or by ethical rules. However, this prohibition on sharing this letter does not preclude you from sharing with others the nature of this transaction or the fact that you consummate it. Very truly yours, BAN/vnm BARRY A. NELSON For the Firm G:\Presentations - Speeches\ FICPA\2010 Planning for Terminally Ill.doc Nelson 94

97 SECTION I - EXHIBIT 10 Seven Steps for Coping with Carryover Basis Steve Leimberg's Estate Planning Newsletter - Archive Message #1701 Date: 27-Sep-10 From: Steve Leimberg's Estate Planning Newsletter Subject: Seven Steps for Coping with Carryover Basis Ever wonder how reporters come up with ideas for cutting-edge stories? The short answer is: they connect the dots. That s precisely what Deborah Jacobs did when she conceived of an article addressing the practical problems caused by carryover basis. During the mid-august doldrums, Deborah noticed a discussion on LinkedIn, the professional-networking website, which suggested widespread confusion on the subject. In more than a dozen exchanges, members of one professional group within the site revealed basic misunderstandings and pointed to questions that are still unanswered by the Internal Revenue Service. Then, on her reader s behalf, Jacobs tracked down leading estate planning lawyers who had clients die this year and interviewed them about how they are tackling the challenges. Her commentary below is based on those interviews, and provides a clear roadmap of what LISI members can do when working with clients. Portions of her commentary were first published on Forbes.com. See Seven Steps for 2010 Heirs, Deborah L. Jacobs is familiar to many advisers as a lawyer and intrepid journalist who has written on estate planning for many publications, including: The New York Times, Bloomberg Wealth Manager, BusinessWeek and Forbes. She is the author most recently of Estate Planning Smarts: A Practical, User-Friendly, Action-Oriented Guide (DJWorking Unlimited, 2009), a book you can feel comfortable giving clients and potential clients as a business generating, action-oriented holiday gift. While the estate tax is in flux, Estate Planning Smarts has another virtue: Deborah keeps readers current between editions by issuing updates that can be downloaded from the book s Web site, and tweets at Here is her commentary: EXECUTIVE SUMMARY: Ever since the estate tax lapsed on Jan. 1, there's been a lot of talk about the windfall it's creating for families of wealthy people, including billionaires, who have died in But behind the scenes, lawyers and accountants are wrestling with a far more practical problem that affects all inheritors this year: the tangled new income tax rules that apply to assets inherited in Whether heirs are stuck with carryover basis, or wind up with a choice for 2010 and elect to use the carryover basis/no estate tax option, inheritors and their advisers need to have assets appraised and locate purchase records as soon as possible. While current Nelson 95

98 SECTION I - EXHIBIT 10 uncertainties persist, it s prudent to delay--or at least curtail--the process of estate administration. FACTS: Unless Congress restores the estate tax retroactively this year, vast sums will pass free of both estate tax and the generation-skipping transfer tax. Under the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, these taxes are scheduled to return Jan. 1 at unfavorable rates that applied 10 years earlier. At that point, the amount that is exempt from each of these taxes will be $1 million, and the tax on the rest will be 55% (60% in a certain phase-out range). During the one-year "gap"--and presumably only for inheritances received this year--there are income tax issues to contend with. What's new: Heirs now must use the original price paid for an asset when computing the income taxes they will owe if they sell inherited assets. Previously, they could use the market value at the time of the owner's death. Each estate is permitted to exempt $1.3 million of gains from this carryover basis rule. An additional $3 million exemption applies to assets inherited from a spouse. COMMENT: The carryover basis rule is new to both advisers and clients, so implementing it takes us into uncharted territory. To make matters even worse, the need for knowledge of the subject may be short-lived. There's a possibility--though as the year wears on it seems increasingly remote--that Congress will restore the estate tax retroactively with the same $3.5 million exemption and 45% top rate that existed in Past court cases suggest that is perfectly legal. But some people with a lot at stake have argued that a retroactive tax is unconstitutional and threatened lawsuits. With the prospect of litigation looming, any legislation that takes effect in 2010 would almost certainly need to offer a choice for heirs of people who die this year: Pay estate tax, or use the modified carryover basis system that's in effect while there is no estate tax. Whether heirs are stuck with carryover basis, or wind up with a choice for 2010 and elect to use the carryover basis/no estate tax option, inheritors and their advisers need to take the following steps. 1. Have Assets Appraised As in past years, unless the date of death value of a costly asset is obvious (as it is, for example, for marketable securities), you will need to get an appraisal. If estate tax is an issue, you use this information to figure the estate tax. Under a modified carryover basis system, you use date of death values for a different Nelson 96

99 SECTION I - EXHIBIT 10 purpose. Subject to certain limitations, if an asset is worth more when someone dies than she paid for it, her estate can apply the $1.3 million basis allowance to the difference. Once this allowance is used up, there might be income tax, but it's not triggered until the asset is sold (a common misconception). At that point the total amount subject to tax would consist of the difference between the date of death value and the basis allowance, plus any appreciation after the date of death. For example, let's say you inherit publicly traded stock from your mother. If she bought the stock for $500,000 and it's worth $2 million when she dies, there's $1.5 million of appreciation, or what tax geeks call "built in" or "unrealized" gain. Without a basis adjustment, if you immediately sold the stock, carryover basis rules would require you to pay tax on all that gain. But instead the law allows you to bump the basis up by $1.3 million, so it's as if the stock cost $1.8 million ($1.3 million plus $500,000) instead. When you sell it, assuming the value hasn't changed since Mom died, you would pay capital gains tax on $200,000 ($2 million minus $1.8 million). 2. Locate Purchase Records Your quest for the other vital data you need to cope with carryover basis--the original cost of the assets--could be far more complicated. If you can't prove what things cost, the IRS assumes the cost is zero and could try to saddle you with capital gains tax on the total sales amount. With investments like Mom's stock, tax returns and brokerage statements can lead you to what someone owned on the date of death. Going back through the years, they also show dividend payments, which may provide another clue about when an investment was purchased. But if the assets have been moved between financial institutions, the original cost might not be on file with the current broker. You may even have to sort through papers that predate computerized records. In other tax situations, when the initial cost was unclear, accountants have had clients estimate when something was bought, and then obtain price information directly from public companies or by checking newspaper archives. The consensus is that approach will work in this context, too. Real estate can pose a much bigger problem, says Carol A. Harrington, a lawyer with McDermott, Will & Emery in Chicago. Consider a home that has been in the family for many years. Basis consists not only of the purchase price, but factors in capital improvements that add value to the home. To recreate those records, you might need to scour grandma's attic for canceled checks showing what she spent to renovate the kitchen or add dormers to the country house, for example. The plot thickens with property inherited from real estate developers, says Dennis I. Nelson 97

100 SECTION I - EXHIBIT 10 Belcher, a lawyer with McGuireWoods in Richmond, Va. Because many have both depreciated the property and borrowed heavily against it, they may have debt that exceeds the basis, he says. "If the fair market value has dropped, it's conceivable that their families won't have enough money to pay the capital gains tax." 3. Delay Selling Appreciated Assets In the past, the standard thinking has been that an executor should sell investments as soon as possible (or at least diversify out of concentrated positions) and hold the proceeds in cash or an equivalent form. Because executors are legally obligated to preserve money going to inheritors or needed to pay estate tax, the theory was that they should not take market risk of continuing to hold the investments. Now an executor must consider the income tax effect of selling property that has increased in value, whether a security, art or real estate. That's not a concern when the proceeds are going to charity, but it is when people are the beneficiaries, Harrington says. To add one more layer of complexity, there is a slim chance that carryover basis applies only to assets both inherited and sold in This interpretation stems from the sunset provision of EGTRRA. Section 901(b) of the law says that in 2011 old laws will apply as if EGTRRA "had never been enacted." If that is true, inheritors may be able to escape the carryover rules by holding assets at least until next year. At that point, if an investment is sold, the capital gains tax would apply only to any increase in value after the date of death. So what should executors do this year? As a practical matter it's still easiest to liquidate the assets, and that's what they should do unless, from an investment perspective, they have good reasons to hold them, says Harrington. On the other hand, Belcher is telling clients "don't sell assets unless there's an investment reason to do so." Some estates holding large positions are using derivatives to protect against investment losses, he says. 4. Postpone Distributions If Congress restores the estate tax retroactively, it could apply to the estates of people who died this year. So heirs of estates that would be subject to the tax need to set aside money for it. Likewise, if there's modified carryover basis, they will need cash to pay the capital gains tax. Therefore a prerequisite to making distributions is to determine whether there is enough money to make the payouts under the worst of the two scenarios. 5. Extend Paperwork Deadlines The deadline for reporting carryover basis is April 15 of the year following a person's death--the same day on which his or her final income tax return must be filed. (This due date is different from the one that applies for the estate tax return, which is due nine months after the date of death.) As with an income tax return, it will be possible to extend Nelson 98

101 SECTION I - EXHIBIT 10 the deadline by six months, to Oct. 15. So far the IRS has not yet created the form that will be used for this purpose or the accompanying instructions. It might be a separate carryover basis return, using the Social Security number of the person who has died. Or, there might be a form or schedule for reporting carryover basis that gets attached to the final income tax return. Either way, the form is likely to ask executors to list each asset, along with its basis and date of death value. They will also need to indicate which assets the free basis (that is, the limited $1.3 million/$3 million step-up in basis) will be applied to, and in each case how much the basis will get bumped up. There's no need to sell the asset before filing this form; what you're allocating is built-in gain between the original cost of the asset and the date of death value. Certain limitations apply. For example, there is no basis adjustment on income in respect of a decedent or IRD, says Keith Schiller, a lawyer in Orinda, Calif., and author of Art of the Estate Tax Return (Innovation Estate Planning Productions 2010). This is income that wasn't taxed before a person's death and would have been taxed if the individual had lived long enough to receive it. Schiller notes that examples include: distributions from traditional pre-tax individual retirement accounts; qualified retirement plans including traditional pre-tax 401(k)s; a company bonus; income from an S corporation; and money owed on a promissory note under an installment sale. Also keep in mind that while the $1.3 million exemption can be applied to assets given to anyone, the $3 million one is limited to assets given exclusively to a spouse, either outright or in certain kinds of trusts, Harrington says. So you may not use this exemption for assets going into a trust that will benefit people in addition to the spouse. Other issues remain unclear, including how an executor allocates basis to assets that have been put into a family limited partnership. Schiller recommends taking an extension to file the return, both in the hope that the IRS will provide some guidance in the meantime, and to see what approaches the IRS accepts to balance various unknowns (like valuing assets when purchase records aren't available). 6. Apply the Basis Allowance Fairly If some assets may be kept in the family, it's most efficient to allocate the basis to those that are likely to be sold first, Belcher says. But this strategy could cause some inheritors to benefit from the free basis more than others. And that "creates all sorts of conflicts," when an executor is also a beneficiary and allocating the basis a certain way would benefit herself. This problem is analogous to one that has come up previously, when all assets were valued as of the date of death, Harrington says. Often several years pass before beneficiaries receive those assets. And meantime, values Nelson 99

102 SECTION I - EXHIBIT 10 can fluctuate. When making in-kind distributions to beneficiaries (as opposed to handing out the proceeds of assets that have been liquidated), executors have always tried to give out assets that are not only roughly equal in value, but also have a roughly similar basis. The principles are the same in this setting, she says. 7. Guard against an Executor's Added Risks Legally, an executor is a fiduciary, who is expected to act prudently and be impartial. Under the best of circumstances, it can be a difficult job, with a risk of liability for missteps. Still, the complicated landscape this year, especially as it involves carryover basis, seems to leave an executor extra vulnerable. As Belcher notes: "It's complicated, there's no guidance, there are no forms. And it may be around for only one year." He suggests executors advise families of the uncertain state of the law, alert them to the investment risks of waiting to sell assets, give reasons for any strategies they recommend and ask beneficiaries what they want to do. Along the way, it's wise to document conversations with follow-up correspondence and notes to the file. If you're an executor and family members disagree with your recommendations, do what they ask, Belcher advises. But in that case you might want to get them to sign a document releasing you from liability and indemnifying you for losses. Such precautions are unusual--executors are expected (and often paid) to navigate difficult situations. But in the current environment, you might just want this document in your back pocket. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Deborah Jacobs CITE AS: LISI Estate Planning Newsletter #1701 (September 27, 2010) at Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. Copyright 2010 Deborah L. Jacobs. CITES: Economic Growth and Tax Relief Reconciliation Act of 2001, Section 901(b). Copyright 2010 Leimberg Information Services Inc. Nelson 100

103 SECTION I - EXHIBIT 11 Applicable Federal Mid-Term 120% Annual Rates JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC % 10.00% 11.22% 11.58% 11.68% 11.26% 10.54% 10.01% 9.68% 10.10% 10.07% 9.70% % 9.70% 10.27% 10.54% 10.61% 10.97% 10.53% 10.44% 10.28% 10.63% 10.59% 10.25% % 9.64% 9.41% 9.50% 9.62% 9.53% 9.66% 9.87% 9.59% 9.08% 8.69% 8.51% % 7.64% 8.06% 8.43% 8.56% 8.47% 8.25% 7.82% 7.19% 6.96% 6.83% 7.40% % 7.50% 7.08% 6.56% 6.57% 6.41% 6.67% 6.40% 6.44% 6.02% 5.91% 6.10% % 6.42% 6.45% 7.08% 7.74% 8.33% 8.22% 8.49% 8.49% 8.56% 8.97% 9.33% % 9.59% 9.34% 8.84% 8.58% 8.22% 7.56% 7.27% 7.68% 7.59% 7.35% 7.12% % 6.75% 6.56% 7.08% 7.65% 7.93% 8.12% 8.24% 7.99% 8.09% 7.94% 7.59% % 7.68% 7.72% 7.82% 8.25% 8.19% 8.00% 7.69% 7.51% 7.63% 7.34% 7.25% % 6.84% 6.72% 6.85% 6.84% 6.95% 6.83% 6.70% 6.67% 6.16% 5.42% 5.43% % 5.67% 5.80% 6.35% 6.28% 6.46% 7.01% 7.16% 7.19% 7.25% 7.32% 7.46% % 7.90% 8.19% 8.08% 7.70% 7.96% 7.96% 7.62% 7.50% 7.33% 7.23% 7.07% % 6.10% 6.10% 5.95% 5.73% 6.04% 6.16% 6.01% 5.79% 5.52% 4.97% 4.78% % 5.58% 5.43% 5.60% 6.01% 5.71% 5.53% 5.10% 4.51% 4.16% 3.68% 3.98% % 3.93% 3.89% 3.56% 3.82% 3.68% 3.06% 3.25% 4.12% 4.39% 3.99% 4.26% % 4.13% 4.01% 3.80% 3.81% 4.67% 4.94% 4.81% 4.61% 4.36% 4.26% 4.28% % 4.60% 4.60% 4.92% 5.15% 4.82% 4.63% 4.71% 5.04% 4.91% 5.09% 5.43% % 5.29% 5.42% 5.68% 5.82% 6.09% 6.08% 6.27% 6.03% 5.79% 5.65% 5.70% % 5.65% 5.84% 5.54% 5.56% 5.59% 5.96% 6.13% 5.76% 5.23% 5.28% 4.97% % 4.22% 3.57% 3.45% 3.29% 3.84% 4.14% 4.26% 4.16% 3.81% 3.57% 3.43% % 1.98% 2.33% 2.59% 2.47% 2.71% 3.32% 3.37% 3.45% 3.20% 3.10% 3.16% % 3.39% 3.23% 3.25% 3.45% 3.20% 2.80% 2.60% 2.40% 2.07% REV. RUL TABLE 1 Applicable Federal Rates (AFR) for October 2010 Period for Compounding Annual Semiannual Quarterly Monthly Short-term AFR.41%.41%.41%.41% 110% AFR.45%.45%.45%.45% 120% AFR.49%.49%.49%.49% 130% AFR.53%.53%.53%.53% Mid-term AFR 1.73% 1.72% 1.72% 1.71% 110% AFR 1.90% 1.89% 1.89% 1.88% 120% AFR 2.07% 2.06% 2.05% 2.05% 130% AFR 2.25% 2.24% 2.23% 2.23% 150% AFR 2.60% 2.58% 2.57% 2.57% 175% AFR 3.03% 3.01% 3.00% 2.99% Long-term AFR 3.32% 3.29% 3.28% 3.27% 110% AFR 3.65% 3.62% 3.60% 3.59% 120% AFR 3.99% 3.95% 3.93% 3.92% 130% AFR 4.33% 4.28% 4.26% 4.24% Nelson 101

104 SECTION I - EXHIBIT 12 Intra-Family Loans and AFRs October 2010 Example Intra-Family Loans and AFRs This information has been prepared in accordance with Circular 230. Please review the following paragraph before reading this or it's attachments. No one, without our express prior written permission, may use any part of this letter in promoting, marketing or recommending an arrangement relating to any federal tax issue. Furthermore, it may not be shared with any other person without our prior written consent other than as required by law or by ethical rules. However, this prohibition on sharing this letter does not preclude you from sharing with others the nature of this transaction or the fact that you consummate it. Intra-Family Loans are an effective way to shift wealth between family members. For those who routinely take advantage of annual exclusion gifts and want to convey additional tax-free wealth to family members, Intra-Family Loans should be considered. The transaction is premised on the assumption that the funds loaned will appreciate at a greater rate than the interest the IRS requires to be charged on the loan. The required interest rate is updated monthly by the IRS and is referred to as the Applicable Federal Rate ("AFR"). The October 2010 AFR for loans with a duration of three (3) years or less is 0.41% and for loans of more than 3 years but not greater than 9 years the interest rate is approximately 1.73% in October Loans of greater than 9 years for October 2010 require interest of 3.32%. These rates assume annual compounding and are at record lows. To see how easily this transaction can work, consider a loan of $1 million to your children or a trust for your children. If the money grows by 7% annually, your children or the trust for their benefit will earn $70,000 per year and yet only owe $4,100 in interest (assuming a 3 year loan in October of 2010). The additional growth of $65,900 is a tax-free gift to your children (or to their trust). AFRs are adjusted monthly and the interest rate for the upcoming month is typically published on the 20th of the prior month (e.g., the interest rate for November of 2010 will be released around October 20th, 2010). Planning requires only a simple promissory note. If the borrower is able to benefit from returns that exceed the interest charged the borrower will have received a benefit from the loan transaction and the transfer of benefit will not be considered a gift as long as the AFR for the month the promissory note is entered into is charged and the terms of the note are compiled with. This is the case even if interest rates trend upward during the term of the loan. This may also be an opportunity to consider refinancing intra-family loans that may have been made in the past at significantly higher interest rates. Any such negotiation should be at arm's length and if the interest rate is reduced, cautious taxpayers should consider having the borrower under the note should give the lender some type of consideration, Nelson 102

105 SECTION I - EXHIBIT 12 such as a prepayment of a portion of the principal or a reduction of loan duration, in exchange for the reduction of interest rates to current AFRs. The link for the IRS site that reports monthly adjustments to the AFRs is at: IRS Index of Applicable Federal Rates (AFR) Rulings Regards, Barry A. Nelson Nelson & Nelson, P.A. barry@estatetaxlawyers.com Nelson 103

106 SECTION I - EXHIBIT 13 The GRAT Rush of 2010-Short Term GRAT Planning May be Prohibited Steve Leimberg's Estate Planning Newsletter - Archive Message #1626 Date: 08-Apr-10 From: Steve Leimberg's Estate Planning Newsletter Subject: The GRAT Rush of 2010 More drastically, the House bill requires GRATs to have a term of at least 10 years, compared with the current two-year minimum. This greatly accentuates what is called the "mortality risk" of a GRAT: if the grantor dies during the trust term, all or part of the trust assets will be included in her estate for estate tax purposes. Clients would no longer be able to use short-term GRATs to minimize that risk. This provision of the bill alone would raise an estimated $4.5 billion in 10 years, according to a March 18 report by Citizens for Tax Justice, a lobbying group that describes its mission as "requiring the wealthy to pay their fair share." Deborah L. Jacobs, a lawyer and journalist, is the author of Estate Planning Smarts: A Practical, User-Friendly, Action-Oriented Guide (DJWorking Unlimited, 2009). To learn more, visit In her commentary, Deborah examines H.R. 4849, which passed the House of Representatives March 24 and could be the beginning of the end for short-term GRATs. She suggests strategies to use before the ax falls in the Senate, and also sees a larger significance in this development, which took the form of a revenue-raiser to a jobs bill. This development might be a sign of what she describes as "creeping estate tax reform" that whittles away some terrific tax strategies for high net worth clients. Now, here is her commentary: EXECUTIVE SUMMARY: For several years, financial advisers have been warning their clients that Congress might soon curtail some popular estate planning tools. The House of Representatives took a giant step in that direction on March 24 when it passed H.R a bill that would eliminate the low-risk grantor retained annuity trust or GRAT. Assuming the Senate follows suit, it will still be possible to use these trusts, but they will become much less attractive as a tool for shifting wealth to future generations. Before that happens, there is a window of opportunity to tap into the huge gift-tax savings now associated with a GRAT. FACTS: A GRAT allows someone to put assets into an irrevocable trust and retain the right to receive distributions back over the trust term. The annuity is equal to the value of what's been contributed plus interest at a rate set each month by the Treasury called the Section 7520 rate, named after the section of the Internal Revenue Code that applies. For April, this rate is 3.2%. If the value of the trust assets increases by more than the hurdle rate, the GRAT will be economically successful. In that case, the excess appreciation will go to family members (the Nelson 104

107 SECTION I - EXHIBIT 13 remainder beneficiaries) or to trusts for their benefit when the GRAT term ends. If the appreciation never occurs, the trust can satisfy its payout obligations by returning more of the assets to the grantor the person who created the trust. COMMENT: The anti-grat provisions recently adopted by the House were included as a revenue-raiser in the Small Business and Infrastructure Jobs Tax Act of 2010, which includes tax breaks for small businesses, among other things. These provisions would radically change the playing field for GRATs set up after the law is enacted. For the moment, it is possible to form what's called a zeroed-out GRAT, in which the remainder is theoretically worth nothing so that there is no taxable gift. Although the estate tax was repealed for one year at the end of 2009, there's still a gift tax (currently at a 35% rate) if you give away more than $1 million in cash or other assets during life. A zeroed-out GRAT enables clients to use their $1 million lifetime gift tax exemption for other transfers. Plus, there's no exemption wasted if the asset does not perform as hoped. In its March 19 report on H.R. 4849, the House Committee on Ways and Means stated, "such uses of GRATs for gift tax avoidance are inappropriate." Without requiring a specific value for the remainder interest, the bill indicates that it must be "greater than zero." More drastically the House bill requires GRATs to have a term of at least 10 years, compared with the current two-year minimum. This greatly accentuates what is called the "mortality risk" of a GRAT: if the grantor dies during the trust term, all or part of the trust assets will be included in her estate for estate tax purposes. Clients would no longer be able to use short-term GRATs to minimize that risk. This provision of the bill alone would raise an estimated $4.5 billion in 10 years, according to a March 18 report by Citizens for Tax Justice, a lobbying group that describes its mission as "requiring the wealthy to pay their fair share." Another drawback of the House bill is that it limits the ability to structure the payout to reflect a client's expectations about investment performance. For the first 10 years of the trust term, it would no longer be possible to provide for a higher initial payment, and lower ones in subsequent years. In the past, this strategy might have been used when clients expected a big capital gain in year number one, for example. Since the law would apply only to GRATs put in place after it is passed, clients who are concerned about estate tax once the tax springs back in 2011 (or sooner if Congress restores it retroactively), should act swiftly. In particular, a GRAT may appeal to people who have a liquidity event, such as a sale, on the horizon, or expect depreciated assets to recover during the trust term. For now, there are many possible variations on the theme. You can engineer both the GRAT term and the annuity for maximum economic benefit. And you can hedge the mortality and investment risks using a series of short-term GRATs created over a certain period of time say, five GRATS, each with a two-year term and holding a different investment. Nelson 105

108 SECTION I - EXHIBIT 13 This is also a great time to review existing GRATs. Let's say asset values have declined, so that a GRAT now in place is unsuccessful, but the client believes that the asset will bounce back. In that case, there may be a benefit to moving the volatile asset out of an existing GRAT and putting it into a new one at the lower rate, essentially giving the client a fresh start. That can be done by exchanging the property either for cash or for another asset of equal value. Alternatively, the asset can be bought from the GRAT using a promissory note. Since a GRAT is a grantor trust one in which the person creating the entity retains certain rights or powers transactions between the trust and the grantor are not taxable events. Therefore it is possible for the grantor to take these steps without generating additional capital gains or income. With Congress on Easter recess until April 12, there's a pause in the action and time to reflect on the potentially larger significance of H.R This may well be a sign that we are in for creeping estate tax reform, rather than a single piece of legislation. It may also be the first step toward whittling away at some really great tax deals for high net worth clients. We may soon look back on the past decade as the golden era of wealth transfer. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Deborah Jacobs CITE AS: LISI Estate Planning Newsletter #1626 (April 8, 2010) at Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission.Copyright 2010 Deborah L. Jacobs CITES: H.R. 4849, House Report , March 19, 2010; Citizens for Tax Justice, "Tax Provisions in Recent Jobs Legislation," March 18 Nelson 106

109 SECTION I - EXHIBIT 14 New Florida Statute Gives Courts Flexibility to Construe Formula Dispositions Steve Leimberg's Estate Planning Newsletter - Archive Message #1659 Date: 17-Jun-10 From: Steve Leimberg's Estate Planning Newsletter Subject: New Florida Statute Gives Courts Flexibility to Construe Formula Dispositions In LISI Estate Planning Newsletter #1634, Bruce Steiner described how at least nine states enacted legislation construing formula dispositions in the absence of a Federal estate tax or GST tax based upon 2009 law. Bruce's commentary indicated that clients in states that construe formula clauses based upon 2009 law should review their wills and revise them, especially if this is not the result they want. Bruce also suggested that members review the helpful citations to state law he added at the end of his commentary to see if a state they practiced in was affected. Now, Bruce returns to describe for members how Florida recently enacted a statute giving the courts flexibility in construing wills in the absence of a Federal estate tax or GST tax. Bruce D. Steiner, of the New York City law firm of Kleinberg, Kaplan, Wolff & Cohen, P.C., and a member of the New York, New Jersey and Florida Bars, is a long time LISI commentator team member and frequent contributor to Estate Planning, Trusts & Estates and other major tax and estate planning publications. He is on the editorial advisory boards of Trusts & Estates and the CCH Journal of Retirement Planning, and is a popular seminar presenter at continuing education seminars and for Estate Planning Councils throughout the country. Here is Bruce s commentary: EXECUTIVE SUMMARY: Florida has enacted a statute giving the courts flexibility in construing wills in the absence of a Federal estate tax or GST tax. FACTS: Many wills contain formula dispositions geared to the estate tax exempt amount, or to the GST exemption amount. These formula provisions may not make sense, or may produce unintended results in the absence of a Federal estate tax or GST tax. At least nine states have enacted legislation construing these provisions as if the Federal estate tax and GST tax law in effect in 2009 remained in effect. Florida has enacted a broader and more flexible statute that allows the court to construe the will based upon the intention of the testator. Nelson 107

110 SECTION I - EXHIBIT 14 COMMENT: The wills of most married clients contain formula marital deduction and credit shelter dispositions geared to the Federal estate tax exempt amount. The Federal estate tax exempt amount was $675,000 in 2001, and had been scheduled to increase in stages to $1 million by Under the Economic Growth and Tax Reform Reconciliation Act of 2001, the estate tax exempt amount was increased to $1 million in 2002 and 2003, $1.5 million in 2004 and 2005, $2 million in 2006 through 2008, and $3.5 million in There is no estate tax in The old law returns in 2011, with a $1 million exempt amount. Under a typical formula provision, a client would leave the Federal estate tax exempt amount to a credit shelter trust, or to or in trust for children, and the rest of his or her estate to the spouse, or to a QTIP trust for the benefit of the spouse. What happens under such a formula provision if the client dies at a time when there is no Federal estate tax? Depending upon the language of the formula, the entire estate could pass to the credit shelter trust or to or in trust for the children, and no amount might pass to the spouse or the QTIP trust. States React with New Legislation In response, at least nine states enacted legislation that would construe a formula clause geared to the estate tax exempt amount or the GST exemption amount to refer to the Federal estate tax and GST tax law in effect in Similar legislation is pending in other states. Under these laws, if a testator dies at a time when there is no Federal estate tax, the estate will pass as if the person died in This means that, as a general rule, the amount passing to the credit shelter trust or other non-spouse beneficiaries will be limited to $3.5 million. The rest of the estate will go to the spouse or QTIP trust. These laws apply to Wills signed before 2010, unless the Will expresses a different intention as to what would happen if the testator dies at a time when there is no Federal estate or GST tax. Do These Statutes Generate a Positive Outcome? This is not necessarily a desirable result, particularly for high net worth testators. If the excess above $3.5 million passes to the spouse, it will make the spouse s estate larger. This will result in a larger estate tax in the surviving spouse s estate if the spouse dies when the estate tax is in effect. Nelson 108

111 SECTION I - EXHIBIT 14 Even if the marital share is in the form of a QTIP-type trust (there being no Federal QTIP election if the decedent dies at a time when there is no Federal estate tax), the income from that trust will be payable to the spouse, and will be included in the spouse s estate. This will likewise make the spouse s estate larger, resulting in a larger estate tax in the spouse s estate if the spouse dies when the estate tax is in effect. Some testators may prefer not to have a marital share if they die when there is no Federal estate tax, so that their entire estate will go to the credit shelter trust, where it can be fully sheltered from inclusion in the surviving spouse s estate. Of course, the spouse needs to have the appropriate interest in and the appropriate degree of control over the credit shelter trust. Other testators may want to first leave to the credit shelter trust sufficient assets to take advantage of the $1.3 million basis increase, then leave to a marital trust sufficient assets to take advantage of the $3 million spousal basis increase, and finally leave the remaining assets to the credit shelter trust. Still other testators, particularly in smaller estates in states that have a state death tax, may want to leave to the credit shelter trust the largest amount that can pass free of state estate tax, and the rest of the estate to a marital trust for which a qualified terminable interest property (QTIP) election can be made for state estate tax purposes. Florida s Flexible Approach Florida enacted a more flexible solution. The Florida statute gives the courts the authority to construe the Will based upon the testator s intention. This permits the court to provide the appropriate construction in each case. The Florida statute does not contain a default construction. The Florida statute also has a broader application than those in other states. The statutes in other states apply where the Will contains a formula referring to the estate tax or GST tax exempt amount. However, the Florida statute also applies where the Will contains a provision that appears to be intended to reduce or minimize the estate tax or GST tax. The Florida statute gives the court the following direction: In construing the will, the court shall consider the terms and purposes of the will, the facts and circumstances surrounding the creation of the will, and the testator s probable intent. In determining the testator s probable intent, the court may consider appropriate evidence relevant to the testator s intent even though the evidence contradicts an apparent plain meaning of the will. Nelson 109

112 SECTION I - EXHIBIT 14 Thus, in Florida, a personal representative or other interested party may obtain a construction providing for something other than a $3.5 million credit shelter trust. Observe: The statute is retroactive to January 1, This essentially gives the court the flexibility to rewrite the Will after the testator s death. It is a powerful tool where the family is in agreement as to the desired result, but may result in litigation where the family is not in agreement. Concluding Observation If the estate tax is not validly retroactively reinstated, estates of Florida decedents have the opportunity to obtain a Will construction based upon the facts and circumstances of the particular case. I d like to thank Sharon L. Klein, the Head of Wealth Advisory for Lazard Wealth Management LLC in New York for bringing this to my attention. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Bruce Steiner CITE AS: LISI Estate Planning Newsletter #1659 (June 17, 2010) at Copyright 2010 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. CITES: Florida Statutes (added by H.B. 1237) and (added by S.B. 998); Idaho Code (added by H.B. 472); Indiana Code (8) (added by S.B. 65); Maryland Code, Estates & Trusts, (added by H.B. 449 and S.B. 337); Nebraska L.B (2010); North Dakota H.B (2010); Tennessee Code (added by S.B. 3045); Utah Code (added by S.B. 121); Code of Virginia (added by H.B. 755); Revised Code of Washington chapter (new sections added by S.B. 6831); Howard M. Zaritsky, State Efforts to Cure the 2010 Problem With Formula Clauses, 37 Estate Planning 48 (May 2010). Copyright 2010 Leimberg Information Services Inc. Nelson 110

113 SECTION I - EXHIBIT 15 Pierre Valuation of Gifts of Single Member LLC Interests (Pierre 2) Pierre v. Comr., T.C. Memo , May 13, 2010 Taxpayer formed an LLC owning 100%. Twelve days later she gifted and sold interests to two trusts. In a case decided on August 24, 2009 the tax court ruled the transfers would be valued as interests in LLCs (subject to discount) rather than transfers of a proportionate share of the LLC s assets (that would have resulted in no discounts). 133 T.C. No. 2, August 24, 2009 In the second Pierre case decided May 13, 2010, the court addressed whether the step transaction required the gift/sale (on the same day) to be treated as a transfer of an aggregated 50% interest or whether the gift could be valued separately than the sale to each trust thereby creating a larger discount. The gifts to each trust were 9.5% and the sale was 40.5%. The court held the interests should be aggregated as 50% transfers for purposes of the appraisal. Nevertheless, the court allowed an 8% lack of control and 30% lack of marketability discount resulting in a combined discount of 36.5%. Of interest the assets sold to a trust were in exchange for 10 year promissory notes requiring annual interest only. During the eight years between the sale and the trial no principal payments were made. Nelson 111

114 SECTION I - EXHIBIT 16 Ludwick: A Wake-up Call for Lawyers Steve Leimberg's Estate Planning Newsletter Archive Message #1687 Date: 17-Aug-10 From: Steve Leimberg's Estate Planning Newsletter Subject: Ludwick: A Wake up Call for Lawyers LISI s coverage of the Ludwick case (See, LISI Estate Planning Newsletters #1642, 1652 and 1653) provided members with commentary and detailed analysis by Paul Hood, Owen Fiore and Steve Akers. Now, Dennis Webb adds his thoughts to the dialogue. Dennis starts with Judge Halpern s findings, and shows how they are connected with partition analysis, and more importantly, how members can use a specific process to incorporate the facts of their case, and counter with consistent, persuasive arguments that preserve the right discounts. In other words, Dennis s commentary is a guide to protecting your next audit from Ludwick. Dennis A. Webb, ASA, MAI, FRICS is designated in both real estate appraisal and business valuation, and has specialized in fractional interest valuation for 15 years. He is a frequent speaker, and his articles have appeared in Valuation Strategies, Estate Planning, The Appraisal Journal, the Journal of Business Valuation and Economic Loss Analysis, and others. He wrote the case study textbook Valuing Undivided Interests in Real Property: Partnerships and Cotenancies published by the Appraisal Institute. Most of his publications and papers are available at: Here is Dennis s commentary: EXECUTIVE SUMMARY: There is a lot of conversation so far, and there will be a lot of worry, about what Ludwick [1] means for valuing tenancy-in-common (TIC) interests in vacation homes, and maybe for valuing TIC interests generally. Rightly or wrongly, it has the potential to influence valuation practice, and will almost certainly be used by the IRS to challenge discounts. If you are faced with such a challenge based on Ludwick, all is not lost. Counter arguments can be persuasive if they are based on careful investigation and application of the facts. If our experience over the past 15 years is any guide, it is highly unlikely that the correct discount will be as low as 17%. Facts should underlie all applications of valuation processes. But, an important key is to know which facts. This in turn requires knowing something about the valuation processes in which they are going to be applied. FACTS: The Ludwicks built a large vacation home in Hawaii in They then established two Nelson 112

115 SECTION I - EXHIBIT 16 qualified personal residence trusts (QPRTs) and transferred respective half-interests into each QPRT. At the time of the February 2005 transfers, the fair market value (FMV) of the home was concluded at $7.25 million, and the reported FMV of each interest was discounted by 30%. COMMENT: The basics are rarely enough to support a convincing value analysis; in this case, the search for facts has barely begun. Hawaii law provides for partition, which is effectively a remedy for disputes between co-owners. Neither appraiser used a model based on partition and the judge found their other arguments unpersuasive. He reasoned that buyers would use the exit costs posed by partition and its likelihood as a ceiling for the market discount, as each would bid up the interest until pursuing the exit strategy would make the buyer whole. The taxpayer s appraiser failed to convince him that this would not be the case. This reasoning does have its weaknesses, such as the implicit assumption that an action to sell would commence immediately upon purchase. However, it is a generally valid way of looking at one strategy, and such possibility should not be dismissed. The discount depends on the input assumptions, which I will address in the commentary, below. Reality is that a careful analysis of the facts does not always support a partition action as a reasonable exit strategy. Our analysis of partition strategies usually produces a pretty high discount, demonstrating that such a strategy is frequently not economically feasible. Besides the general design of the model, another assumption adopted by Judge Halpern was that a heavy weight should be given to a cooperative outcome; that the desire to sell would be unopposed. His assumed the buyer would assign a 90% likelihood to cooperation, leaving only a 10% likelihood of a lawsuit. He cited a limited reasoning presented by the respondent if the [hypothetical] buyer told petitioner wife that he wanted to sell the property, why would she object? Apparently no one asked her. They had just built the property, and she might have good reasons to hold onto it. Market values may no longer be favorable. There are many other facts (below) that can influence such a decision. There was also an agreement between the parties indicating a desire to avoid a lawsuit and sell in the event of a dispute. [2] While there is no indication if the intent demonstrated by the agreement had any influence, such a stated desire might support some likelihood of cooperation. It is unfortunate that the opinion does not reveal whether a more comprehensive analysis was undertaken by the appraisers. For the hypothetical buyer to use this for pricing the interest, there should be affirmative evidence for expecting cooperation. After all, a 90% chance of cooperation means that at a later time, and allowing for influences that are as yet unknown (who else in or outside of the family will have an influence on that decision when the time comes?), a desired sale will be unopposed. Nelson 113

116 SECTION I - EXHIBIT 16 It turns out that the facts in Ludwick could support Judge Halpern s decision, and his method is, indeed, applicable to lots of TIC interests. But changes in fact patterns can have huge effects on the concluded discounts. The commentary below shows how the lawyer can help to identify the material facts affecting value, and suggests that lawyers make sure their expert s arguments are tied to the facts and make sense. The petitioner s evidence in Ludwick was short on all counts, making this case an important wakeup call for estate practitioners, and doubly important for the taxpayers they serve. VALUATION SCENARIOS: This case uses two valuation scenarios, one for immediate sale of the property, and one that requires a partition action. The comments that follow are for the latter; the immediate sale is much simpler, beginning with a listing to sell. The present value model used to analyze the partition scenario in Ludwick is generally appropriate: Construct a likely timeline between the date of value and the ultimate disposition of the property; grow the property value to the end of the period at the current market value growth rate; deduct selling costs; deduct annual operating costs; deduct court and other out-of-pocket costs; and discount net sale proceeds and periodic cash flows to present value using a rate of return that the buyer would demand. (There is no reference to a loan, but in the event that one is present, debt service and equity at the end of the period would also have to be considered.) The inputs to the model are critical, and must be based on case-specific facts. But which facts should we be looking for? The most important inputs to the present value model, and indeed to all comparisons of market data to case facts, are a) risk to the hypothetical buyer of the interest, and b) the period during which the buyer will be trapped in the deal. An analysis of the facts will give the holding period and the discount rate (for calculating present value). Such analysis should be careful and comprehensive, but a few points can be made quickly. HOLDING PERIOD Nelson 114

117 SECTION I - EXHIBIT 16 How long would it take for the entire process, from purchase to exit? What if the other party were cooperative? What if they were not? The Ludwick case used two years overall, but it might be far longer. If we string together the time from: The (presumably agreeable) purchase to disagreement to negotiation to threatening a lawsuit, to filing the partition action, to court proceedings, to sale of the underlying property and disbursement of proceeds. Ludwick ended up with a 1-year partition; very fast, which pretty much requires that the lawsuit exit option would commence immediately upon purchase of the interest, and that it would get through the court system with relative ease. Definitely a fast track, although probably faster than would be expected in most jurisdictions with a policy. If partition is a viable method, then the likely period should be confirmed with lawyers familiar with the process in that specific county. An additional year was added for marketing the property, closing the sale and distributing the proceeds. However, it would not be uncommon to end up with three years as a reasonable period. If there is a real (temperamental and financial) ability and desire on the part of the other party to obstruct (say, by filing a counter-suit), a realistic period might be even longer. VALUE GROWTH, PROCEEDS AND COSTS Market assumptions are included as well. The first is the market-expected value growth rate over the selected period. The case used 3.0%, which is relatively common. What would it be for, say, a property interest gifted today? 0%? If there is no growth, then selling costs (brokerage fees and other amounts paid in escrow) become significant, and have a big effect on the discount. Partition and any other costs are usually small in relation to the value of the underlying property. [3] DISCOUNT RATE (RISK) Nelson 115

118 SECTION I - EXHIBIT 16 All real estate holdings carry risk, which is built into the purchase price of the property. Risk is increased for a fractional interest holder because its rights are limited, sometimes drastically so. Being trapped in the investment means that the owner cannot respond to changing market conditions by selling or borrowing, without cooperation. Market timing is sometimes critical, as recent history will attest, and sale restrictions require substantial discounts for all types of assets. Risks are also related to the identities of the other owners, personal facts suggested above, and possibly others. Other sources of risk were broached in the case, [4] but the opinion seems to intimate that they were apparently not developed to any meaningful extent. Risk is reflected in a present value model through the use of a discount or yield rate. In Ludwick, Judge Halpern used 10%, based on testimony by the respondent s expert. The taxpayer s expert stated that it should be 30%, but provided no support according to the opinion. This is unfortunate, because 10% is essentially a property rate, which reflects only the risk faced by the 100% owner. A properly adjusted rate for the fractional position should be much greater, usually at least 4-5% more. Given that we are modeling a lawsuit, the rate should be increased still further, from 14-15% to maybe 20% or more. (What return would you require to knowingly enter into an investment where your exit could easily be the fun of bringing a lawsuit?) The taxpayer s expert s claim of 30% might have been high, but he was at least moving in the right direction. Increasing the hypothetical buyer s yield requirement and expected holding period to account for all the facts would substantially increase the concluded discount. [5] Using the facts to determine the appropriate valuation process, and then further fitting the valuation model to the facts, is the essence of the valuation process. It might as well have been a finding of the case, but I suspect Judge Halpern would have been happier if all this had been demonstrated by the experts. FINDING THE FACTS It should be apparent by now that even if Ludwick is invoked on audit, the facts and circumstances of your case are the key to proper analysis and discount conclusion, using a present value or any valuation model. There is usually a fairly long list of facts that influence discounts in these sorts of circumstances, but little is revealed in Judge Halpern s memorandum. Ludwick is not a reasonable guide to identifying which facts are important in determining value. It points out that holding period and (buyer) risk are key, which is correct, but the reasoning that support the inputs to the model are in my opinion - woefully lacking. Accordingly, it can be important, even critical, to ask many more questions. For the Ludwicks: Nelson 116

119 SECTION I - EXHIBIT 16 How did they use the home? How frequently? They had built it only two years before the date of value, so there was not much history; did they intend to hold it for a long time? How old are the principals? What about succession - were their children or grandchildren into visiting Hawaii on a regular basis? Did they have specific expectations for future usage? Why would the hypothetical buyer purchase the interest in the first place? In this case, it would seem that periodic use of a vacation home is a good enough reason. But, how would they model their pricing? Presumably the parties would be agreeable going in, but circumstances change over time, and any impairment of the exit process would give rise to a discount. Would it be prudent to assume that future cooperation with a buyout or sale would be certain? If not, then how likely is litigation? A long list of facts that are typically found in fractional interest valuation cases may be found online. [6] Analysis under the fair market value standard relies largely on the hypothetical buyer s pricing process, above. These expectations are, logically, based on this buyer s reasonable due diligence efforts. Given this, important facts should show themselves to any lawyer thinking buyer due-diligence, and certainly to any qualified appraiser. The appraiser then has the obligation to find analytical models that represent the pricing behavior of the hypothetical buyer and seller. The partition model, from this case, is one such model. [7] WHAT CAN WE CONCLUDE FROM LUDWICK? Even if your facts do not support bringing a partition action as a feasible option available to the hypothetical buyer of the subject interest, a present value model as described above and used by Judge Halpern should have been considered in your appraisal. Its inputs should be supported by a detailed examination of the facts, and its inclusion will put those facts and analysis on record in case of challenge, even if no one in their right mind would pursue such an action. This case is a wakeup call for the lawyer, who can be directly helpful in the valuation process by checking whether the appraiser s exposition of the facts matches a reasonable due-diligence effort of the hypothetical buyer. There is no reason that the presented analysis, arguments and conclusions of the appraisers should not be tied to the facts, and be clear and easily followed. In their absence, the judge is stuck, and will come up with a decision one way or the other, just as he did in Ludwick. Nelson 117

120 SECTION I - EXHIBIT 16 HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Dennis Webb TECHNICAL EDITOR: L. PAUL HOOD, JR. This commentary underscores the importance of the estate planner in the due diligence and draft review phases of any valuation. CITE AS: LISI Estate Planning Newsletter #1687 (August 17, 2010) at Copyright 2010 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission Express Permission CITE: Ludwick v. Commissioner, T.C. Memo CITATIONS: [1] Ludwick v. Commissioner, T.C. Memo [2] TAM Bites Taxpayer, Carsten Hoffman, FMV Valuation Alert, May 12, 2010 [3] Although expenses are fairly high in this case ($350,000/year), this is still a small amount in relationship to the total property value. Cutting the expenses in half would only reduce the discount conclusion by 2%. [4] Petitioners have failed to explain what (in that hypothetical) petitioner wife would stand to gain by opposing partition [5] The conclusion of the non-partition model is 16%, and of the partition model is 27%; the 17% conclusion is a weighted average. Most important for nearly all cases is the partition model, and its inputs are important. For example, changing the (present value) discount rate from 10% to 15% increases the discount concluded by the partition model from 27% to 34%. Acknowledging that the timeline could easily increase by six months for early wrangling between the parties, and then another six months for court delays (still a fast track) increases the holding period from 24 months to 36 months. Making only this change increases the discount to 37%, and making both changes increases the discount to 46%. This does not necessarily mean that the discount conclusion would be as great at 46%, though, because at some point a partition action becomes unfeasible, and other models will be much more usable, providing a better fit to the facts. [6] See Asset Fractions: Integrating Real Property and Business Valuations [Getting a Handle on the Facts] at [7] There are many valuation models that effectively connect the facts for tenancy-in-common cases, which are quite similar to those for general partnerships and other modified-control entities. Application of the models is discussed in Advanced Modeling for Holding Company Valuation, also at Copyright 2010 Leimberg Information Services Inc. Nelson 118

121 SECTION I - EXHIBIT 17 Forum Shopping For Favorable FLP and LLC Law: 2010 LLC Asset Protection Planning Table Steve Leimberg's Asset Protection Planning Newsletter- Archive Message # 154 Date: 25-May-10 From: Steve Leimberg's Asset Protection Planning Newsletter Subject: Forum Shopping For Favorable FLP and LLC Law: 2010 LLC Asset Protection Planning Table In August 2007, LISI published the first table regarding sole remedy and judicial foreclosure by Mark Merric and Bill Comer. See LISI Asset Protection Planning Newsletter #112. This turned into a series on Forum Shopping For Favorable FLP and LLC Legislation, see LISI Asset Protection Planning Newsletters #114, #117, #127. Over the past three years, states have continued to change their laws regarding charging orders, and Marc Merric, Bill Comer and Mark Monasky have joined together to provide members with their latest table updating the status of each state. Merric Law Firm is a boutique practice emphasizing activity in the areas of estate planning, international tax, and asset protection planning. Mark is co-author of CCH's treatise on asset protection first edition, The Asset Protection Planning Guide (first edition), and the ABA's treatises on asset protection, Asset Protection Strategies Volume I, and Asset Protection Strategies Volume II. Mark's articles have been published in Trusts & Estates, Estate Planning Magazine, Journal of Practical Estate Planning, Lawyers Weekly Heckerling Edition, Journal of Taxation, and the Asset Protection Journal. Mark speaks nationally on estate planning and asset protection. William Comer is a financial consultant specializing in estate preservation, asset protection and privacy. He is a certified senior advisor, a long-time member of the Offshore Institute and has spoken on these issues throughout the U.S., Costa Rica and the Bahamas. He is the author of Freedom, Asset Protection & You a complete encyclopedia of asset protection and estate preservation. Mark Monasky is a board certified neurosurgeon and attorney with a legal practice limited to estate planning and asset protection. Mark graduated from Columbia University College of Physicians & Surgeons, trained at Mayo Clinic, and is a graduate of University of North Dakota School of Law. Mark is a member of Wealth Counsel, a fellow of the American College of Surgeons and American College of Legal Medicine, and belongs to the American Association of Neurological Surgeons, Congress of Neurological Surgeons, Christian Medical & Dental Society, and American Medical and Bar Associations. Mark is a past recipient of the Best Doctors Award, America Central Region. Now, here is their commentary: EXECUTIVE SUMMARY: Nelson 119

122 SECTION I - EXHIBIT 17 The following table depicts the following four key areas regarding charging order protection: 1. Whether a creditor may petition the court for a judicial dissolution of an LLC; 2. Whether state law allows for the judicial foreclosure sale of the member s interest; 3. Whether a state law allows or prohibits a broad charging order; and 4. Whether a state law permits or prevents equitable remedies. FACTS: A few states that adopted the Uniform Limited Liability Company Act of 1996 ( ULLC 1996 ) allow a creditor with a charging order to petition for the judicial dissolution of a limited liability company if it is impractical to carry on the business of the company. While the authors have concerns regarding this asset protection weakness, the authors are unaware of any reported case where a creditor has utilized this unusual remedy. Further, this remedy is not part of the Uniform Limited Liability Act of 2006 ( ULLC 2006 ). Conversely, both the ULLC 2006 as well as the Uniform Limited Partnership Act of 2001 ( ULPA 2001 ) allow for the judicial foreclosure sale of a member s interest. As discussed in LISI XXXX, Adams and the Porcupine, the authors generally find the judicial foreclosure sale of a member s interest to be an effective creditor remedy. COMMENT: Many states seek to prevent the judicial foreclosure sale of a member s interest by providing that a charging order is the sole and exclusive remedy. Unfortunately, there is a division regarding what sole remedy means.[i] For purposes of this article, if a statute states something similar to the following language the authors considered this a sole remedy ( SR ) that prevents the judicial foreclosure sale of the member s interest: On application to a court of competent jurisdiction by any judgment creditor of a member or assignee, the court may charge the interest of the member or assignee with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of financial rights. This section shall be the sole and exclusive remedy of a judgment creditor with respect to the judgment debtor's membership interest. In addition to whether a membership interest may be sold at a judicial foreclosure sale, there is the further issue of whether a judge may issue a broad charging order that would restrict the activities of an LLC from engaging in the following actions without Nelson 120

123 SECTION I - EXHIBIT 17 court and/or creditor approval: Making loans; Making capital acquisitions[ii]; Making distributions (for example, non-pro rata distributions); Selling any partnership interest; and Providing a full accounting of the partnership activities. This commentary takes the position that absent specific statutory language that prevents a court from issuing a broad charging order, then such action by a court is permitted. Finally, there is the issue of equitable remedies that are directed at the partnership itself and seek to reach the underlying assets of the partnership such as a constructive trust, resulting trust, alter ego, and reverse veil pierce.[iii] A limited number of states have passed statutes that prevent all equitable and legal remedies other than the sole remedy of a charging order. For purposes of this article, unless a state specifically has statutory language that prevents equitable remedies, it is deemed to permit them. STATE Creditor May Petition Court Judicial Dissolution Judicial Foreclosure = JF; Simple Sole Remedy = SR; or Silent Broad Charging Order Permits Prohibits Equitable Remedies Permits Prohibits Alabama No SR [iv] Silent Permits Alaska No SR [v] Prohibits [vi] Permits Arizona No SR [vii] Silent Permits Arkansas No Silent [viii] Silent Permits California No JF [ix] Permits [x] Permits Colorado No JF [xi] Silent Permits Connecticut No Implied JF [xii] Silent Permits Delaware No SRx [x] Silent Prohibits [xiv] District of No Silent [xv] Silent Permits Columbia Florida No Silent [xvi] Silent Permits Georgia No SRxiv [xiv] Prohibitsxv [xv] Permits Hawaii Yes [xviii] JF [xix] Permits [xx] Permits Idaho No JF [xxi] Permits [xxii] Permits Illinois Yes [xxiii] JF [xxiv] Silent Permits Indiana No Probably SR [xxv] Silent Permits Iowa No JF [xxvi] Permits [xxvii] Permits Kansas No JF [xxviii] Silent Permits Kentucky No JF [xxix] JF [xxx] Permits Louisiana No Silent [xxxi] Silent Permits Maine No Silent [xxxii] Silent Permits Nelson 121

124 SECTION I - EXHIBIT 17 Maryland No Silent [xxxiii] Silent Permits Massachusetts No Silent [xxxiv] Silent Permits Michigan No Silent [xxxv] Silent Permits Minnesota No SR [xxxvi] Silent Permits Mississippi No Silent [xxxvii] Silent Permits Missouri No Silent [xxxviii] Silent Permits Montana Yes [xxxix] JF [xl] JF [xli] Permits Nebraska No Statute [xlii] Statute [xliii] Prohibits [xliv] Nevada No SR [xlv] Silent Permits New Hampshire No Silent [xlvi] Silent Permits New Jersey No SR [xlvii] Prohibits [xlviii] Permits New Mexico No Silent [xlix] Silent Permits New York No Silent [l] Silent Prohibits [li] North Carolina No SR by Case Law [lii] Silent Permits North Dakota No SR [liii] Silent Permits Ohio No Silent [liv] Silent Permits Oklahoma No SR [lv] Silent Permits Oregon No Silent [lvi] Silent Permits Pennsylvania No No charging order Silent Permits language [lvii] Rhode Island No Silent [lviii] Silent Permits South Carolina Yes [lix] JF [lx] Permits [lxi] Permits South Dakota No SR [lxii] Prohibits [lxiii] Prohibits [lxiv] Tennessee No SR [lxv] Silent Permits Texas No Statute [lxvi] Silent Prohibits [lxvii] Utah No JF [lxviii] Permits [lxix] Prohibits [lxx] Vermont Yes [lxxi] JF [lxxii] Permits [lxxiii] Permits Virginia No SR [lxxiv] Silent Prohibits [lxxv] Washington No Silent [lxxvi] Silent Permits West Virginia No JF [lxxvii] Permits [lxxviii] Permits Wisconsin No Silent [lxxix] Silent Permits Wyoming No SR [lxxx] Prohibits [lxxxi] Permits HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Mark Merric Bill Comer Mark Monasky TECHNICAL EDITOR: Duncan Osborne CITE AS: Steve Leimberg's Asset Protection Planning Newsletter #154 (May 25, 2010) at Reproduction in Any Form or Forwarding to Any Person Prohibited - Without Express Permission. Nelson 122

125 SECTION I - EXHIBIT 17 Copyright Mark Merric, Bill Comer, and Mark Monasky All rights reserved. CITATIONS: [i] [ii] [iii] [iv] [v] [vi] For a detailed discussion regarding various interpretations of the term sole and exclusive remedy see Merric, Comer, Worthington, Charging Order What Does Sole and Exclusive Remedy Mean?, Trust and Estates, April This article may be downloaded at Comments to both the ULPA (2001) and ULLC (2006) state that a court should not issue a charging order that would restrict capital acquisitions. As the comments are not the statute passed by the legislature, there is always the question of whether a court is required to follow the comments. A reverse veil pierce is a new cause of action, and states are divided regarding whether they allow a reverse veil pierce action. Ala. Code Alaska Stat Alaska Stat [vii] Ariz. Rev. Stat [viii] [ix] [x] [xi] Ark. Code Cal. Corp. Code Severson v. Superior Ct WL unreported. Cal. Corp. Code Colo. Rev. Stat [xii] Conn. Gen. Stat PB Real Estate, Inc. v. Dem II Properties, 1997 WL dictum regarding that an LLC statute should also be able to import the remedies of the UPA, including the judicial foreclosure sale of the LLC interest. [xiii] Del. Code [xiv] Del. Code [xv] D.C. Code [xvi] Fla. Stat. ch (4) [xvii] [xviii] Ga. Code Ann (b), similar to the limited partnership statute above states that a charging order is not a creditor s exclusive remedy. Hopson v. Bank of North Georgia, 574 S.E. 2d 411 (Ga. App. 2001). Haw. Rev. Stat (e)(3) [xix] Haw. Rev. Stat [xx] Haw. Rev. Stat [xxi] Idaho Code , which adopted the ULLC (2006) [xxii] [xxiii] [xxiv] [xxv] Idaho Code , which adopted the ULLC (2006) 805 Ill. Comp. Stat. 180/ Ill. Comp. Stat. 180/30-20; In re Lahood, 2009 WL (Bkrtcy C.D. Ill. 2009). But See, Bobak Sausage Co. v. Bobak Orland Park, Inc., 2008 WL (N.D. Ill. 2008) where the court notes that there was considerable risk in acquiring an interest at judicial foreclosure sale and that there was no ready market value for such an interest. The court seems to imply that due to this lack of a market value (i.e. a very low sales value) a sheriff judicial foreclosure sale may not be the appropriate remedy. Ind. Code ; Brant v. Krilich, 835 N.E. 2d 582 (Ind. App. Ct. 2005) when discussing whether a debtor could use a garnishment statute and execute against the member s interest, the Indiana Appellate Court held that the charging order was the sole remedy. In other words, it denied the execution. However, the court did not discuss whether a judicial foreclosure sale would be allowed under the statute. In this respect, at first blush it appears that Indiana is sole remedy. However, further case law may develop to the contrary if a court is properly briefed on judicial foreclosure sale as applied to Nelson 123

126 SECTION I - EXHIBIT 17 [xxvi] [xxvii] [xxviii] [xxix] [xxx] [xxxi] [xxxii] [xxxiii] [xxxiv] [xxxv] [xxxvi] [xxxvii] [xxxviii] [xxxix] [xl] Indiana s statute that is silent on the issue. Iowa Code passed the ULLC (2006) at this point the statutory section is unknown. Iowa Code passed the ULLC (2006) at this point the statutory section is unknown. Kan. Stat , 113 Ky. Rev. Stat , which adopted the ULLC (2006). KY SB 210 adds sub-section 6 stating that the partnership is not a necessary party to issue a charging order. Ky. Rev. Stat , which adopted the ULLC (2006). La. Rev. Stat. 12: Me. Rev. Stat. 686 Md. Code 4A-607 Mass. Gen. Laws ch Mich. Comp. Laws Minn. Stat. Ann. 322B.32 Miss. Code Mo. Rev. Stat Mont. Code Ann (6)(c) Mont. Code Ann [xli] Mont. Code Ann (2)(b) [xlii] [xliii] [xliv] Neb. Rev. Stat adopting ULLC (2006) Neb. Rev. Stat adopting ULLC (2006) Neb. Rev. Stat (5) [xlv] Nev. Rev. Stat [xlvi] [xlvii] [xlviii] [xlix] [l] [li] [lii] N.H. Rev. Stat. 304-C:47 N.J. Stat. 42:2B-45 N.J. Stat. 42:2B-45 N.M. Stat N.Y. Ltd. Liab. Co. Law 607. N.Y. Ltd. Liab. Co. Law 607(b) N.C. Gen. Stat. 57C Herring v. Keasler, 563 S.E.2d 614 (N.C. App. 2002) [liii] N.D. Cent. Code [liv] Ohio Rev. Code [lv] Okla. Stat. tit [lvi] Or. Rev. Stat [lvii] [lviii] Zokaites v. Pittsburgh Irish Pubs, LLC, 962 A.2d 1220 (PA Super. 2008). While the Pennsylvania statute does not specifically mention the charging order remedy, the appellate court imported the concept based on an economic right and management right theory based on the comment to 15 Pa.C.S.A Originally, the creditor was granted a right to sell the membership interest including all of the managerial rights. The appellate court reversed this decision, holding that only economic rights could be transferred. However, it did not discuss whether the economic rights were subject to judicial foreclosure. R.I. Gen. Laws [lix] S.C. Code Nelson 124

127 SECTION I - EXHIBIT 17 [lx] S.C. Code [lxi] S.C. Code [lxii] [lxiii] [lxiv] S.D. Codified Laws 47-34A-504 S.D. Codified Laws 47-34A-504 S.D. Codified Laws 47-34A-504 [lxv] Tenn. Code [lxvi] [lxvii] [lxviii] [lxix] Tex. Bus. Orgs. Code Texas Bus. Orgs. Code Utah Code 48-2c Please note that this section also provides no charging order protection for a single member LLC. Utah Code 48-2c-1103 [lxx] Utah Code 48-2c-1103 [lxxi] [lxxii] [lxxiii] [lxxiv] [lxxv] [lxxvi] [lxxvii] [lxxviii] [lxxix] [lxxx] [lxxxi] Vt Stat. Title (e)(4) Vt Stat. Title Vt. Stat. Title Va. Code ; Wooten v. Lightburn, 2009 WL (W.D. Va. 2009) where the appellate court allowed the debtor to lien the partner s interest, but there was no discussion of a judicial foreclosure sale. Va. Code where Wash. Rev. Code W. Va. Code 31B W. Va. Code 31B Wis. Stat Wyo. Stat (g) effective July 1, Wyo. Stat (g) effective July 1, Copyright 2010 Leimberg Information Services Inc. Nelson 125

128 SECTION I - EXHIBIT 18 Forum Shopping For Favorable FLP and LLC Law: Part VII Steve Leimberg's Asset Protection Planning Newsletter - Archive Message #162 Date: 14-Sep-10 From: Steve Leimberg's Asset Protection Planning Newsletter Subject: Forum Shopping For Favorable FLP and LLC Law: Part VII In August 2007, LISI published the first table regarding sole remedy and judicial foreclosure by Mark Merric and Bill Comer. See LISI Asset Protection Planning Newsletter #112. This turned into a series on Forum Shopping For Favorable FLP and LLC Legislation. See LISI Asset Protection Planning Newsletters #114, #117, #127 and #154. Over the past three years, states have continued to change their laws regarding charging orders, and Marc Merric, Bill Comer and Mark Monasky have joined together to provide members with their latest table updating the status of each state. Mark Merric is special counsel working with Holme, Roberts, and Owen, one of Denver s largest law firms in the areas of estate planning, international tax and business transactions, and asset protection planning. Mark is also co-author of CCH's treatise on asset protection The Asset Protection Planning Guide (first edition), and the ABA's treatises on asset protection, Asset Protection Strategies Volume I, and Asset Protection Strategies Volume II. Mark has been quoted in the Wall Street Journal, Forbes, Investor s News, Oil and Gas Investor, The Street, and several other publications. His articles have been feature in Trusts and Estates, Estate Planning Magazine, Journal of Practical Estate Planning, Lawyer s Weekly Heckerling Edition, Journal of Taxation as well as Leimberg LISI s. Many of these articles have been multi-part series on discretionary dynasty trusts, Who Can Be a Trustee Without an Estate Inclusion Issue, Reciprocal Trusts, Spousal Access Trusts, and this series on Charging Order Protection. William Comer is a financial consultant specializing in estate preservation, asset protection and privacy. He is a certified senior advisor, a long-time member of the Offshore Institute and has spoken on these issues throughout the U.S., Costa Rica and the Bahamas. He is the author of Freedom, Asset Protection & You a complete encyclopedia of asset protection and estate preservation. Mark Monasky is a board certified neurosurgeon and attorney with a legal practice limited to estate planning and asset protection. Mark graduated from Columbia University College of Physicians & Surgeons, trained at Mayo Clinic, and is a graduate of University of North Dakota School of Law. Mark is a member of Wealth Counsel, a fellow of the American College of Surgeons and American College of Legal Medicine, and belongs to the American Association of Neurological Surgeons, Congress of Neurological Surgeons, Christian Medical & Dental Society, and American Medical and Bar Associations. Mark is a past recipient of the Best Doctors Nelson 126

129 SECTION I - EXHIBIT 18 Award, America Central Region. Please join Mark Merric and Michael Graham in Las Vegas for one to five days of estate planning seminars, September 13-17, As always, it's a great speaker panel with great topics at a great price and great location! The following courses qualify for 8 hours of CLE: Estate and Gift Tax Boot Camp; Turbo Charging Estate Planning Tools; Modular Approach to Estate or Business ; Succession Planning; The Sizzle to Drafting Irrevocable Trusts. The final course Asset Protection Planning for High Net Worth Clients qualifies for 8 hours of CLE including 1 hour ethics. This program is being held in cooperation with the University of Denver's Graduate Tax Program. Linda Browning, Marketing Director Graduate Tax Program, University of Denver: Now, here is their commentary: EXECUTIVE SUMMARY: The generally are four key areas regarding charging order protection: 1) Whether a creditor may petition the court for a judicial dissolution of an LLC; 2) Whether state law allows for the judicial foreclosure sale of the member s interest; 3) Whether a state law allows or prohibits a broad charging order; and 4) Whether a state law permits or prevents equitable remedies Unlike the Uniform Limited Liability Company Act of 1996, the uniform limited partnership acts never allowed a creditor to petition for the judicial dissolution of a limited partnership. Therefore, this is not an asset protection issue reflected in the table below. However, the Uniform Limited Liability Company Act ( ULLC 2006 ) as well as the Uniform Limited Partnership Act of 2001 ( ULPA 2001 ) allow for the judicial foreclosure sale of a member s interest. As discussed in LISI Estate Planning Newsletter #1637, the authors generally find the judicial foreclosure sale of a member s interest to be an effective creditor remedy. Many states seek to prevent the judicial foreclosure sale of a partner s interest by providing that a charging order is the sole and exclusive remedy. Unfortunately, there is a division regarding what sole remedy means.[i] For purposes of this article, if a statute states something similar to the following language the authors considered this to be a sole remedy ( SR ) that prevents the judicial foreclosure sale of the partner s interest: Nelson 127

130 SECTION I - EXHIBIT 18 On application to a court of competent jurisdiction by any judgment creditor of a member or assignee, the court may charge the interest of the member or assignee with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of financial rights. This section shall be the sole and exclusive remedy of a judgment creditor with respect to the judgment debtor's membership interest. In addition to whether a partnership interest may be sold at a judicial foreclosure sale, there is the further issue of whether a judge may issue a broad charging order that would restrict the activities of a Limited Partnership from engaging in the following actions without court and/or creditor approval: Making loans; Making capital acquisitions[ii]; Making distributions (for example, non-pro rata distributions); Selling any partnership interest; and Providing a full accounting of the partnership activities. This commentary takes the position that absent specific statutory language that prevents a court from issuing a broad charging order, then such action by a court is permitted. Finally, there is the issue of equitable remedies that are directed at the partnership itself and seek to reach the underlying assets of the partnership such as a constructive trust, resulting trust, alter ego, and reverse veil pierce.[iii] A limited number of states have passed statutes that prevent all equitable and legal remedies other than the sole remedy of a charging order. For purposes of this article, unless a state specifically has statutory language that prevents equitable remedies, it is deemed to permit them. COMMENT: Corrections to Prior Chart As always, when preparing a chart on 50 states, occasionally there is an error or a legislative change that is missed. In our last chart that was included in Asset Protection Planning Newsletter #154 it stated Delaware = JF allowed judicial foreclosure sale. This was a clerical error. It should have read SR. On another note, the authors thank Christopher Riser for pointing out the legislative change to Georgia s limited liability company statute. They now have adopted the Alaska prototype that prevents a judicial foreclosure sale as well as a broad charging order. Please note that only limited partnership cases are listed in the footnotes below. The Uniform Partnership Act (i.e. General Partnerships) specifically allows for the judicial foreclosure sale of general partnership interest. In this respect, these general partnership cases following the UPA statute are irrelevant for analysis of a limited Nelson 128

131 SECTION I - EXHIBIT 18 partnership statute that does not specifically allow for judicial foreclosure sale (i.e. RULPA 1976). Limited Partnership State Judicial Foreclosure = JF; Simple Sole Remedy = SR; or Silent Broad Charging Order Permits; or Prohibits; or Silent Equitable Remedies Permits; or Prohibits Alabama SR[iv] Silent[v] Permits Alaska SR[vi] Prohibits[vii] Permits Arizona SR[viii] Silent Permits Arkansas JF[ix] Permits[x] Permits California Statute[xi] Permits[xii] Prohibits[xiii] Colorado Probably[xiv] Silent Permits Connecticut Case Law[xv] Silent Permits Delaware SR[xvi] Silent Prohibits District of Silent[xvii] Silent Permits Columbia Florida SR[xviii] Prohibits[xix] Permits Georgia JF[xx] Silent Permits Hawaii JF[xxi] Permits[xxii] Permits Idaho Statute[xxiii] Permits[xxiv] Permits Illinois Statute[xxv] Permits[xxvi] Permits Indiana Silent[xxvii] Silent Permits Iowa JF[xxviii] Permits[xxix] Permits Kansas Silent[xxx] Silent Permits Kentucky JF[xxxi] Silent Permits Louisiana No charging order Silent Permits language Maine JF[xxxii] Permits[xxxiii] Permits Maryland JF[xxxiv] Silent Permits Massachusetts Silent[xxxv] Silent Permits Michigan Silent[xxxvi] Silent Permits Minnesota JF[xxxvii] Permits[xxxviii] Permits Mississippi Silent[xxxix] Silent Permits Missouri???[xl] Silent Permits Montana Silent[xli] Silent Permits Nebraska Silent[xlii] Silent Permits Nevada two statutes JF[xliii] SR[xliv] Permits[xlv] Silent Permits Permits New Hampshire JF[xlvi] Silent Permits New Jersey Silent[xlvii] Silent Permits New Mexico JF[xlviii] Permits[xlix] Permits New York Probably[l] Silent Permits North Carolina Silent[li] Silent Permits Nelson 129

132 SECTION I - EXHIBIT 18 North Dakota SR[lii] Silent Permits Ohio Possibly JF[liii] Silent Permits Oklahoma JF[liv] Permits[lv] Permits Oregon Silent[lvi] Silent Permits Pennsylvania JF[lvii] Silent Permits Rhode Island Silent[lviii] Silent Permits South Carolina Silent[lix] Silent Permits South Dakota JF[lx] Silent Prohibits Tennessee Silent[lxi] Silent Permits Texas SR[lxii] Silent Prohibits Utah Silent[lxiii] Silent Permits Vermont Silent[lxiv] Silent Permits Virginia SR[lxv] Silent Prohibits Washington JF[lxvi] Permits[lxvii] Permits West Virginia Silent[lxviii] Silent Permits Wisconsin Silent[lxix] Silent Permits Wyoming Silent[lxx] Silent Permits HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Mark Merric Bill Comer Mark Monasky TECHNICAL EDITOR: Duncan Osborne CITE AS: Steve Leimberg's Asset Protection Planning Newsletter #162 (September 14, 2010) at Reproduction in Any Form or Forwarding to Any Person Prohibited - Without Express Permission. Copyright Mark Merric, Bill Comer, and Mark Monasky. All rights reserved. CITATIONS: [i] [ii] [iii] [iv] For a detailed discussion regarding various interpretations of the term sole and exclusive remedy see Merric, Comer, Worthington, Charging Order What Does Sole and Exclusive Remedy Mean?, Trust and Estates, April This article may be downloaded at Comments to both the ULPA (2001) and ULLC (2006) state that a court should not issue a charging order that would restrict capital acquisitions. As the comments are not the statute passed by the legislature, there is always the question of whether a court is required to follow the comments. A reverse veil pierce is a new cause of action, and states are divided regarding whether they allow a reverse veil pierce action. Ala. Code 10-9C-703 Nelson 130

133 SECTION I - EXHIBIT 18 [v] [vi] [vii] [viii] [ix] [x] [xi] Ala. Code 10-9C-703, a creditor may not request accountings, but it appears a court may issue other orders affecting the management of the partnership. Alaska Stat Alaska Stat , also see Lumbermens Mutual Casualty Company, 2005 WL (D. Ala. 2005) upholding Alaska s prohibition for a broad charging order. Ariz. Rev. Stat This statute reversed a judicial foreclosure sale holding under the prior RULPA (1976) language. Bohonus v. AMERCO, 602 P.2d 469 (Ariz. 1979). Ark. Code adopting the ULPA (2001) Ark. Code adopting the ULPA (2001) Cal. Corp. Code adapting ULPA 2001, previously judicial foreclosure sale was allowed by the following cases Hellman v. Anderson, 233 Cal. App. 3d 840 (1991); Crocker Nat. Bank v Perroton, 208 Cal. App. 3d 1 (1989). However, it should be noted that (f) specifically denies a creditor from directly attacking the partnership itself with equitable remedies. [xii] Cal. Corp. Code adapting ULPA 2001, previously judicial foreclosure sale was allowed by the following cases Hellman v. Anderson, 233 Cal. App. 3d 840 (1991); Crocker Nat. Bank v Perroton, 208 Cal. App. 3d 1 (1989). [xiii] Cal. Corp. Code (f) specifically denies a creditor the right to directly attack the partnership itself with equitable remedies. [xiv] Colo. Rev. Stat was amended in 2000 to specifically state that a charging order was not the sole remedy. In this respect, Colorado is similar to Georgia. When Georgia interpreted this type of provision, it allowed for the judicial foreclosure sale of the limited partnership interest. [xv] Madison Hills Limited Partnership II v. Madison Hills, Inc., 644 A.2d 363 (Conn. App. Ct. 1994). Noting that the ULPA(1976) provides that the remedies of the UPA may be imported. The UPA provides for the judicial foreclosure sale of partnership interests [xvi] Del. Code [xvii] [xviii] [xix] D.C. Code Fla. Stat. ch ; also previously by case law In re Stocks, 110 B.R. 65 (Bankr. N.D. Fla. 1989); Givens v. National Loan Investors, L.P., 724 So.2d 610 (Fla. App. 1998). Fla. Stat. ch states that a court may not order an accounting or other remedies. Presumably, other remedies would include an order controlling the management of the partnership. [xx] Ga. Code Ann , which specifically states a charging order is not a creditor s exclusive remedy; Stewart v. Lanier Medical Office Building, Ltd. 578 S.E. 2d 572 (Ga. App. 2003). Also, prior to the current statute, when interpreting RULPA (1976) language, a Georgia Appellate Court held for the judicial foreclosure sale of the limited partnership interest, Nigri v. Lotz, 453 S.E.2d 780 (Ga. App. Ct. 1995). Conversely, in In re Smith, 17 B.R. 541 (Bkrtcy MD Ga. 1982) held the RULPA (1976) language was the sole remedy. [xxi] Haw. Rev. Stat. 425E-703 [xxii] [xxiii] [xxiv] [xxv] [xxvi] [xxvii] [xxviii] [xxix] [xxx] [xxxi] Haw. Rev. Stat. 425E-703 Idaho Code , which adopted the ULPA (2001) Idaho Code , which adopted the ULPA (2001) 805 Ill. Comp. Stat. 215/703 which adopted the ULPA (2001) 805 Ill. Comp. Stat. 215/703 which adopted the ULPA (2001) Ind. Code Iowa Code , which adopted the ULPA (2001) Iowa Code , which adopted the ULPA (2001) Kan. Stat. 56-1a403 Ky. Rev. Stat ( ), which adopted the ULPA (2001). KY SB 210 adds sub-section 7 stating that the partnership is not a necessary party to issue a charging order. Nelson 131

134 SECTION I - EXHIBIT 18 [xxxii] [xxxiii] [xxxiv] [xxxv] [xxxvi] [xxxvii] [xxxviii] [xxxix] [xl] 31 Me. Rev. Stat. 1383, which adopted the ULPA (2001) 31 M.R.S.A. 1383, which adopted the ULPA (2001) Md. Code Lauer Construction, Inc. v. Claude Schrift, 716 A.2d 1096 (Md.App. 1998); Gibson s Lodging v. Lauer, 721 A.2d 989 (Md. 1989) Mass. Gen. Laws ch Mich. Comp. Laws Minn. Stat. Ann. 322A.0703 adopting ULPA(2001) and reversing prior case law regarding sole remedy under Chrysler Credit Corp. v. Peterson, 342 N.W. 2d 170 (Minn. Ct. 1984). Minn. Stat. Ann. 322A.0703 adopting ULPA(2001) and reversing prior case law regarding sole remedy under Chrysler Credit Corp. v. Peterson, 342 N.W. 2d 170 (Minn. Ct. 1984). Miss. Code Mo. Rev. Stat Deutsch v. Wolf, 7 S.W. 3d 460 (Mo. App. 1999). It is uncertain whether Missouri allows for the judicial foreclosure sale of a limited partnership interest. While the Deutsch Court states that the debtor/partner held general and limited partnership interests, this statement is incorrect. The authors discussed the issue with Brad Stevens who was a member of Spencer and Fane, the Plaintiff s attorney. Brad confirmed that Wolf held only a general partnership interest and the court ordered a foreclosure of only his general partnership interest. Therefore, it is uncertain whether Deutsch provides authority for the judicial foreclosure sale of a limited partnership interest in Missouri. For a more detailed discussion of this issue between Steven Gorin and Mark Merric, please see Part II of this series. [xli] Mont. Code Ann [xlii] [xliii] [xliv] Neb. Rev. Stat Nev. Rev. Stat adopted the ULPA (2001) and, for all limited partnerships formed after October 1, 2007 that do not elect out of the statute, N.R.S provides for the judicial foreclosure sale of the limited partnership interest. Therefore, limited partnerships formed before October 1, 2007, and those that elect out of ULPA (2001) are subject to the previous statute that provides for sole remedy asset protection. By electing out of the ULPA (2001), one may retain the sole remedy benefits of Nev. Rev. Stat [xlv] Nev. Rev. Stat adopted the ULPA (2001). [xlvi] [xlvii] [xlviii] [xlix] [l] [li] [lii] [liii] Baybank v. Catamount Construction, Inc., 693 A.2d 1163 (N.H. 1997) stating that a court may look to the UPA for remedies not mentioned in the ULPA (1976), including the judicial foreclosure sale of the limited partnership interest. However, a court may not order the dissolution of a limited partnership by virtue of a charging order. N.J. Stat. 42:2A-48 N.M. Stat. 54-2A-703. Codified prior law regarding the judicial foreclosure sale of a limited partnership interest. In re Priestley, 93 B.R. 253 (D.N.M. 1988). N.M. Stat. 54-2A-703. Codified prior law regarding the judicial foreclosure sale of a limited partnership interest. In re Priestley, 93 B.R. 253 (D.N.M. 1988). N.Y. Partnership Chapter 39, Article 8, Section 111(3) specifically states that a charging order is not the exclusive remedy. When Georgia interpreted this type of provision, it allowed for the judicial foreclosure sale of the limited partnership interest. N.C. Gen. Stat N.D.Cent. Code Ohio Rev. Code originally adopted the ULPA (2001) allowing judicial foreclosure sale. However, it was subsequently amended, and the specific reference to judicial foreclosure sale was omitted. Now the statute is silent. Previously, under the RULPA (1976) language which is also silent a district court allowed for the judicial foreclosure sale. Larson v. Larson, 2000 WL (Ohio App. 11. Dist.) unreported. [liv] Oklahoma s sole remedy statute Okla. Stat. tit. 54, 342, was reversed in 2010 when SB 1132 cleared the legislature adopting the ULPA Sent for governor s signature May 29, [lv] Id. [lvi] Or. Rev. Stat Nelson 132

135 SECTION I - EXHIBIT 18 [lvii] [lviii] Pa. Stat. Title RI Gen. Laws [lix] SC Code Ann [lx] S.D. Codified Laws [lxi] Tenn. Code [lxii] [lxiii] [lxiv] Texas Rev. Stat Utah Code 48-2a-703 Vt. Stat. Title [lxv] Va. Code :1, also prior to statutory law, In re Pischke, 11 B.R. 913 (Bankr. E.D. Va. 1981) held that a charging order was the sole remedy. [lxvi] Wash. Rev. Code (In April 2009, the Washington legislature passed HB 1067 adopting the ULPA 2001, which is effective July 1, At this point, a new code section has not been assigned. [lxvii] Id. [lxviii] [lxix] W. Va. Code 31B. Wis. Stat [lxx] Wyo. Stat Copyright 2010 Leimberg Information Services Inc. Nelson 133

136 SECTION I - EXHIBIT 19 Robertson v. Deeb Inherited IRAs Not Asset Protected Under Interpretation of Fla. Law Date: From: Subject: 20-Apr-10 Steve Leimberg's Employee Benefits and Retirement Planning Robertson v. Deeb - A Beneficiary by Any Other Name Is Still a Beneficiary Steve Leimberg's Employee Benefits and Retirement Planning Newsletter - Archive Message #524 The statutory treatment of exemptions for all forms of IRAs is a very hot topic in the current economic environment and no doubt will continue to be a hot topic for years ahead, as it is estimated that over $14 trillion dollars are either currently held in IRAs or are held in qualified plans that will eventually roll over into IRAs. Creditors are becoming more aggressive and more creative in their attempts to attack these types of accounts. Simple steps can be taken in order to protect IRA funds in light of the errant decision in Robertson. If the IRA owner is concerned about the vulnerability of the IRA to creditors when the IRA reaches the hands of the beneficiary, then, instead of naming the beneficiary directly, the IRA owner may wish to create a spendthrift trust specifically for that beneficiary. Finally, while the purchase of an annuity may have disadvantages in certain circumstances, if an IRA owner has reason to believe that the beneficiary could have creditor issues or is at risk for bankruptcy under current Florida law, apart from the Robertson case, an annuity would seem to provide the protection sought. The extent to which inherited IRAs are exempt in bankruptcy has been at issue in two recent Bankruptcy Court decisions. As Bob Keebler and Jennifer Voigt reported in LISI Employee Benefits & Retirement Planning Newsletter #518, the United States Bankruptcy Court for the District of Minnesota held in the case of In re Nessa that funds in an inherited IRA account are exempt from the debtor's bankruptcy estate. Subsequent to that decision, Bob Keebler and Michelle Ward provided members with their analysis of In re Chilton (See LISI Employee Benefits & Retirement Planning Newsletter #520), a decision in which the United States Bankruptcy Court for the Eastern District of Texas found that an inherited IRA is not equivalent to an IRA for purposes of determining whether the account contains "retirement funds" that may be exempted from the bankruptcy estate under U.S.C. 522(d)(12). Now, Kristen M. Lynch and Linda Suzzanne Griffin provide members with their analysis of another inherited IRA decision, Robertson v. Deeb, a case of first impression in Florida that arose out of that state's Second District Court of Appeals. Kristen M. Lynch is an AV-rated attorney and a trusts and estates partner in the Ft. Lauderdale office of Ruden McClosky. She has over 20 years of experience specific to IRAs regarding estate planning, post-mortem issues, asset protection issues, institutional compliance, and self-directed investments, both as an attorney and as a trust officer. She is a member of the executive council for The Florida Bar Real Property and Probate Trust Law Section, Chair of the IRA and Employee Benefits Committee and a member of the Estate ant Trust Tax Planning Committee, and the Asset Protection Committee. Nelson 134

137 SECTION I - EXHIBIT 19 Linda Suzzanne Griffin is an AV-rated attorney who practices in the areas of estate planning, trusts, wills, probate and taxation in Clearwater and has her own firm, Linda Suzzanne Griffin, P.A. She is board certified in taxation and wills, trusts, and estates. She is also a fellow of the American College of Estates and Trust. She is a member of the executive council for The Florida Bar Real Property and Probate Trust Law Section, vice-chair of the IRA and Employee Benefits Committee, a member of the Estate and Trust Tax Planning Committee, and the Asset Protection Committee. Here is their commentary: EXECUTIVE SUMMARY: When does the term "beneficiary" not mean "beneficiary"? In the recent case of Robertson v. Deeb,[1] the court determined that an interest of a beneficiary of an inherited individual retirement account ("IRA") was not an exempt asset protected from creditors under the terms of Section of the Florida Statutes ("Fla. Stat."), even though the statute has, by its terms, protected the interests of a "beneficiary" in an IRA since the statute was originally enacted in The authors of this commentary respectfully disagree with the decision in this case. As Robertson is a case of first impression in Florida, the authors believe this case addresses an issue of great importance, potentially affecting thousands of non-spouse beneficiaries of IRAs and other types of tax-qualified plans or accounts in the State of Florida. FACTS: Background: The Name of the IRA Game IRAs are a form of a retirement account established in accordance with Section 408 or 408A of the Internal Revenue Code (the "Code"). Although IRAs and other types of qualified or taxdeferred plans are creatures of the Code, state laws may impact these accounts. Examples of state laws that could impact retirement accounts are guardianship and intestacy laws, principal and income act provisions, elective share statutes, trust statutes, real estate statutes, and bankruptcy exemption statutes, such as those relied upon in the Robertson case. Every state has a different statutory scheme, and the decision as to which state's law applies depends on the issue at hand and whether the issue is based upon the domicile of the IRA owner, the IRA beneficiary, or the state law specified in the IRA agreement. Qualified plans and IRAs present an estate and asset protection planning challenge because they cannot (except in the case of divorce) be transferred from the IRA owner to anyone else during lifetime without losing tax-deferred status. The primary goal of most clients is to preserve and maximize the tax-deferred growth opportunities provided by these types of accounts. In fact, many clients choose to leave this type of asset to children or grandchildren for the enhanced taxdeferral opportunities. This appears to be one of the reasons that the Pension Protection Act of 2006 includes provisions for non-spouse beneficiaries of qualified plans to roll those assets into "inherited" IRAs after the death of the plan participant.[2] Under federal bankruptcy law, assets that a beneficiary elects to leave in a qualified plan would be protected from the beneficiary's creditors, whereas the Nelson 135

138 SECTION I - EXHIBIT 19 protected status of those assets transferred into an "inherited" IRA in Florida has now been called into question. The Robertson Case In Robertson, Kevin J. Deeb ("Deeb") sued Richard A. Robertson ("Robertson") on a promissory note. Deeb obtained a judgment of $188,000 against Robertson and served a writ of garnishment against RBC Wealth Management ("RBC"), the custodian of an IRA which Robertson had inherited from his father, Harold Robertson. Under federal law, if an IRA owner dies and has named a beneficiary of the IRA which is either an individual or a trust that meets certain requirements, then the beneficiary of that IRA is allowed, under federal law, to transfer the IRA from the name of the deceased IRA owner into an IRA titled in the decedent's name as owner (deceased) for benefit of the beneficiary. This is commonly referred to as an "inherited IRA". The advantage of creating an inherited IRA is that, if done properly, the Code provides the required minimum distributions from the IRA may be spread out over the life expectancy of the beneficiary, as opposed to a presumably older IRA owner and no premature distribution penalties are assessed against the beneficiary, regardless of his or her age.[3] This is true whether the beneficiary is a spouse or a non-spouse, unless the spouse rolls it into their own name, at which point the spouse becomes the owner. In Robertson, RBC, the custodian of the IRA, informed Robertson that he had two options with respect to the distribution of his father's IRA. The first option would be to transfer his father's IRA into an "inherited IRA", which would require that he take minimum distributions[4] based on his remaining life expectancy, with the ability to withdraw more than the minimum distributions without a penalty. The second option would be to keep the IRA in his father's titled account and take distributions over 5 years without penalty.[5] Robertson chose the first option. The funds were transferred from his father's IRA into an inherited IRA, properly titled "Richard Robertson, Beneficiary, Harold Robertson, Decedent RBC Capital Markets, Custodial IRA". The issue before the court was whether Robertson's interest in the inherited IRA, was exempt from garnishment. The lower court held that it was not exempt because the "account became Robertson's property and no longer qualified for the same exemptions from taxation."[6] Further, the lower court determined that Robertson's inherited IRA was "not like an IRA in terms of taxing and penalty tax for early withdrawal and things of that nature so I don't think that's what (the legislature) meant".[7] Robertson argued - correctly, in the authors' opinion - that under Fla. Stat (2)(a) he was a "beneficiary" of a "fund or account" and therefore his beneficial interest in the inherited IRA was exempt. However, the appellate court agreed with the lower court and determined that the inherited IRA was not exempt. The appellate court determined that the statute did not "exempt the money or assets at issue"[8] unless such amounts were maintained in the original "fund or account". The court determined that the inherited IRA was a different fund or account which was "created when the original fund or account passes to a beneficiary upon the death of the participant."[9] Nelson 136

139 SECTION I - EXHIBIT 19 The court also conditioned the exemption as "identified by its tax exempt status."[10] Therefore, once the IRA was distributed upon the death of the original owner, the inherited IRA's taxexempt status changed. The court stated that, while inherited IRAs are exempt from taxes until distributions are made to the beneficiary, beneficiaries of inherited IRAs are required to take distributions. The court did not note that, generally, the original owner is also required to take minimum distributions upon reaching age 70 ½. Furthermore, a spouse who inherits an IRA is ultimately required to take distributions either by stepping into the shoes of the owner by rolling it over, or by taking distributions as a beneficiary. Additionally, the court seemed to make a distinction between leaving the IRA in the name of the decedent and withdrawing the funds over five years, and transferring the original IRA into an "inherited IRA". There is no basis for such a distinction under state law, in the Code, or under federal bankruptcy law. The court then analyzed cases from other states, and relied on an Oklahoma bankruptcy case[11] which denied an exemption for a beneficiary of an inherited IRA based on an Oklahoma statute. The Oklahoma law exempts assets "only to the extent that contributions by or on behalf of a participant were not subject to federal income taxation to such participant at the time of such contribution."[12] The language in the Oklahoma statute is not in the Florida statute. The court then noted that in the Oklahoma case "(t)he purpose of the Legislature in exempting individual retirement accounts is to allow debtors to preserve assets which have been earmarked for retirement in the ordinary course of the debtor's affairs. Such a purpose would not be served by upholding the (beneficiary's) request to keep his interest in the IRA as exempt."[13] COMMENT: A recent decision from Minnesota illuminates the issue in Robertson quite well. In re: Nessa (105 AFTR 2010-XXXX, 01/11/2010) is a Minnesota bankruptcy case with a fact pattern similar to Robertson, except that the debtor in this case claimed an exemption for the IRA inherited from her father under the federal statute, 11 U.S.C. 522(d)(12). The trustee objected to the exemption, arguing that inherited IRAs do not qualify under the statute. The Court disagreed and overruled the objection. The Court in Nessa cited language contained in IRS Publication 590, Individual Retirement Arrangements, which states in part: "If you inherit a traditional IRA from anyone other than your deceased spouse, you cannot treat the inherited IRA as your own. This means that you cannot make any contributions to the IRA. It also means you cannot roll over any amounts into or out of the inherited IRA." The IRA beneficiary in Nessa had properly transferred the funds into an inherited IRA, much as Richard Robertson did in the case at hand. The Court in Nessa then stated that the tax-deferred character of the IRA did not change because the IRA was transferred into an inherited IRA. Further the trustee did not claim that the IRA was not in compliance or that the funds in the inherited IRA were not exempt from taxation until they were distributed. Nelson 137

140 SECTION I - EXHIBIT 19 The History of the Statute Fla. Stat was enacted in 1987,[14] with amendments in 1998,[15] 1999,[16] 2005[17] and 2007[18] that do not affect the provisions of the statute discussed in the Robertson case. The applicable portions of the statute currently provide as follows: "(2)(a) Except as provided in paragraph (d), any money or other assets payable to an owner, a participant, or a beneficiary from, or any interest of any owner, participant, or beneficiary in, a fund or account is exempt from all claims of creditors of the owner, beneficiary, or participant if the fund or account is:" (emphasis added)... [Provisions in the statute, providing that the creditor protection inures to the benefit of the persons described above as long as the fund or account is tax-qualified, are omitted.] (c) Any money or other assets that are exempt from claims of creditors under paragraph (a) do not cease to qualify for exemption by reason of a direct transfer or eligible rollover that is excluded from gross income under s. 402(c) of the Internal Revenue Code of The original statute was intended to insure that the creditor protection of a qualified plan created under the Code which contains a spendthrift clause to implement the anti-alienation rules of Section 401(a)(13) of the Code also applied to single owner/participant plans.[19] There was a concern that Bankruptcy Courts were permitting creditors to attach single owner/participant plans on the theory that the plan which was required to have a spendthrift provision was a self-settled trust which, then and now, does not defeat claims of the settlor's creditors. This statute was enacted to make clear that all plans would be exempt even if there was a single owner/participant. Further, one of the original drafters, who testified before the Florida House and Senate, has confirmed to the authors that the intent of the word "beneficiary" under the statute was to mean any beneficiary, including, not only the beneficiary of the original IRA, but also a beneficiary of an inherited IRA. In addition, a Florida Bar Journal article co-authored by the same drafter soon after the statute was enacted indicates that the legislation "should protect from creditors(sic) interests in all types of tax qualified retirement plans (including.. individual retirement accounts)"[20] emphasis added. This legislation used the word "beneficiary" with no qualifiers. The drafters and the legislature could certainly have denied or limited protection afforded to beneficiaries. Neither did so. In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA") became effective, and the Florida statute was amended to mirror the changes in BAPCPA. Paragraph 2(c) was added to Fla. Stat (2), stating, in part, "Any money or other assets that are exempt from claims of creditors under paragraph (a) do not cease to qualify for exemption by reason of a direct transfer or eligible rollover that is excluded from gross income." This language was added to clarify those tax-qualified funds could be rolled over or transferred between accounts without losing the protection intended to be afforded by the statute. The provisions of EGTRRA[21] were intended to create more flexibility in tax-qualified accounts, allowing IRA owners to roll IRA funds into qualified plans, qualified plan funds into other qualified plans, and attempting to make tax-qualified funds more manageable. No change was made to the language regarding beneficiaries, owners or participants. In fact, the Florida Session Law analysis states that the change "is made because technically the owner of an Nelson 138

141 SECTION I - EXHIBIT 19 IRA is neither a beneficiary nor a participant in the account."[22] It is therefore clear that the term, "beneficiary", is not the same as the term, "owner", of an IRA. The Clear Meaning of the Statute The well-reasoned brief by Robertson's attorney, James Byrne, Esquire, points out that Robertson was listed by RBC as a beneficiary of the account. [23] Survivor beneficiaries should be provided the same protection under the statute as that afforded to the actual contributors because no distinction has been made between the two in the statute. The language as to whose interests are protected is clear and unambiguous. When the language of a statute is clear and unambiguous and conveys clear meaning, the statute must be given its plain and ordinary meaning.[24] In such instances, courts will not go behind the plain and ordinary meaning of the words used in the statute unless an unreasonable or ridiculous conclusion would result from a failure to do so.[25] In LeCroy v. McCallum, 612 So. 2d 572 (Fla. 1992), the Supreme Court considered whether a structured settlement in a wrongful death claim constituted an annuity under Fla. Stat , and therefore exempt from creditor claims. The Legislature has not defined the term, "annuity contracts" in Chapter 222. Thus, the court looked to other chapters of the Florida Statutes for guidance as to the meaning of the word. Similarly the term "beneficiary" is not defined in Chapter 222, but Fla. Stat provides that the term "beneficiary" includes a person who has a present or future beneficial interest in a trust, vested or contingent and Fla. Stat defines a "beneficiary" as the beneficiary of a future interest and includes a class member if the future interest is in the form of a class gift. Robertson's status with regard to the IRA in question is fairly described by any one of the foregoing definitions, and there is no differentiation in Fla. Stat (2)(a) between survivor beneficiaries and owner beneficiaries. Moreover, Florida has a longstanding policy that favors liberal construction of exemption statutes so as to prevent debtors from becoming public charges.[26] Some may argue even though the language may be clear, it is not the intent of the Legislature to protect the beneficiaries of an account because the beneficiary did not "earn" or contribute to the account. The Legislature has not enacted any such policy. When a beneficiary receives proceeds from annuities, those proceeds are exempt from the beneficiary's creditors. To find that an inherited IRA beneficiary would not be protected would encourage IRA holders to purchase so-called "individual retirement annuities" within an IRA to qualify under the exemption statute for annuities. It is the authors' opinion that the Legislature would not want to unduly encourage IRA holders to purchase retirement annuities. Qualified or retirement annuity sales are an area rife with abuse and are currently the subject of several national class action suits. Further Reading of the Statute Confirms Exempt Treatment Fla. Stat (2)(c) specifically states that assets that are exempt from claims of creditors under paragraph (a) do not cease to qualify for exemption "by reason of a direct transfer or eligible rollover that is excluded from gross income under s. 402(c) of the Code. Section 402(c)(11) of the Code specifically addresses distributions to inherited IRAs of non-spouse beneficiaries from qualified plans. The Code states that if "a direct trustee-to-trustee transfer is made to an individual retirement plan" from a qualified trust under 401(a) of the Code "for the Nelson 139

142 SECTION I - EXHIBIT 19 purposes of receiving the distribution on behalf of an individual who is a designated beneficiary" "the transfer shall be treated as an eligible rollover distribution."[27] The Robertson court provided that an IRA which is owned by the original owner is exempt from creditor's claims under Fla. Stat (2)(a). The court reasoned that "the plain language of that section references only the original "fund or account"[28] Section 402(c)(11) of the Code provides that the transfer to an inherited IRA is an eligible rollover. Fla. Stat (2)(c) provides that the exemption does not cease as to eligible rollovers or transfers (which are nontaxable events). Therefore, the statute clearly provides that Robertson's interest in the inherited IRA was exempt from creditor claims. The term "IRA owner" is a term of art used in the Code. Under Section 408 of the Code, the inherited IRA continues the tax-exempt status afforded to the original IRA owner. When the beneficiary establishes the inherited IRA, the beneficiary becomes the beneficial or equitable owner of that inherited IRA. Fla. Stat (2)(a) confers an exemption on "owners" if the plan is maintained in accordance with a plan or governing instrument that has been determined by the Internal Revenue Service to be exempt from taxation under the relevant provisions of the Code. Nothing in the statute states that the word "owner" must be the original IRA owner. Thus, it can be argued that the inherited IRA, which is owned in equity by the beneficiary, is exempt from claims of creditors under the protection the statute affords to "owners." Planning with a Modicum of Caution Simple steps can be taken in order to protect IRA funds in light of this errant decision. If the IRA owner is concerned about the vulnerability of the IRA to creditors when the IRA reaches the hands of the beneficiary, then, instead of naming the beneficiary directly, the IRA owner may wish to create a spendthrift trust specifically for that beneficiary. Finally, while the purchase of an annuity may have disadvantages in certain circumstances, if an IRA owner has reason to believe that the beneficiary could have creditor issues or is at risk for bankruptcy under current Florida law, apart from the Robertson case, an annuity would seem to provide the protection sought. Conclusion The statutory treatment of exemptions for all forms of IRAs is a very hot topic in the current economic environment and no doubt will continue to be a hot topic for years ahead, as it is estimated that over $14 trillion dollars are either currently held in IRAs or are held in qualified plans that will eventually roll over into IRAs. Creditors are becoming more aggressive and more creative in their attempts to attack these types of accounts. As such, it is extremely important that the law is clearly interpreted. It is not the intent of the authors to change existing policy, but rather to confirm the intent of the original drafters, as well as the drafters of subsequent amendments to Fla. Stat of the Florida Statutes, that the interests of beneficiaries of IRAs, in whatever form, are protected. While the case of Robertson is the law in the Second District Court of Appeals this will not be the final answer to this timely issue. Post Script Nelson 140

143 SECTION I - EXHIBIT 19 Since this article was written and submitted for publication in The Florida Bar Journal, another decision, In re Chilton, has been published. Even though it was decided after Nessa, the Chilton Court did not cite or even acknowledge the decision in Nessa, and came to an exact opposite opinion with a fact pattern that seems identical to both the Robertson and Nessa cases. Considering that there are 214 separate federal bankruptcy courts in the United States, and so far the two that have heard cases addressing the federal exemption have come to decisions that are completely opposite each other, and mix in the fact that there are 50 states, each with different statutory schemes, it would seem we are headed into a time of great uncertainty as to the protection of these accounts. In each state, the Supreme Court of that state is the ultimate authority as to interpretation of state statutes, while on a federal level the United States Supreme Court is the ultimate decision maker over such conflicts. Absent legislative intervention on some level, it seems inevitable that the fate of these inherited IRAs in a bankruptcy context will be decided in the court of highest authority. Kristen Lynch, CISP, CFTA, AEP Linda Suzzanne Griffin CITE AS: LISI Employee Benefits & Retirement Planning Newsletter #524 (April 20, 2010) at Copyright 2010 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission CITES: Robertson v. Deeb, 16 So.3d. 936 (Fla. 2d D.C.A. 2009) CITATIONS: [1] Robertson v. Deeb, 16 So. 3d 936 (Fla. 2d D.C.A 2009). [2] The Pension Protection Act of 2006, P.L , 8/17/2006. [3] Section 401(a)(9) of the Internal Revenue Code of 1986 as amended (the "Code")and related regulations [4] Id. [5] Robertson, 16 So. 3d at 937 [6] Id. at 938 [7] Id. [8] Id. [9] Id. [10] Id. at 939 [11] In re Sims, 241 B.R. 467 (Bankr. N. D. Okla. 1999) [12] Id. at n. 2 [13] Robertson, 16 So. 3d 936, 937 [14] Fla. Laws Ch , 1 [15] Fla. Laws Ch , 1 [16] Fla. Laws Ch. 99-8, 25 [17] Fla. Laws Ch , 5 [18] Fla. Laws Ch , 1 [19] See E. Jackson Boggs and Steven K Barber, New Florida Statute Protects Retirement Plan Assets for Claims of Creditors, 61 FLA. B.J. 51 (Nov.1987). [20] Id. at 52 [21] Economic Growth and Tax Relief Reconciliation Act of 2001 Nelson 141

144 SECTION I - EXHIBIT 19 [22] Fla. Staff Analysis S.B. 660 (3/22/05) [23] Initial Brief of Appellant; Appeal No. 2 D , pg78 [24] LeCroy v. McCollam, 612 So.2d 572 (Fla. 1993); Streeter v. Sullivan, 509 So.2d 268 (Fla. 1987). [25] Holly v. Auld, 450 So.2d 217 (Fla. 1984). [26] Goldenberg, 791 So.2d at 1081 [27] I.R.C. 402(c)(11)(A)(i).. [28] Robertson, 16 So. 3d at 938 Nelson 142

145 SECTION I - EXHIBIT 20 Nessa-Inherited IRAs Protected Under Bankruptcy Law Steve Leimberg's Employee Benefits and Retirement Planning Newsletter - Archive Message #518 Date: 15-Mar-10 From: Steve Leimberg's Employee Benefits and Retirement Planning Newsletter Subject: In re Nessa - Inherited IRA Held Exempt from Bankruptcy Estate under Federal Exemption This is a significant case in which inherited IRA assets were held to be protected from creditor attachment under bankruptcy. Prior to this ruling, the line of bankruptcy cases addressing the issue of whether an inherited IRA, other than for a surviving spouse, is exempt from the bankruptcy estate have all found that the inherited IRA is not exempt. However, In re Nessa can be distinguished from these prior cases because the prior cases all questioned whether an inherited IRA was protected under a state exemption statute. This appears to be the first case in which protection for an inherited IRA is sought under the federal exemption statute. Now, Bob Keebler and Jennifer Voigt provide LISI members with their analysis of In re Nessa, an important case that should be of interest to advisors in all disciplines. Robert S. Keebler is the co-author "The Big IRA Book" with Carol Gonnella and Cecil Smith. This book is now complete and available for order, and is accompanied by a related 60-page, full color PowerPoint deck that can be used when making client presentations. In essence, the book and accompanying CDs and PowerPoint give practitioners the knowledge and expertise they need to easily advise and guide their clients to the desired results in naming the beneficiaries of their IRAs and Qualified Plans. This book is unlike any other book in the country about beneficiary designations for retirement assets. Ordering information is here or you may call To learn more or preview the entire table of contents and some of the actual pages, please visit our website For information about Robert S. Keebler's CDs, seminars on CD, or speaking engagements, please contact Lisa Chapa at (920) or lisa.chapa@bakertilly.com. To learn more about Roth IRAs, please see our current educational opportunities. Jennifer L.Voigt, CPA, JD is a consultant on the Financial and Estate Planning Team as part of the Strategic Tax Services Group at Baker Tilly Virchow Krause, LLP. She specializes in sophisticated estate planning as well as retirement distribution planning. She also prepares and submits Private Letter Rulings on behalf of clients and researches and prepares tax opinion letters. Jennifer's CPA license to practice is in Wisconsin and she is also a member of the State Bar of Wisconsin and the American Bar Association. Here is their commentary: EXECUTIVE SUMMARY: In the case of In re Nessa, the United States Bankruptcy Court for the District of Minnesota held that funds in an inherited IRA account are exempt from the debtor's bankruptcy estate. The trustee's objection to Chapter 7 debtor's 11 USCS 522(d)(12) exemption of inherited IRA was overruled. Although the IRA funds were subject of a post-death trustee-to-trustee transfer, such transfer didn't Nelson 143

146 SECTION I - EXHIBIT 20 affect their character as retirement funds or qualification as such for exemption. This case presents planners with a number of important questions: Do inherited IRA accounts qualify for exemption from the bankruptcy estate under 11 U.S.C. 522(d)(12), which provides an exemption from the bankruptcy estate for retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986? Further, does an inherited IRA transferred to another trustee remain retirement funds prior to distribution? FACTS: At the filing of her Bankruptcy petition on January 28, 2009, Nancy Nessa was the beneficiary of an IRA owned by her deceased father, Robert Borrett. The funds in the IRA account were qualified contributions under Section 408 of the Internal Revenue Code made by Mr. Borrett, who died August 18, Ms. Nessa claimed the inherited IRA exempt under 11 U.S.C. 522(d)(12). The parties stipulated that at the time the debtor filed bankruptcy, she was in possession of roll over beneficiary account no. xxx9505 (hereinafter "Beneficiary IRA Account") which was funded with money she inherited from her father Robert Borrett. However, the Court found that this was an incorrect characterization. The account was not rolled over. The funds were transferred in November 2008 into a Beneficiary Retirement Account, Wells Fargo Bank IRA C/F Nancy Nessa, As Bene of Robert Borrett. Therefore, the total amount in the account was transferred after Mr. Borrett's death to a different trustee, but the recipient account remained in the name of the decedent and it was not legally owned by the debtor. The trustee objected to the exemption, arguing that inherited IRAs do not qualify for exemption under the statute. RULING Inherited IRAs transferred to another trustee remain retirement funds prior to distribution. Further, they can be claimed exempt under 11 U.S.C. 522(d)(12) by debtor beneficiaries who are their equitable owners. The trustee's objection to the debtor's claim of exemption of the funds in Beneficiary Retirement Account, Wells Fargo Bank IRA C/F Nancy Nessa As Bene of Robert Borrett, under 11 U.S.C. 522(d)(12), is overruled, and the funds are exempt from the debtor's bankruptcy estate. BANKRUPTCY COURT ANALYSIS 11 U.S.C. 522(d)(12) provides an exemption for retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of The bankruptcy trustee argued that an inherited IRA section 408 account does not qualify for Nelson 144

147 SECTION I - EXHIBIT 20 exemption under the statute. However, the Court found that the plain language of the statute compels the contrary conclusion. The Court noted that none of the cases cited by the trustee dealt with 11 U.S.C. 522(d)(12); but, for the most part, interpreted state exemption statutes. The Court reasoned that the transferred amounts did not lose their character as retirement funds. Proper transfer of funds to another trustee upon the death of the original owner of the IRA results in continued exemption from taxation under section 408. The trustee does not claim that the transfer here was not in compliance with section 408 of the Internal Revenue Code, or that the funds in the transferred retirement account are not exempt from taxation under section 408 until distribution. Therefore, the Court overruled the trustee's objections and found that under the plain language of 11 U.S.C. 522(d)(12), the funds qualify for exemption under that provision and have been properly claimed exempt. COMMENT: This is a significant case in which inherited IRA assets are protected from creditor attachment under bankruptcy. Prior to this ruling, the line of bankruptcy cases addressing the issue of whether an inherited IRA, other than for a surviving spouse, is exempt from the bankruptcy estate have all found that the inherited IRA is not exempt.[i] However, In re Nessa can be distinguished from these prior cases because the prior cases all questioned whether an inherited IRA was protected under a state exemption statute. This appears to be the first case in which protection for an inherited IRA is sought under the federal exemption statute, 11 U.S.C. 522(d)(12). The debtor in this case was able to rely on the federal bankruptcy exemptions rather than the less favorable state exemptions because Minnesota bankruptcy law allows debtors to choose to utilize the federal exemption set instead of the state exemptions. However, many states do not allow such a choice but instead require the debtor to use the state exemptions. Unfortunately, when the courts have directly addressed the issue, other than for a surviving spouse, it does not appear that there has been one favorable ruling that an inherited IRA is protected under a state exemption statute. Therefore, while some states may allow the use of the 11 U.S.C. 522(d)(12) federal exemption from the bankruptcy estate; which, as evidenced by this ruling, protects inherited IRA assets from creditor attachment in bankruptcy, the use of additional measures to protect inherited IRA assets is still advocated. A carefully drafted standalone IRA trust, sitused in a state which has statutorily codified the asset protection benefits of the Restatement (Second) of Trusts, may still be the best vehicle for providing inherited IRA assets maximum creditor protection. EDITOR'S NOTE: Subsequent to the issuance of the Nessa decision, the United States Bankruptcy Court for the Eastern District of Texas issued a decision that conflicts with the Nessa Court and further solidifies Nelson 145

148 SECTION I - EXHIBIT 20 the importance of utilizing a standalone IRA trust to protect Inherited IRA assets from creditors. In the case of In re Chilton, the Court found that an inherited IRA is not equivalent to an IRA for purposes of determining whether the account contains "retirement funds" that may be exempted from the bankruptcy estate under U.S.C. 522(d)(12). The Court also found that an inherited IRA is not a traditional IRA exempt from taxation under IRC 408(e)(1). LISI will be providing members with a more detailed analysis of Chilton, and will keep members posted as this ongoing saga continues! HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Bob Keebler Jennifer Voigt TECHNICAL EDITORS: DUNCAN OSBORNE & BARRY PICKER CITE AS: LISI Employee Benefits and Retirement Planning Newsletter #518 (March 15, 2010) at Copyright 2010 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. CITES: In re Nessa, (2010, Bktcy Ct MN) 105 AFTR 2d , 01/11/2010; In re Chilton, 105 AFTR 2d XXX, 03/05/2010. P.S. Barry C. Picker, of Picker & Auerbach, CPAs, P.C. is the author of the terrific "Barry Picker's Guide to Retirement Distribution Planning." Bob Keebler and Barry Picker have just released a new book entitled, 100+ Roth Examples and FlowCharts. It contains Roth IRA Contribution Limitations, Recharacterizations, Taxability of Distributions, 10% Early Withdrawal Penalty, Asset Protection Issues, and Post-Mortem Roth Distributions. Bob and Barry's book can be ordered through an order form on Barry's website, or via phone at CITATIONS: [i] See In re Navarre, 332 B.R. 24 (M.D. Ala. 2004); In re Greenfield, 289 B.R. 146 (S.D. Calif. 2003); In re Taylor, 2006 WL (Bkrtcy C.D. Ill. 2006) unreported; In re Sims, 241 B.R. 467 (N.D. Okla. 1999); In re Jarboe, 2007 WL (Bkrtcy S.D. Tex. 2007) and In re Kirchen, 344 B.R. 908 (E.D. Wisc. 2006). Nelson 146

149 SECTION I - EXHIBIT 21 Chilton Inherited IRAs Not Protected Under Bankruptcy Law Steve Leimberg's Employee Benefits and Retirement Planning Newsletter - Archive Message #520 Date: From: Subject: 29-Mar-10 Steve Leimberg's Employee Benefits and Retirement Planning Newsletter Chilton Inherited IRA Not Protected Under Bankruptcy Code Chilton highlights the dangers in relying on the bankruptcy code to provide protection for inherited retirement accounts. As we've stated in the past, to obtain solid asset protection, it is recommended that retirement plans be payable to trusts that are drafted to qualify as designated beneficiary under IRC 401(a)(9) and that contain spendthrift language.. As Bob Keebler and Jennifer Voigt reported in LISI Employee Benefits & Retirement Planning Newsletter #518, the United States Bankruptcy Court for the District of Minnesota held in the case of In re Nessa that funds in an inherited IRA account are exempt from the debtor's bankruptcy estate. Subsequent to that decision, the United States Bankruptcy Court for the Eastern District of Texas found in the case of In re Chilton that an inherited IRA is not equivalent to an IRA for purposes of determining whether the account contains "retirement funds" that may be exempted from the bankruptcy estate under U.S.C. 522(d)(12). The Court also found that an inherited IRA is not a traditional IRA exempt from taxation under IRC 408(e)(1). Now, Bob Keebler returns with Michelle Ward, to provide members with their analysis of Chilton, which includes their thoughts on which court got it right. Robert S. Keebler, Cecil Smith and Carol Gonnella have been working to complete the BIG IRA BOOK and related 60-page, full color PowerPoint that can be used when making client presentations. We are happy to announce that the package is now complete and has just rolled off the press. In essence, the book and accompanying CDs and PowerPoint give practitioners the knowledge and expertise they need to easily advise and guide their clients to the desired results in naming the beneficiaries of their IRAs and Qualified Plans. This book is unlike any other book in the country about beneficiary designations for retirement assets. Ordering information is here or you may call To learn more or preview the entire table of contents and some of the actual pages, please visit the website For information about Robert S. Keebler's CDs, seminars on CD, or speaking engagements, please contact Lisa Chapa at (920) or lisa.chapa@bakertilly.com. Join Robert S. Keebler and estate planning attorney, Philip J. Kavesh, in their special 3-part teleconference series called "The Ultimate Roth IRA Training". If you're a CPA, estate planning attorney or financial planning professional, this is a very timely topic that you don't want to miss! Go to for more information. Michelle L. Ward is a Manager who joined the Virchow, Krause & Company, LLP, Financial and Estate Planning Group in Her emphasis is in estate planning with primary focus on retirement distribution planning. Michelle has authored articles for Tax Management Inc.'s Tax Management Compensation Planning Journal, CCH's Taxes Magazine, and BNA Tax Nelson 147

150 SECTION I - EXHIBIT 21 Management's online Insights & Commentary. Here is their important and timely commentary: EXECUTIVE SUMMARY: In direct contrast to the recently released Nessa decision, the United States Bankruptcy Court for the Eastern District of Texas held that a debtor's inherited IRA is not exempt from her bankruptcy estate. FACTS: Prior to the debtors' bankruptcy, Janice Chilton's (one of the debtors) mother established an IRA and named Janice as the beneficiary on the IRA. In 2007 Janice's mother died. In early 2008, Janice established an inherited IRA from her mother's IRA. The account was titled as "Janice Chilton, Beneficiary, Shirley Heil, Decedent." None of the funds or assets in the inherited IRA was the result of contributions made by the debtors. The debtors filed for relief under Chapter 7 (later converted to Chapter 13) of the Bankruptcy Code in late In their bankruptcy schedules, the debtors disclosed a community property interest in the inherited IRA. The total value of the debtors' interest in the inherited IRA was $170,000. The debtors claimed this property as exempt from their creditors pursuant to 11 U.S.C. 522(d)(12). The bankruptcy trustee objected to the debtors' claimed exemption of the inherited IRA. Court Analysis 11 U.S.C. 522(d) establishes a minimum set of federal exemptions from a bankruptcy estate. Although subsection (b)(2) empowers the states to "opt out" of the federal exemption scheme by prohibiting their citizens from selecting the exemptions set out in subsection (d), Texas permits a debtor in bankruptcy proceedings to choose between the federal and state exemptions. The debtors in this case elected the federal exemption scheme, and claimed that the inherited IRA was exempt under 11 U.S.C. 522(d)(12). Section 522(d)(12) allows the exemption of "[r]etirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457 or 501(a) of the Internal Revenue Code of 1986." In order to determine whether funds are exempt under 522(d)(12), the Court must engage in a two-part test. First, the Court must determine whether the funds are "retirement funds." Second, if the funds are retirement funds, the Court must determine whether the funds are exempt from taxation under the applicable provisions of the Internal Revenue Code. As an initial matter, the Court recognized that an inherited IRA is fundamentally different from an IRA. The Court pointed out that Congress created IRAs with a goal to create a system whereby employees not covered by qualified retirement plans would have the opportunity to set aside at least some retirement savings on a tax-sheltered basis. In keeping with this retirement saving goal, the IRA rules require that distributions be taken from account upon the individual reaching age 70 ½. The Court began with an analysis of the meaning of "retirement funds" under 522(d)(12), a term Nelson 148

151 SECTION I - EXHIBIT 21 which is not defined in the Bankruptcy Code. The debtors argued that the plain meaning of "retirement funds logically means those funds legally authorized to be in a tax exempt account." The Court rejected this interpretation for several reasons. First, the Court stated that the debtors' argument violated a fundamental tenet of statutory construction that all the words of a statute should be given meaning by reading the word "retirement" out of "retirement funds." Moreover, the Court felt that the debtors' argument collapsed the question of whether an inherited IRA is a tax exempt account with whether an inherited IRA contains retirement funds. The Court looked to the whole statutory text and all the words of 522(d)(12) in determining the plain meaning of "retirement funds." The Court pointed out that Congress repeatedly uses the word "retirement" in 522 to qualify the types of funds and accounts that may be exempted from the estate. Referencing Merriam Webster's Collegiate Dictionary, the Court stated that the term "retirement" is generally understood as "withdrawal from one's position or occupation or from active working life." Viewing the words "retirement funds" in their entire context, the Court felt that it could not reasonably be understood to authorize an exemption of an inherited IRA. The Court concluded that "the funds contained in an inherited IRA are not funds intended for retirement purposes but, instead, are distributed to the beneficiary of the account without regard to age or retirement status." The Court found that their interpretation agreed with the legislative history of 522(d)(12). Prior to the enactment of 522(d)(12), a debtor's right to payment from an IRA could be exempted from the bankruptcy estate under 522(d)(10)(E) under certain circumstances. Section 522(d)(10)(E) provides an exemption of a debtor's right to receive payment "under a stock bonus, pension, profitsharing, annuity, or similar plan," but only to the extent the funds are reasonably necessary for the support of the debtor or the debtor's dependents. In Patterson v. Shumate, 504 U.S. 753 (1992), the Supreme Court suggested but did not hold that a debtor's right to receive payments from an IRA could be exempted from the bankruptcy estate under 522(d)(10)(E). In Rousey v. Jacoway, 544 U.S. 320 [95 AFTR 2d ] (2005), the Supreme Court followed its suggestion in Patterson, holding that IRAs can be exempted from the bankruptcy estate pursuant to 522(d)(10)(E). Subsequent to the Rousey decision, Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which expanded the 522(d)(10)(E) exemption by enacting subsection (d)(12), which allows a debtor to exempt an interest in an IRA (or other qualified plan) without a showing of age or necessity. Instead, as provided in 522(b)(4)(A), the fact that the "retirement funds are in a retirement fund that has received a favorable determination under section 7805 of the Internal Revenue Code" creates a presumption that the "retirement funds" are exempt. Alternatively, if the "retirement funds are in a retirement fund that has not received a favorable determination under section 7805," the debtor may exempt the "retirement funds" from the estate if, among other things, the "retirement fund is in substantial compliance with the requirements of the Internal Revenue Code of 1986." 11 U.S.C. 522(b)(4)(B). In enacting these changes to 522, the Court stated that Congress clearly expressed an interest in protecting a debtor's retirement assets even in the event of bankruptcy. The Court pointed out, however, that Congress repeatedly qualified the exemption of funds under 522(d)(12) by limiting that exemption to "retirement funds" in a "retirement fund" exempt from taxation under various Nelson 149

152 SECTION I - EXHIBIT 21 sections of the Internal Revenue Code that relate to different types of retirement and pension plans. Because the Court did not find any published cases that address the exemption of an inherited IRA under 522(d)(12), it looked to how other courts have interpreted state exemption statutes. In such cases, the bankruptcy courts have recognized the fundamental differences between an IRA owned by the debtor and an inherited IRA. For example, in In re Sims, the beneficiary of an inherited IRA claimed his interest in the inherited IRA as exempt under Oklahoma law. The applicable Oklahoma statute exempted "any interest in a retirement plan or arrangement qualified for tax exemption purposes under present or future Acts of Congress... only to the extent that contributions by or on behalf of a participant were not subject to federal income taxation to such participant at the time of such contributions." The bankruptcy court concluded that the beneficiary's interest in the inherited IRA did not qualify for exemption under that statute. The court explained that, unlike original IRAs, inherited IRAs are not vehicles to defer taxation on income in order to preserve money for retirement. Instead, inherited IRAs are liquid assets that the beneficiary may access at any time without penalty and that the beneficiary must take as income without regard to retirement needs. While Congress did not expressly adopt the analysis of these courts in its amendments to 522, the Court found that the language of 522(b)(12) follows other courts' distinction between IRAs and inherited IRAs. Despite having determined that it would not treat an inherited IRA as a retirement fund for purposes of the bankruptcy exemption, the Court analyzed whether the inherited IRA would meet the second prong of the 522(d)(12) test that the "retirement funds" must be "exempt from taxation under IRC 401, 403, 408, 408A, 414, 457, or 501(a). The bankruptcy trustee argued that an inherited IRA is not exempt from taxation under these provisions. In response, the debtors argued that the inherited IRA is an eligible rollover under IRC 402(c)(11) and, therefore, is exempt from taxation under 408(e)(1). The Court stated that the debtors were intermingling two separate concepts the tax treatment of accounts and the tax treatment of distributions in arguing that an inherited IRA is exempt from taxation under 408(e)(1). IRC 408(d) deals specifically with the taxability of distributions from an IRA, including rollovers, while IRC 408(e) governs the disqualification and taxability of the fund itself. Citing In re Kirchin, 344 B.R. 908, 914 (Bankr. E.D. Wisc. 2006), the court stated that an inherited IRA, which is a vehicle for receiving distribution from a tax exempt account, does not fit within the definitional scope of IRC 408(e)(1). IRC 408(e)(1) stated that "any individual retirement account is exempt from taxation under this subtitle unless such account has ceased to be an individual retirement account by reason of [violation of the prohibited transaction rules or because of borrowing on an annuity contract]." The Court pointed out that the nature of an IRA changes when it becomes an inherited IRA specifically that further contributions cannot be made to an inherited IRA and the account cannot qualify for rollover treatment. It appears to us, however, that these changes in allowable transactions do not take an inherited IRA out of the realm of being tax exempt under IRC 408. The author disagrees with the Court that an Nelson 150

153 SECTION I - EXHIBIT 21 inherited IRA is a vehicle for receiving distributions from a tax exempt account. Rather, an inherited IRA is a specific type of IRA, one that remains tax exempt under IRC 408(e)(1). The Court concluded that an inherited IRA is not equivalent to an IRA for purposes of determining whether the account contains "retirement funds" that may be exempted from the estate under 522(d)(12). COMMENT: The Court's analysis in Chilton can be contrasted with that in Nessa. Without much analysis, the Nessa Court found that the plain language of 11 U.S.C. 522(d)(12) called for an exemption of an inherited IRA. The issue that Nessa focused its analysis on was whether a trustee to trustee transfer of an inherited IRA caused the account to lose its character as a retirement fund to which it determined that it did not. In addition, the Nessa decision appears to be a minority decision. When the courts have previously addressed the issue, other than for a surviving spouse, it does not appear that there has been one favorable ruling that an inherited IRA is protected under a state exemption statute. In these prior cases, the courts have listed the following reasons for distinguishing an inherited IRA from an IRA and allowing creditors to reach inherited IRA assets:[i] The state exemption was for retirement benefits to be available to the retired person, not a child who was still earning a living; The beneficiary has an unrestricted right to withdraw the IRA at anytime without any penalty; and The inherited IRA is significantly different than in IRA under the IRC. Chilton highlights the dangers in relying on the bankruptcy code to provide protection for inherited retirement accounts. As we've stated in the past, to obtain solid asset protection, it is recommended that retirement plans be payable to trusts that are drafted to qualify as designated beneficiary under IRC 401(a)(9) and that contain spendthrift language. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Bob Keebler Michelle Ward TECHNICAL EDITORS: DUNCAN OSBORNE & BARRY PICKER CITE AS: LISI Employee Benefits & Retirement Planning Newsletter #520 (March 29, 2010) at Copyright 2010 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. CITES: Nelson 151

154 SECTION I - EXHIBIT 21 In re Chilton, (Bktcy Ct TX) 105 AFTR 2d 2010-XXXX, 03/5/2010; In re Nessa, (2010, Bktcy Ct MN) 105 AFTR 2d , 01/11/2010; In re Sims, 241 B.R. 467 (Bankr. N.D. Okla. 1999); In re Kirchen, 344 B.R. 908 (E.D. Wisc. 2006). CITATIONS: [i] Derived in part from the article, Are Inherited IRAs Protected Under State Exemption Statutes?, written by Robert S. Keebler, CPA, MST, DEP and Mark Merric. P.S. Barry C. Picker, of Picker & Auerbach, CPAs, P.C. is the author of the terrific "Barry Picker's Guide to Retirement Distribution Planning." Bob Keebler and Barry Picker have just released a new book entitled, 100+ Roth Examples and FlowCharts. It contains Roth IRA Contribution Limitations, Recharacterizations, Taxability of Distributions, 10% Early Withdrawal Penalty, Asset Protection Issues, and Post-Mortem Roth Distributions. Bob and Barry's book can be ordered through an order form on Barry's website, or via phone at Nelson 152

155 SECTION I - EXHIBIT 22 Holman v. Comm. - Dell Stock Owned By Partnership Limited to Discounts of Less Than 25% Steve Leimberg's Estate Planning Newsletter - Archive Message #1628 Date: 13-Apr-10 From: Steve Leimberg's Estate Planning Newsletter Subject: Holman v. Commissioner: 8th Circuit Court of Appeals Affirms Tax Court Holman is a case of great importance involving gift taxes, valuation discounts, FLPs, and Code Section Four of LISI's distinguished commentators provided members with their thoughts on the initial Holman decision: Owen Fiore in Estate Planning Newsletter 1302 Paul Hood in Estate Planning Newsletter # 1304 Steve Akers in Estate Planning Newsletter # 1305 Jeff Pennell in Estate Planning Newsletter # 1306 Now, Jeff Pennell returns to give LISI members the first insight into the decision of the Court of Appeals for the Eighth Circuit which issued its opinion on Holman just last week. Jeffrey N. Pennell is the Richard H. Clark Professor of Law at Emory University School of Law. Jeff is the author of WEALTH TRANSFER PLANNING AND DRAFTING (West 2005), FEDERAL WEALTH TRANSFER TAXATION (West 2004), successor author of ESTATE PLANNING, the incredible and invaluable three volume classic treatise on estate planning originally written by the legendary Harvard Professor A. James Casner. Now, here is Jeff's commentary: EXECUTIVE SUMMARY: On appeal the Court of Appeals for the Eighth Circuit affirmed the Tax Court in every respect, but focused most of its attention on the 2703 issue. Recognizing its own jurisprudence in St. Louis County Bank v. United States, 674 F.2d 1207 (8th Cir. 1982), the court accepted the premise that 2703-style restrictions may properly collar valuation. And it confirmed that "maintenance of family ownership and control of [a] business" may be a bona fide business purpose - but not in a case in which there is no business. FACTS: Parents created an FLP by transferring some of their Dell stock to the partnership. Parents were the general partners (0.89% each) and they owned 98.08% of the FLP as limited partners. (In addition, a trust for children contributed some Dell stock for a very small [0.14%] LP interest.) The parents intended to make gifts of LP interests when they created the partnership. Husband's primary purpose for the partnership was to preserve his Dell wealth and "disincentivize" his children from spending it. Wife's primary purpose was to use the partnership to educate children about family wealth. Potential gift tax savings from valuation discounts "played a role" in the decision to Nelson 153

156 SECTION I - EXHIBIT 22 form the FLP. The partnership agreement contained transfer restrictions commonly found in partnerships. The agreement prohibited limited partners from transferring "all or part" of their interests without the consent of all partners (paragraph 9.1); however, transfers to certain family members were allowed (paragraph 9.2). If a purported prohibited transfer was deemed to be effective, the partnership would have the right to purchase the non-permitted assignment at fair market value, presumably, taking into account appropriate discounts (paragraph 9.3). Six days after the partnership was created the parents made gifts of 70.06% of the LP interests to the children's trust, and partly to a custodianship for one child, to equalize prior gifts to custodianships for their other children. About two months later in the following tax year, the parents made additional annual exclusion gifts of LP interests to the children's trust, which they valued using a 49.25% discount. The following year the parents again contributed Dell stock to the partnership in return for more LP units, and about a month later they made additional annual exclusion gifts of LP units to custodianships for their children (which they again valued using a 49.25% discount). The IRS's arguments in its explanation of adjustments in gift tax audits for 1999, 2000, and 2001 were: The transfer of assets to the FLP is in substance an indirect gift. The opinion said that the IRS explanations were the same for all three years, but at trial the IRS made the "indirect gift of proportionate assets" argument only to the first gifts made. The transfer of LP interests is more analogous to an interest in a trust, and should be valued as such. The IRS dropped this argument at trial. The transferred interests should be valued without regard to "restrictions on the right to sell or use the partnership interest" in the partnership agreement, citing Restrictions on liquidation should be ignored for valuation purposes under 2704(b). The IRS dropped this argument at trial. The amount of the overall discount should be 28%, not 49.25%. The court ultimately allowed even lower discounts (i.e., 22%, 25% and 16.25% in the three different years) than the 28% amount that the IRS allowed in the gift tax audit adjustments. HOLDINGS: a. The gifts made six days after the FLP was formed cannot be viewed as an indirect gift of the shares contributed to the FLP under the gift tax regulations or under the step transaction doctrine. b. Transfer restrictions in the partnership agreement are disregarded for valuation purposes, under 2703(a), and the 2703(b) safe harbor does not apply because the bona fide business arrangement test and the device test were not satisfied. As to the comparability test, the court acknowledged that the experts agreed that the restrictions are common in agreements entered into at arm's length. Because the first two tests in the safe harbor were not met, however, the court said that it did not need to address a novel argument by the IRS that overall circumstances make it unlikely that arm's length third parties would agree to any of the restrictions because third parties would not "get into this deal with the Holmans, period." Nelson 154

157 SECTION I - EXHIBIT 22 Appropriate discounts were considered, and the court ended up significantly closer to the IRS's position, allowing overall discounts of 22.4%, 25% and 16.25% in the three years. COMMENT: MAINTENANCE OF FAMILY OWNERSHIP AND CONTROL OF A BUSINESS CAN BE A BONA FIDE BUSINESS PURPOSE ONLY IF THERE IS A BUSINESS: The opinion states that the court does "not... necessarily... believe that investment-related activities cannot satisfy the [ 2703(b)(1) bona fide business arrangement] test," but that test is not met "[w]hen the restrictions at issue... apply to a partnership that holds only an insignificant fraction of stock in a highly liquid and easily valued company with no stated intention to retain that stock or invest according to any particular strategy." BUY-AND-HOLD STRATEGY REJECTED: The court also rejected the taxpayers' analog to the buy-and-hold investment strategy found to support the legitimate and significant business purpose test under 2036(a) in Estate of Schutt v. Commissioner, 89 T.C.M. (CCH) 1353 (2005), saying that "the maintenance and perpetuation of a specific buy-and-hold investment strategy was, in that case, a legitimate business purpose... based... on an express factual finding that the transferor's primary objective was to preserve his very specific investment strategy." But "the Tax Court appeared to recognize that it was approaching an outside limit as to the meaning of legitimate business purpose,... noted the unique circumstances of [that] case,' [and] noted the general position that the mere holding of an untraded portfolio of marketable securities weighs negatively in the assessment of potential nontax benefits.'" Holman rejects the Schutt buy-and-hold business purpose if taxpayers "do not purport to hold any particular investment philosophy or possess any particular investing insight," or if the family partnership is "a mere asset container." Further, the court said that "the important rule that we believe may be taken from Schutt and cases like it is that context matters.... When viewed in this context, there is little doubt that the restrictions included in the Holmans' limited partnership agreement were not a bona fide business arrangement, but rather, were predominately for purposes of estate planning, tax reduction, wealth transference, protection Nelson 155

158 SECTION I - EXHIBIT 22 against dissipation by the children, and education of the children." Thus put, the taxpayers were not motivated by a bona fide business purpose. Which underscores that the 2036(a) legitimate and significant nontax purpose test is easier for taxpayers to meet than the 2703(b)(1) "bona fide business arrangement" test. Which makes 2703 a more potent government weapon. DISSENT: The dissent made an accurate point, which the majority avoided, by deciding the case under 2703(b)(1) alone. Treas. Reg (b)(1)(ii) changes the "members of the decedent's family" language of 2703(b)(2) to "natural objects of the transferor's bounty," which the dissent attributes to the government's desire to interpret 2703 "to apply to both inter vivos transfers and transfers at death." The majority did not need to address this issue because the taxpayer lost by failing to satisfy the first of the three 2703(b) safe-harbor requirements. This issue is critical, however, because Holman thus allows the government to apply 2703 in gift tax cases, in which 2036(a) is inapplicable. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Jeff Pennell CITE AS: LISI Estate Planning Newsletter #1628 (April 13, 2010) at Copyright 2010 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. CITES: Thomas H. Holman, Jr. et ux. v. Comm'r, No , (8 th Cir. Court of Appeals); Holman v. Commissioner, 130 T.C. No. 12 (2008; Church v. United States, U.S. Tax Cas. (CCH) 60,369 (W.D. Tex. 2000); Senda v. Commissioner, 88 T.C.M. (CCH) 8 (2004), aff'd, 433 F.3d 1044 (8th Cir. 2005); Smith v. United States, U.S. Tax Cas. (CCH) 60,488 (W.D. Pa. 2004) (a Magistrate's recommendation to the District Judge hearing the case), and U.S. Tax Cas. (CCH) 60,490 (W.D. Pa. 2004) (the District Judge's order accepting that recommendation); Treas. Reg (a); Treas. Reg (a)(3). Nelson 156

159 SECTION I - EXHIBIT 23 PLR : IRS Grants Extension of Time to Make QTIP Election for Inter Vivos Transfer Steve Leimberg's Estate Planning Newsletter - Archive Message #1699 Date: 16-Sep-10 From: Steve Leimberg's Estate Planning Newsletter PLR : IRS Grants Extension of Time to Make QTIP Election for Inter Vivos Subject: Transfer We close this week with Bruce Steiner s analysis of a fascinating ruling in which the Service permitted a late QTIP election for a lifetime transfer. As Bruce notes in his commentary, perhaps the extension requested was not for more than six months, perhaps the taxpayer was abroad, or perhaps, the IRS viewed this election as regulatory rather than statutory. All of which raises one question: is this ruling correct? Bruce D. Steiner, of the New York City law firm of Kleinberg, Kaplan, Wolff & Cohen, P.C., and a member of the New York, New Jersey and Florida Bars, is a long-time LISI commentator team member and frequent contributor to Estate Planning, Trusts & Estates and other major tax and estate planning publications. He is on the editorial advisory boards of Trusts & Estates and the CCH Journal of Retirement Planning, and is a popular seminar presenter at continuing education seminars and for Estate Planning Councils throughout the country. Here is Bruce s commentary: EXECUTIVE SUMMARY: The IRS allowed an extension of time to make a QTIP election for a transfer during lifetime after the gift tax return had been filed. FACTS: The taxpayer created a trust for the benefit of her spouse and contributed property to the trust. The spouse was entitled to all of the income of the trust, and the trustees have discretion to distribute principal to the spouse for his health, education, maintenance and support. The taxpayer hired a law firm to prepare her gift tax return. The donor filed a timely gift tax return. A QTIP election was not made on the gift tax return. The spouse subsequently died. The taxpayer then requested an extension of time to make a QTIP election with respect to the property transferred to the trust. The IRS granted the taxpayer an extension of time to make the QTIP election, Nelson 157

160 SECTION I - EXHIBIT 23 saying that the taxpayer acted reasonably and in good faith, and that granting relief would not prejudice the interests of the government. COMMENT: A donor can make a QTIP election with respect to a transfer during lifetime. The statute provides that the QTIP election shall be made on or before the due date for filing a gift tax return. The Internal Revenue Service is authorized to grant a reasonable extension of time for filing any return. Except in the case of taxpayers who are abroad, no such extension shall be for more than six months. The regulations set forth procedures for extensions of time for regulatory elections. The regulations also provide for automatic 6-month extensions of time for statutory elections whose due date is the date of the return, except in the case of elections that must be made by the due date of the return including extensions. In the ruling, the IRS recited that it has discretion to grant a reasonable extension of time to make a regulatory election, or a statutory election, but not more than six months in the case of a taxpayer who is abroad. The IRS said that requests will be granted where the taxpayer provides the evidence to establish that she acted reasonably and in good faith, and that granting relief will not prejudice the interests of the government. The IRS explained that a taxpayer is deemed to have acted reasonably and in good faith if she reasonably relied on a qualified tax professional who failed to make, or advise her to make, the election. But wait a minute! Isn t this a statutory election? How can the IRS grant an extension for more than six months? Perhaps the extension requested was not for more than six months. But in that case, the taxpayer would not have needed a ruling to request the extension. Perhaps the taxpayer was abroad. But in that case, the taxpayer would not have needed a ruling to request the extension. Perhaps the IRS viewed this election as regulatory rather than statutory. Perhaps the ruling is incorrect. That s why a private letter ruling may not be used or cited as precedent. Concluding Observations: Nelson 158

161 SECTION I - EXHIBIT 23 It may be possible to obtain permission to make a late QTIP election for a lifetime transfer. However, we understand that the IRS is reviewing this issue. Stay tuned. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Bruce Steiner CITE AS: LISI Estate Planning Newsletter #1699 (September 16, 2010) at Copyright 2010 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. CITES: Sections 2523(f)(4), 6075(b), 6081(a) and 6110(k)(3); Treas. Reg and , -2 and -3; PLR ; Lischer, 845-2nd T.M., Gifts, A-127. Copyright 2010 Leimberg Information Services Inc. Nelson 159

162 SECTION I - EXHIBIT 24 Price v. Commissioner: Annual Exclusion Gift of FLP Interests Steve Leimberg's Estate Planning Newsletter - Archive Message #1572 Date: 05-Jan-10 From: Steve Leimberg's Estate Planning Newsletter Price v. Commissioner - Transfer of FLP Interest Doesn't Qualify As a Present Interest Subject: Gift Sometimes, the IRC Sec. 2503(b) gift tax annual exclusion is taken for granted. A recent Tax Court decision, Price v. Commissioner, reminds planners of the importance of there being a "present interest," as well as how that term fits in the context of gifts of interests in a family limited partnership. Owen G. Fiore of FioreWealthPlanningConsulting ( in Kooskia, ID, provides his commentary on Price and shows LISI members how this case might impact on planning in the future. Here is his commentary: EXECUTIVE SUMMARY: Having been the successful litigator in the 1991 Cristofani case, extending the 2503(b) exclusion to contingent remaindermen of trusts, I am particularly fond of Section 2503(b). However, the Price decision shows how its availability must be balanced with the appropriate and often restrictive provisions of the FLP or LLC operative agreement. Hackl, and now Price, establish a high standard for FLP gifts under Section 2503(b), and call for careful consideration of partnership or LLC agreement provisions if the annual exclusion is integral to the planning process. FACTS: Walter and Sandra Price, residents of Nebraska, had three children, none of whom was interested in a career with the family's closely-held equipment dealer. This company, Diesel Power Equipment Co. ("DPEC"), eventually grew to distributing and serving 40 lines of equipment with 90 employees. Eventually, a group of long-term employees proposed to buy out the Prices, and then the financial planning began. A "careful financial plan", as stated by the Court, was developed, which involved first establishing an FLP, "Price Investments LP" ("Price LP"), on September 11, The general partner, with a 1% interest in Price LP, was Price Management Corp., with Walter Price as President and he and his wife, through their respective living trusts, owning the stock of this Nebraska corporate entity. Presumably by reason of their contribution of DPEC stock and commercial real estate leased to DPEC and another equipment dealer, Walter and Sandra Price each held a 49.5% limited partnership interest which eventually became the subject of multi-year gifts to the three (3) adult Price children. Thereafter, on January 5, 1998, the Price LP sold all its DPEC stock to the unrelated employee group at the company, investing the proceeds of sale in marketable securities. It is interesting that there was no contention raised by the Service on an "indirect gift" (Sec. 2511) or Nelson 160

163 SECTION I - EXHIBIT 24 "step transaction" theory. Further, as indicated in an opinion footnote, the Service accepted that the gifts were properly valued, i.e. the multi-year gifts of limited partnership interests, even though no doubt substantial valuation discounts were included in the gift computations. So this case focused really on the 2503(b) present interest exclusion availability for several years in question, namely, years 2000, 2001 and No gift tax due was reported for any of these years due to application of gift tax lifetime exemptions by the taxpayers. From 1997 through 2002, the petitioners made separate but equal gifts such that, by the end of the year 2002, the children held ownership of 99% equity in the Price LP, i.e. all of the limited partnership interests. So we must note that, while, as shown below, the 2503(b) issue was determined against the taxpayers, their use of the FLP to shift wealth to children, with the entity being respected and the valuations conceded by IRS, really was a victory! The Tax Court Weighs In It appears surprising that, where in four (4) of six (6) years reviewed for Price LP there were substantial cash distributions to the limited partners (donee children) over $100,000 in the aggregate in two of these years; and yet a "present interest" issue was successfully advanced by the Service. The key here was the Price LP partnership agreement, which did not seem as restrictive as the LLC operating agreement in Hackl, where, in any event, a tree farm was a number of years away from any income on harvesting of trees. Judge Thornton, in Price, reviews a number of provisions of the FLP agreement, including: 1) Investment return on long-term basis with distributions to partners being secondary, 2) General prohibition of any partner withdrawing capital contributions, 3) Broad prohibition against transfer of partnership interests and clear statement of assignee position of a transferee, plus 4) Purchase option in the partnership and its remaining partners. Further, the general partner (the corporation controlled by Walter and Sandra Price) could distributed partnership profits in the discretion of the corporate general partner, including even that there was no obligation to distribute profits to partners even to pay taxes on such profits since Price LP was a passthrough entity. The principal authority relied upon by the Tax Court in the Price case was the Hackl case, as mentioned above, with also reference to the Stinson corporation case. Both these cases were affirmed by the 7th Circuit, and so one wonders about the results in other Circuits. We need to focus, I believe, on the specific language of the Code, and Regulations, as well on the detailed provisions of the operative agreement of the entity, whether an FLP or an LLC is involved. Treas. Regs. Sec (a) points out " a future interest or interests in such contractual obligations may be created by the limitations contained in a trust or other instrument of transfer used in effecting the gift." The term "present interest", under Sec. 2503(b), is defined in the Regulations as "an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property." Further, citing the Fondren case in the U.S. Supreme Court, the Court pointed out that "vested Nelson 161

164 SECTION I - EXHIBIT 24 rights" are not enough for the 2503(b) exclusion. Thus, agreeing with the Hackl case analysis, an outright transfer of an equity interest in a business or property is not necessarily enough. There must be an examination of what present economic enjoyment or benefit that interest carries with it. Thus, the Tax Court in Price refuses to reconsider its Hackl decision, and therefore, determined that the gifts failed to give the donees the immediate use, possession, or enjoyment of either: 1) The transferred property or 2) The income therefrom. One telling statement of the Court was its conclusion that " contingencies stand between the donees and their receipt of economic value for the transferred partnership interests so as to negate finding that the donees have the immediate use, possession or enjoyment of the transferred property." COMMENT: Perhaps the 2503(b) present interest annual exclusion benefit is secondary to the main goal of shifting substantial wealth to younger generations. However, especially with use of trusts so as to take advantage of Crummey/Cristofani powers of withdrawal, a lot of wealth can escape the transfer tax system through exclusion gifting. It would seem that the family goals of entity control and management succession may just trump the 2503(b) exclusion considerations. At least advisors should caution their clients about overly restrictive provisions in operative agreements, i.e. that such provisions may well be viewed as incompatible with the "present interest" requirements of 2503(b). For those, of course, who disagree with Hackl and now Price, tax litigation may be an option, if we cannot provide a means to insure present interest status of the annual exclusion designed gifts. For example, having a mandatory required distribution at some level of entity net income, well-drafted in the operative document, might go far in assuring availability of the annual exclusion. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Owen Fiore CITE AS: LISI Estate Planning Newsletter #1572 (January 5, 2010) at Copyright 2010 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. CITES: Walter M. Price and Sandra K. Price v. Commissioner, T.C. Memo (January 4, 2010); Hackl v. Commissioner, 188 T.C. 279 (2002), affirmed, 335 F. 3d 664 (7th Cir. 2003); Stinson Estate v. U.S., 214 F.3d 846 (7th Cir. 2000); Fondren v. Commissioner, 324 U..S. 18 (1945); see also, Kalinka, "Should the Gift of a Limited Partnership Interest Constitute a Future Interest?" Taxes(CCH), April, Nelson 162

165 SECTION I - EXHIBIT 25 Black v. Commissioner: Graegin Loan not Respected In Combination With FLP Steve Leimberg's Estate Planning Newsletter - Archive Message #1566 Date: From: Subject: 22-Dec-09 Steve Leimberg's Estate Planning Newsletter Black v. Commissioner: Family Limited Partnerships & Graegin Loans "The Tax Court's decision on the Graegin loan issue is curious, and certainly strikes a blow against many of the Graegin loans between related entities. The Tax Court determined that the partnership could have redeemed the estate's partnership interest shortly after the partner's death in order to satisfy the estate tax burden, thereby rendering the loan unnecessary. However, had the estate and partnership done that, the IRS would have certainly argued that the partnership itself was simply a ruse to reduce the estate tax." Smart planners understand that having sufficient liquidity to administer an estate cannot be overstated. Clearly, the lack of liquidity often forces those charged with administering estates into difficult choices. In this regard, LISI has provided members with important commentary on the issue of so-called "Graegin" loans between partnerships and estates in need of liquid funds on a number of occasions. See, e.g., LISI Estate Planning Newsletter # 1532 and Estate Planning Newsletter # As members know, interest payments on these Graegin loans have been held to be deductible administration expenses where the interest was incurred to prevent financial loss from a forced sale of assets to pay estate taxes, on the theory that the loan arrangement was required for the administration of the estate. Now, Paul Hood provides LISI members with his commentary on a recent and significant Tax Court case where the issue of a Graegin loan resulted in a mixed decision for a decedent's estate. Paul Hood is Past Chair of the Tax Section of the Louisiana State Bar Association. Paul is a frequent speaker and his articles have appeared in a number of publications, including BNA Tax Management Memorandum, CCH Journal of Practical Estate Planning, Digest of Federal Tax Articles, Loyola Law Review, Louisiana Bar Journal, Tax Ideas and Charitable Gift Planning News. Here is Paul's commentary: EXECUTIVE SUMMARY: In this federal gift and estate tax case, the Tax Court determined in a reviewed opinion that: 1) The decedent's transfer of corporate stock to a family limited partnership interest was a "bona fide sale for an adequate and full consideration in money or money's worth" within the meaning of IRC Sec. 2036(a); 2) The funding date of the marital bequest was the date of the surviving spouse's death; 3) The loan from FLP to the surviving spouse's estate was not "necessarily incurred" within the meaning of Treas. Reg. Sec (a) and, thus, the interest thereon is not a deductible Nelson 163

166 SECTION I - EXHIBIT 25 administration expense under IRC Sec. 2053(a)(2); and 4) Only part of the attorney's fees, secondary offering expenses and executor's commission is deductible under IRC Sec FACTS: Samuel and Irene, husband and wife, were married in 1932 and remained married until Samuel's death in Irene died shortly thereafter. Samuel was a longtime employee, director and shareholder of a large property and casualty insurance company. Samuel was bullish on the company and acquired its stock at every opportunity. In 1988, he began gifting shares of nonvoting stock to trusts created for his grandchildren. Each trust terminated in stages upon a grandchild's attainment of ages 25, 20 and 35. As the stock of the company continued to increase, Samuel became concerned that the grandchildren would sell the stock when the trusts terminated. Samuel also was worried about his son's loan, where he had pledged stock as collateral, as well as the stability of the son's marriage. Formation of the FLP In an attempt to quell his fears, Samuel's professional advisors recommended the formation of a family limited partnership ("FLP"), which he formed at age 91. At the time that he formed the FLP, he was in very good health and was still very active in the business of the company as well as in a separately owned insurance agency. Samuel retained approximately $4,000,000 in assets outside of the stock put into the partnership. Samuel contributed all of his nonvoting stock and 390 of his 400 voting shares to the FLP in exchange for a 1% general partnership interest and % limited partnership interest. His son contributed stock in the company in exchange for a.5% general partnership interest and a % limited partnership interest. The son, as trustee of his sons' trusts, contributed the stock held in the trusts in exchange for separate.599% limited partnership interests. The partnership agreement recited several reasons for forming the FLP, which included Samuel's concerns about both his son and his grandchildren. Subsequently, Samuel made gifts of general and limited partnership interests to his son. He also made gifts of limited partnership interests to his grandchildren's trusts, to his grandchildren individually and to five charitable trusts that he created. Samuel also was concerned about a potential rift among the two families that held most of the shares, so he was very interested in maintaining his family's shares as a block as it would be a swing vote if a shareholder squabble ensued. Samuel and Irene Die Samuel and Irene died within five months of each other; Samuel died first. Their son, as successor trustee and executor, treated the marital legacy in the revocable trust as having been funded with limited partnership interests as of Irene's death, even though it was never actually funded due to the Nelson 164

167 SECTION I - EXHIBIT 25 deaths having occurred so close in time. Even with the substantial marital deduction taken in Samuel's estate, there was still approximately $1,700,000 in estate tax due in Samuel's estate. Nevertheless, the son knew that there would be substantial tax due in Irene's estate, and the estates lacked the liquidity to pay the $20,000,000 charitable legacy, the estate tax as well as administration expenses and attorneys fees. The Liquidity Shortfall Therefore, the son approached several banks about a loan, but he didn't like the terms and the banks didn't want partnership interests as collateral. The banks would have taken the shares as collateral with a collar, but again the son didn't like that term for fear of a forced sale of the stock at a bad time in the future. The son also approached the company about a loan, but it turned him down. Accordingly, and with the blessing of the company, the son as general partner, undertook a secondary offering of approximately one-third of the partnership's shares. In order to get the company to agree to participate in the secondary offering, the partnership had to pay the underwriting expenses of the secondary offering, which worked out to approximately 98,000,000. The partnership and Irene's estate worked out a loan whereby the partnership would lend her estate approximately $71,000,000 to pay the estate taxes, satisfy the $20,000,000 charitable legacy, repay some expenses to the company in conjunction with the secondary offering, pay the state inheritance tax, pay some state fiduciary income tax, pay the legal fees for administering the estate as well as the executor's fee. The terms of the loan prohibited payment of interest prior to November 30, 2007, being patterned after the loan in Graegin Est. v. Comr. The son deducted the estimated $20,296,274 in loan interest on Irene's federal estate tax return as well as attorney's fees and executor's fees. Here Comes the IRS The IRS audited the estate tax returns and assessed a deficiency in Samuel's estate tax in excess of $129,000,000 and in excess of $82,000,000 in Irene's estate. The IRS argued that the stock should have been included directly in Samuel's estate under IRC Sec The IRS also argued that the marital deduction was properly computed by the value of the stock that actually passed to Irene. Moreover, the IRS asserted that the proper date of funding of the marital legacy was the date of Samuel's death; the son had treated the date of hypothetical funding as the date of Irene's death on the federal estate tax return in Samuel's estate. Additionally, the IRS denied the deductibility of the interest paid as well as the attorney's fees and executor's fees. The parties also disagreed about who bore the burden of proof under IRC Sec However, the parties worked out the valuation issues and stipulated to the values of both the shares as well as the partnership interests. Enter the Tax Court The Tax Court made short shrift of the IRC Sec issue, noting that resolution of these types of Nelson 165

168 SECTION I - EXHIBIT 25 cases didn't depend upon who bore the burden of proof, citing Bongard Est. v. Comr. The Tax Court then took up the IRC Sec issue. It spent the bulk of the 78 page opinion on this issue. However, it determined that there was a substantial non-tax reason for forming the partnership, finding the facts analogous to those in Shutt Est. v. Comr. Moreover, the Tax Court determined that the partnership exchange was a bona fide sale for adequate consideration in money or money's worth, despite that the Tax Court determined that the subject partnership was not an operating company. The Tax Court also determined that its decision was consistent with that of the U.S. Third Circuit in Thompson Est. v. Comr. With respect to the marital legacy funding date issue, the Tax Court again held in favor of the estate, reasoning that the funding date of Irene's death was consistent with common sense and logic. The Tax Court then turned its attention to the Graegin loan interest deductibility issue. The estate argued that the loan was bona fide and was similar to that the Tax Court blessed in Graegin. The IRS countered that the son stood on both sides of the loan transaction and that they simply made an unnecessary loan in order to save on estate taxes. The Tax Court sided with the IRS on this issue, finding the loan to have been unnecessary and that the partnership could have distributed company stock in redemption of the estate's partnership interest in an amount that could have covered the estate tax, the charitable legacy and other expenses and taxes. The Tax Court then took up the deductibility of the reimbursement of secondary offering expenses to the company, legal fees and executor fees issue. The court permitted deductibility of 49% of the secondary offering reimbursement expenses, reasoning that only 49% of the underlying expenses resulted from actual debts of the estate. With respect to the legal fees and executor fees deductibility issues, the Tax Court permitted deductibility of one-half of the executor fees in each estate, and only one-half of the legal fees. COMMENT: This is another John Porter case, although it didn't result in a complete taxpayer victory. The Tax Court's rationale on the IRC Sec issue is detailed, well-reasoned and supported by citations. However, its decision on the Graegin loan issue is curious and certainly strikes a blow against many of the Graegin loans between related entities. The Tax Court determined that the partnership could have redeemed the estate's partnership interest shortly after the partner's death in order to satisfy the estate tax burden, thereby rendering the loan unnecessary. However, had the estate and partnership done that, the IRS would have certainly argued that the partnership itself was simply a ruse to reduce the estate tax. And the Tax Court has twice bought such an argument under those facts in Erickson Est. v. Comr., which the Tax Court didn't bother to cite. What if the estate and partnership had instead gone to a third party lender, even if it would have required a stock pledge and a collar arrangement? Would that have made a difference. Nelson 166

169 SECTION I - EXHIBIT 25 I certainly think that it should, but how the Tax Court would view that fact is uncertain. The Tax Court was bothered by the term prohibiting prepayment as well as by the fact that the son essentially stood on both sides of the loan transaction through being the general partner as well as executor. What if the son hadn't been on both sides of the transaction, i.e,. there had been someone else serving as general partner or an independent party would have served a executor? Would this have made a difference? I'm not sure. The deductibility issues could scare you, although one should well bracket this decision on the basis that you essentially had two estates being administered at the same time due to the close proximity in deaths. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Paul Hood CITE AS: LISI Estate Planning Newsletter #1566 (December 22, 2009) at Copyright 2009 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. CITATIONS: Black Est. v. Comr., 133 T.C. No. 15 (Dec. 15, 2009); IRC Secs and 2053; Treas. Reg. Secs (a), (e), Exs. 1 and 8; (b)(3) and (a); Schutt Est. v. Comr., T.C. Memo ; Thompson Est. v. Comr., 382 F. 3d 367 (3rd Cir. 2004); Bongard Est. v. Comr., 124 T.C. 95 (2005); Graegin Est. v. Comr., ; Todd Est. v. Comr., 57 T.C. 288 (1971); McKee v. Comr., 1996 T. C. Memo ; Erickson Est. v. Comr., ; and Byrle Abbin's Comprehensive Quality Control FLP Checklist in LISI Estate Planning Newsletter #1475. Nelson 167

170 SECTION I - EXHIBIT 26 Petter v. Commissioner: Defined Value Clause Respected In Combination With LLC Steve Leimberg's Estate Planning Newsletter - Archive Message #1562 Date: 16-Dec-09 From: Steve Leimberg's Estate Planning Newsletter Subject: Petter v. Commissioner - Defined Value Formulas, Do They Work and How! In LISI Estate Planning Newsletter #1557, Paul Hood provided members with his analysis of why the Petter v. Commissioner decision was so significant. Now, Charlie Nash provides members with his analysis of this landmark case. Charles Ian Nash, a partner in the Brevard County law firm of Nash, Moule & Kromash, LLP., is a Board Certified Wills, Trusts & Estates attorney, a past president of the Brevard County Estate Planning Council, a member of the Iowa Bar Association and The Florida Bar, a Fellow of the American College of Trust and Estate Counsel and serves as the Resource Editor and is a member of ACTEC's Estate and Gift Tax Committee, Business Planning Committee, and Editorial Board. Charlie is a contributing author to Basic Estate Planning in Florida, Sixth Edition, Litigation Under Florida Probate Code, Fifth Edition, Administration of Trusts In Florida, Fourth Edition, and Asset Protection in Florida, First Edition, each published by The Florida Bar, and Estate Planner's Manual for Evaluating Appraisals and Appraisers, published by the American College of Trust and Estate Counsel, (ACTEC) First Edition, Here is Charlie's commentary: EXECUTIVE SUMMARY: On December 7, 2009, the United States Tax Court issued its opinion in Estate of Anne Y. Petter, deceased v. Commissioner, T.C. Memo Judge Holmes upheld the validity for federal gift tax purposes of a defined value formula gift which specifically transferred units in a limited liability company to trusts for the benefit of two of the donor's children with the value that exceeded a specific amount being gifted to a publicly supported charitable organization. Judge Holmes found that the formula clause used by the late Anne Y. Petter did not to create a condition subsequent and was not contrary to public policy. FACTS: General Facts. Anne Y. Petter inherited a significant amount of stock in United Parcel Service of America, Inc. ("UPS") in Ms. Petter had been a school teacher much of her life and had three children, Donna, Terry and David. Ms. Petter first sought advice from her attorney but was ultimately referred to an estate planning attorney with significant experience in estate planning and tax law due to the large value of the block of stock in UPS. Ms. Petter, among other things, established a single member limited liability company under the laws of the State of Washington known as Petter Family, LLC (the "LLC"). Before being able to Nelson 168

171 SECTION I - EXHIBIT 26 transfer ownership of her shares of stock in UPS to the LLC, UPS announced that it was going public and that transfers of ownership of stock in UPS were prohibited until the public offering was completed. Thereafter, Ms. Petter transferred over 400,000 shares of UPS stock worth in excess of $22,000,000 to the LLC. The membership units were divided into three classes: Class A, Class D and Class T. The holders of each class of membership units had the right to elect a manager by majority vote. Ms. Petter became the manager of the Class A units, Donna became the manager of the Class D units and Terry became the manager of the Class T units. A majority of the managers had to approve decisions relative to the management of the LLC, but no vote could pass without the approval of the manager in charge of the Class A units, thus giving Ms. Petter veto power over all company decision making. Ms. Petter also established an irrevocable trust for the benefit of her daughter, Donna (the "Donna Trust"), and an irrevocable trust for the benefit of her son, Terry (the "Terry Trust"). Both of the irrevocable trusts were structured such that Ms. Petter would be considered to be the owner of both irrevocable trusts for federal income tax purposes (intentionally defective grantor trusts). On March 22, 2002, Ms. Petter made gifts to both of the irrevocable trusts in the form of membership units in the LLC intended to make up 10% of the Terry Trust and 10% of the Donna Trust. On March 25, 2002, Ms. Petter sold to both irrevocable trusts membership units in the LLC worth 90% of the ultimate assets to comprise the Terry Trust and the Donna Trust in exchange for a promissory note issued by both of the irrevocable trusts and secured with the membership units being sold to both of the irrevocable trusts. Ms. Petter also gifted some membership units to two separate charities- The Seattle Foundation and the Kitsap Community Foundation. Donor advised funds were established with each of the community foundations on behalf of the Petter family. With respect to the gifts made to the Donna Trust and the Terry Trust, a defined value formula was used. The gift document relative to the Terry Trust provided the following formula: The Trust agrees that, if the value of the units it initially receives is finally determined for federal gift tax purposes to exceed the amount described in Section 1.1.1, Trustee will, on behalf of the Trust and as a condition of the gift to it, transfer the excess Units to The Seattle Foundation as soon as practical. In addition, the irrevocable trust agreement which established the Terry Trust provided as follows: Transferor***1.1.1 assigns to the Trust as a gift the number of Units described in Recital C above that equals one-half the minimum dollar amount that can pass free of federal gift tax by reason of Transferor's applicable exclusion amount allowed by Code Section 2010(c). Transferor currently understands her unused applicable exclusion amount to be $907,820.00, so that the amount of this gift should be $453,910.00; and assigns to The Seattle Foundation as a gift to the A.Y. Petter Family Advised Fund of The Seattle Foundation the difference between the total number of Units described in Recital C above and the number of Units assigned to the Trust in Section Nelson 169

172 SECTION I - EXHIBIT 26 The documents pertaining to the Donna Trust had similar language except that it conveyed Class D membership units, and the ultimate charitable recipient was the Kitsap Community Foundation. With respect to the sale that occurred on March 25, 2002, the sale documents contained language that indicated the intention of the seller (Ms. Petter) was that membership units having a value of $4,085, as finally determined for federal gift tax purposes was intended to be sold to the Trust, and that the difference between the total number of units being assigned and the total of units intended to be sold to the Trust were being gifted to the charitable donee, namely The Seattle Foundation with respect to the transaction involving the Terry Trust and the Kitsap Community Foundation with respect to the Donna Trust. The Seattle Foundation engaged the services of an experienced estate planning and tax attorney to represent its interests, and, in fact, changes were made to various documents employed in connection with the gifting and sales which were requested by the attorney for The Seattle Foundation. Such changes were designed to better protect the interest of The Seattle Foundation. Apparently the Kitsap Community Foundation benefitted from the changes required by the attorney for The Seattle Foundation. When she timely filed her federal gift tax return in August 2003, Ms. Petter disclosed the gifts she made to the Donna Trust, the Terry Trust, The Seattle Foundation and the Kitsap Community Foundation. A disclosure statement was included to which the formula clauses from the transfer documents, the organizational documents for the LLC and the Trust Agreements, and transfer documents were attached. When the Internal Revenue Service ultimately examined the 2002 federal gift tax return for Ms. Petter, the IRS took issue with the amount being presented as the value of the membership units and with the viability of the defined value formula gift. The business valuation firm used by the taxpayer took the position that a unit value was $ The Internal Revenue Service, however, took the position that a unit value was $ Ms. Petter and the Internal Revenue Service were ultimately unable to resolve the differences of opinion which resulted in the filing of a tax court petition. Although the parties ultimately agreed to a final valuation of $ per LLC unit, the Tax Court was asked to decide whether to honor the formula clause for the gifts on the sales. Moreover, if the Tax Court was to uphold the viability of the formula clause, the Tax Court would also then need to decide whether Ms. Petter is entitled to a charitable contribution deduction associated with additional units in the LLC being allocated to The Seattle Foundation and the Kitsap Community Foundation. Ms. Petter took the position that because the defined value formula clause is valid under the property laws of the State of Washington, whose laws allow a person to pass a particular dollar amount to intended beneficiaries, it must be honored as a valid transfer under federal gift tax laws. The Internal Revenue Service took the position that defined value formula clauses are void because they are contrary to public policy. Case Law Considered. Judge Holmes of the Tax Court noted the old case of Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944) which was the cornerstone of the position of the Internal Revenue Service that the Nelson 170

173 SECTION I - EXHIBIT 26 defined value formula clauses used by Ms. Petter violate public policy. Judge Holmes noted that the opinion of the United States Court of Appeals for the Fourth Circuit rested on two propositions that now frequently appear in gift tax cases involving adjustment clauses. The first is that the gift is a present gift of a future interest in property in that the formula creates a condition subsequent. The second is that a defined value formula clause is contrary to public policy because it has a tendency to discourage the collection of gift tax, it obstructs the administration of justice by requiring courts to pass upon a moot case, and a judicial proclamation on the value of the trust would be a declaratory judgment because the condition is not to become operative until there has been a judgment. Judge Holmes also noted that the issue in Procter concerned an adjustment clause involving the sale of stock in a corporation. In addition, Judge Holmes considered the decision in King v. United States, 545 F. 2d 700 (10th Cir. 1976) where United States Court of Appeals for the Tenth Circuit reviewed a clause that stated that if the fair market value of the stock is ever determined by the Internal Revenue Service to be greater or less than the fair market value determined in connection with the agreement, the purchase price is to be adjusted to the fair market value determined by the Internal Revenue Service. The United States Court of Appeals for the Tenth Circuit found this clause to be a price-adjustment clause because it adjusts the consideration paid in the sale in order to be valid. Judge Holmes also made note of prior decisions by the Tax Court in Knight v. Commissioner, 115 T.C. 506 (2000), Ward v. Commissioner, 87 T.C. 78 (1986) and Harwood v. Commissioner, 82 T.C. 239 (1984). Furthermore, Judge Holmes discussed the attendant facts and the legal analysis in the various decisions which ultimately resulted in a final ruling by the United States Court of Appeals for the Fifth Circuit in McCord v. Commissioner, 461 F. 3d 614 (5th Cir. 2006). Finally, Judge Holmes took note of the tax court's decision in Estate of Christiansen v. Commissioner, 130 T.C. No. 1 (2008), in which the Tax Court, in essence, approved a defined value formula clause in connection with a disclaimer. The Tax Court opinion in Christiansen was recently affirmed by the United States Court of Appeals for the Eighth Circuit on November 13, The issuance of this opinion on Friday, the 13th of November, 2009, may make those who are otherwise superstitious rethink the negative connotations of Friday the 13th. Note that Christiansen involved an estate in which the ultimate distribution and transfer was accomplished through the use of a disclaimer. Analysis. Judge Holmes reasoned that Ms. Petter was gifting membership units which were intended to have an ascertainable dollar value rather than a specific number of membership units in the LLC. The sale documents were even more explicit in terms of describing what was being sold as the number of units that equal a value of a stated dollar amount ($4,085,190.00). The gift tax examination did not change what Ms. Petter had given, but instead triggered a final allocation of the membership units that Ms. Petter had gifted or sold. Judge Holmes did not view the defined value formula clause employed by Ms. Petter to be sufficiently similar to that in Procter. Judge Holmes stated that there is a general public policy in favor of encouraging gifts to charities. The facts in this case establish that the charities stuck up for Nelson 171

174 SECTION I - EXHIBIT 26 their interests. Judge Holmes also took note of the fact that the foundations conducted arm's length negotiations, retained their own legal counsel and were successful in securing changes to the transfer documents to protect their interests. For example, the foundations were successful in insisting that they become substituted members of the LLC with the same voting rights as the other members. Judge Holmes did not feel that the gifts that benefitted the foundations were susceptible to abuse as was argued by the Internal Revenue Service. The directors of the foundations owed fiduciary duties to their organizations to make sure that the appraisal was acceptable before approving the gift and the managers of the LLC themselves had fiduciary duties to the foundations due to the fact that the foundations were being admitted as members and not receiving the membership units as mere assignees. Ms. Petter also pointed out other instances in which the Internal Revenue Service and Congress specifically allow formula clauses like the one she used in effectuating the gifts and sales. Thus, there must not be general public policy against using formula provisions. Despite arguments made by the Internal Revenue Service to the contrary, Judge Holmes found that the gifts made by Ms. Petter to the Donna Trust and the Terry Trust were an assignment of a fraction of a certain value, rather than an open ended amount exceeding a certain dollar value. Judge Holmes also held that the additional units that were ultimately determined to pass to the foundations did qualify as a charitable deduction for federal income tax purposes and were deemed to have occurred on March 22, The Tax Court opinion did not delve into the timing with respect to the additional membership units that inured to the benefit of the charities as a result of the sale that occurred on March 25, COMMENT: The decision of the Tax Court in Petter is certainly a nice holiday present for taxpayers, especially immediately following the opinion of the United States Court of Appeals for the Eighth Circuit in Estate of Christiansen. Practitioners must work with their clients in determining the type of formula clause which best suits the needs of their clients. In other words, should your clients consider using a formula allocation clause (the gift over type of defined formula gift) such as that used in Petter and in McCord, or should your clients consider using a formula transfer clause (the type of defined formula gift which results in an extra amount being deemed as been given (e.g. as an extra 1% of the amount finally determined for federal gift tax purposes)), such as that discussed by the distinguished estate planner, Carlyn S. McCaffrey in "Tax Tuning the Estate Plan By Formula," 33 U. of Miami Inst. on Est. Planning 4 (1999). This author has had success in obtaining acceptance of that type of formula by the Internal Revenue Service albeit through the appeals process. Although the Internal Revenue Service may continue to take issue with the use of defined value formula gifts, the taxpayer victories secured in McCord, Christiansen and now Petter may signal clearer seas ahead for taxpayers. Finally, it was interesting that Judge Holmes readily accepted the estate planning structure used by Nelson 172

175 SECTION I - EXHIBIT 26 Ms. Petter, including the sale to an intentionally defective grantor trust with a 10% pre-sale gift infusion of capital. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Charlie Nash CITE AS: LISI Estate Planning Newsletter #1562 (December 16, 2009) at Copyright 2009 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. CITES: Estate of Anne Y. Petter, deceased v. Commissioner, T.C. Memo ; Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944); King v. United States, 545 F.2d 700 (10th Cir. 1976); Knight v. Commissioner, 115 T.C. 506 (2000); Ward v. Commissioner, 87 T.C. 78 (1986); Harwood v. Commissioner, 82 T.C. 239 (1984); McCord v. Commissioner, 461 F.3d 614 (5th Cir. 2006); Estate of Christiansen v. Commissioner, 130 T.C. No. 1 (2008). Nelson 173

176 SECTION I - EXHIBIT 27 Estate of Christiansen: Formula Gift in Favor of Noncharitable and Charitable Benes Respected Steve Leimberg's Estate Planning Newsletter - Archive Message #1560 Date: 14-Dec-09 From: Steve Leimberg's Estate Planning Newsletter Subject:Estate of Christiansen - Eight Circuit Affirms Tax Court Decision Providing Lesson Last week, LISI provided members with Steve Akers' commentary on the landmark case Estate o Christiansen. Now, charitable planning authority Richard Fox shares his views on Estate of Christiansen. Richard L. Fox is an attorney and a partner in the law firm of Dilworth Paxson LLP, in Philadel where he heads the Philanthropic and Nonprofit Group. He represents a multitude of charitable organizations, including some of the largest private foundations in the country. He is a member of editorial board of Estate Planning and BNA Tax Management, and writes and speaks frequently o issues pertaining to philanthropy. Richard was also recently named by Worth Magazine as one of Top 100 Attorneys in the country representing affluent families and individuals, including in the a of private foundations and philanthropy, as well as a Pennsylvania Super Lawyer in these areas. Richard has also just been named to the Chartered Advisor in Philanthropy Board of Advisors at t American College in Bryn Mawr, PA, and was just named as a top wealth management attorney b on client satisfaction by Philadelphia Magazine, which will appear in the November 2009 issue (s We reviewed Richard's latest book, Chari Giving: Taxation, Planning and Strategies in LISI Charitable Planning Newsletter # 139. Here is Richard's commentary. EXECUTIVE SUMMARY: In Estate of Christiansen, the Tax Court, and now the Eight Circuit Court of Appeals (in a Novem 13, 2009 decision), approved the ability of a taxpayer to establish a "charitable lid" estate plan act by a formula clause disclaimer. A charitable lid estate plan essentially involves one in which a dec leaves a set dollar amount of his estate to noncharitable beneficiaries, with the residuary estate pas to a qualified charitable organization. The portion passing to charity qualifies for the estate tax charitable deduction under IRC 2055, t putting a "lid" on the amount that can be included in the taxable estate. The "lid" is created becaus if the IRS should successfully assert that the estate assets are undervalued in determining the dece gross estate, then any increase in the taxable estate is offset by a corresponding increase in the esta charitable deduction. The purpose of this technique is to eliminate any incentive for the IRS to contest valuations made estate because if the IRS is successful in increasing the value of the gross estate, then the residual transfer to charity would necessarily increase by the same amount. The Christiansen case approve formula clause disclaimer in the context of an estate lid plan despite attacks by the IRS on public p grounds. Nelson 174

177 SECTION I - EXHIBIT 27 It also provides a valuable lesson that if a disclaimant disclaims property resulting in a transfer of the property to a charitable split-interest trust, the disclaimer will not be effective unless the interest in the split-interest trust is also disclaimed. In Christiansen, because the disclaimant retained her interest as the remainder beneficiary of a charitable lead trust, the disclaimer resulting in the transfer of estate property to the charitable lead trust was not effective. As a result, no estate tax charitable deduction was allowed for the transfer to the charitable lead trust as a result of the disclaimer. FACTS: In Estate of Christiansen, the decedent left her entire estate to her daughter. The will provided that should the daughter disclaim all or any portion of her interest in the estate, the disclaimed property would pass 75% to a testamentary charitable lead annuity trust (CLAT) and 25% to a family private foundation. Within nine months after the decedent's death and after determining that she required $6,350,000 to meet her needs, the daughter executed a formula disclaimer of a portion of her interest in her mother's estate. The disclaimed property was a fraction of daughter's inheritance, the numerator of which was the difference between (a) the fair market value of the entire estate passing to the daughter in the absence of any disclaimer and (b) $6,350,000, and the denominator of which was the fair market value of the entire estate passing to the daughter in the absence of any disclaimer. Importantly, the term "fair market value" was defined in the disclaimer as the fair market value "as finally determined for federal estate tax purposes." The effect of this formula disclaimer was to cap the amount passing to the daughter at $6,350,000, with the assets of the estate in excess of $6,350,000 passing to the CLAT and the private foundation. The actual disclaimer executed by the daughter read as follows: Partial Disclaimer of the Gift: Intending to disclaim a fractional portion of the Gift, [Daughter] hereby disclaims that portion of the Gift determined by reference to a fraction, the numerator of which is the fair market value of the Gift (before payment of debts, expenses and taxes) on April 17, 2001, less Six Million Three Hundred Fifty Thousand and No/100 Dollars ($6,350,000.00) and the denominator of which is the fair market value of the Gift (before payment of debts, expenses and taxes) on April 17, 2001 ("the Disclaimed Portion"). For purposes of this paragraph, the fair market value of the Gift (before payment of debts, expenses and taxes) on April 17, 2001, shall be the price at which the Gift (before payment of debts, expenses and taxes) would have changed hands on April 17, 2001, between a hypothetical willing buyer and a hypothetical willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts for purposes of Chapter 11 of the [Internal Revenue] Code, as such value is finally determined for federal estate tax purposes. The disclaimer also contained a "savings clause" providing that to the extent the disclaimer was not effective to make it a qualified disclaimer within the meaning of IRC 2518, the daughter would take such actions to the extent necessary to make the disclaimer a qualified disclaimer within the meaning of IRC The estate valued its assets at approximately $6,500,000. This included a 35% minority interest valuation discount on partnership interests held by the estate. Based on this $6,500,000 value, as a result of the disclaimer, only $40,555 would pass to the foundation and $121,667 would pass to the CLAT. Nelson 175

178 SECTION I - EXHIBIT 27 The estate took a charitable deduction for the amount passing to the foundation and for the present value of the annuity amount payable to the foundation. Upon auditing the estate tax return, the IRS determined that the fair market value of the limited partnership interests should be increased by more than 35% over the value reported by the estate. The estate asserted, however, that the effect of the increase in values upon the IRS audit should only result in an increase in the amount of property passing to charity, so that the increase in value of the estate should be fully offset by an estate tax charitable deduction (and, therefore, not resulting in any additional estate tax). Disclaimer to CLAT Not Valid Because Disclaimant Retained Remainder Interest in CLAT The IRS successfully challenged the charitable deduction for the property passing to the CLAT because the disclaimer by the daughter did not disclaim her interest in the CLAT and, therefore, was not a qualified disclaimer under IRC The IRS relied on a example in the regulations stating that "if a disclaimant who is not a surviving spouse receives a specific bequest of a fee simple interest in property and as a result of the disclaimer of the entire interest, the property passes to a trust in which the disclaimant has a remainder interest, then the disclaimer will not be a qualified disclaimer unless the remainder interest in the property is also disclaimed." The court stated that but for the daughter "retaining a remainder interest and giving up present enjoyment instead of the reverse, the example describes this case." Because the decedent's daughter retained a contingent remainder interest in the disclaimed property, the court held that the disclaimer was not a qualified disclaimer under IRC The estate argued that if daughter's retention of the contingent remainder interest caused the disclaimer to fail to qualify under IRC 2518, then the savings clause provisions of the disclaimer would then become operative, and would cause the daughter to be deemed to have disclaimed that remainder interest in order to preserve the disclaimer's qualified status. The Tax Court rejected this argument on two grounds. First, the court stated that if the saving language is read as a promise that upon a determination that the daughter's disclaimer is no qualified, the daughter would then disclaim her contingent remainder in some more of the property that her mother left her, it fails as a qualified disclaimer as one made more than nine months after her mother's death. Second, the court stated that if the saving language is read as somehow meaning that the daughter disclaimed the contingent remainder interest in the CLAT back when she signed the disclaimer, it fails for not identifying the property being disclaimed and not doing so unqualifiedly because its effect depends upon a subsequent decision of the court. Such clauses, the court stated, are contingent because they depend for their effectiveness on a condition subsequent. Formula Disclaimer Valid For Amounts Passing to Foundation With respect to the amount passing to the foundation, the IRS argued that the estate the formula disclaimer should be ignored and, therefore, the estate could deduct only $40,555 amount originally passing to the foundation based upon the $6,500,000 estate valuation determined by the estate. The IRS made two arguments against the formula disclaimer. Nelson 176

179 SECTION I - EXHIBIT 27 First, the IRS asserted that the disclaimer was not a qualified disclaimer under IRC 2518 because the amount ultimately transferred to the foundation was contingent upon a subsequent event. The IRS cited Reg (b)(1) in asserting that the amount deducted must be ascertainable at the decedent's death, and cannot be dependent upon some subsequent action. The court disagreed with this contention, stating: The regulation speaks of the contingency of "a transfer" of property passing to charity. The transfer of property to the Foundation in this case is not contingent on any event that occurred after Christiansen's death (other than the execution of the disclaimer) it remains 25 percent of the total estate in excess of $6,350,000. That the estate and the IRS bickered about the value of the property being transferred doesn't mean the transfer itself was contingent in the sense of dependent for its occurrence on a future event. Resolution of a dispute about the fair market value of assets on the date Christiansen died depends only on a settlement or final adjudication of a dispute about the past, not the happening of some event in the future. Our Court is routinely called upon to decide the fair market value of property donated to charity for gift, income, or estate tax purposes. And the result can be an increase, a decrease, or no change in the IRS's initial determination. Second, the IRS took the position that formula disclaimers are against public policy because they reduce the IRS's incentive to challenge estate tax values. The IRS argued that a policy supporting audits as a means to enforce accurate reporting requirements mandates that it disallow fixed-dollar-amount partial disclaimers because of the potential moral hazard or untoward incentive they create for executors and administrators to undervalue estates. In connection with this argument, the IRS raised its long-argued position that such clauses are against public policy for the reasons set forth in Proctor v. Commissioner. In Procter, the court was faced with a trust clause specifying that a gift would be deemed to revert to the donor if it were held subject to gift tax. The court voided the clause as contrary to public policy, citing three reasons: 1) The provision would discourage collection of tax, 2) It would render the court's own decision moot by undoing the gift being analyzed, and 3) It would upset a final judgment. The court stated that the Christiansen case was not Procter, as the contested phrase would not undo a transfer, but only reallocate the value of the property transferred among the daughter, the CLAT, and the foundation. If the fair market value of the estate assets is increased for tax purposes, then property must actually be reallocated among the three beneficiaries. The court noted that such a reallocation would not make the court opine on a moot issue and would not in any way upset the finality of the court's decision. The court noted that the IRS's incentive to audit returns affected by such a clause would "marginally decrease" if the court allowed the increased estate tax charitable deduction and, thus, encourage similarly situated taxpayers to "lowball the value of the estate to cheat charities." The court noted, however, that executors and foundation managers are bound by fiduciary duties, which have punitive consequences under state law and federal tax law if those duties are violated. Nelson 177

180 SECTION I - EXHIBIT 27 The court also noted that under the applicable state law, as in most states, the state attorney general has authority to enforce these fiduciary duties using the common law doctrine of parens patriae. In affirming the decision of the Tax Court, the Eight Circuit generally agreed with the Tax Court's reasoning. In connection with the subsequent event argument, the Eight Circuit agreed that there was no subsequent event. According to the Eight Circuit, all that remained uncertain following the disclaimer was the valuation of the estate, and therefore, the value of the charitable donation and related deduction. The foundation's right to receive twenty-five percent of those amounts in excess of $6,350,000 was certain. The court specially stated that in pressing his current argument, the IRS failed to distinguish between events that occur post-death that change the actual value of an asset or estate and events that occur post-death that are merely part of the legal or accounting process of determining value at the time of death. Further, the court stated that "Because the only uncertainty in the present case was the calculation of value to be placed on a right to receive twenty-five percent of the estate in excess of $6.35 million, and because no post-death events outside the context of the valuation process are alleged as post-death contingencies, the disclaimer was a qualified disclaimer..' We find no support for the Commissioner's assertion that his challenge to the estate's return and the ultimate valuation process and settlement are the type of post-death events that may disqualify a partial disclaimer." With regard to the public policy argument, the Eight Court, like the Tax Court, agreed that formula disclaimers "may marginally detract from the incentive to audit estate returns." The court noted that it is, indeed, possible that in some hypothetical case involving a fixed-dollar-amount partial disclaimer, a post-challenge correction to an estate's value could result in a charitable deduction equal to the increase in the estate, resulting in no increased estate tax. Nonetheless, like the Tax Court, the Eight Circuit disagreed with the IRS, stating: For several reasons, we disagree with the Commissioner's argument that we must interpret the statue and regulations in an effort to maximize the incentive to audit. First, we note that the Commissioner's role is not merely to maximize tax receipts... Rather, the Commissioner's role is to enforce the tax laws... Second, we find no evidence of a clear Congressional intent suggesting a policy to maximize incentives for the Commissioner to challenge or audit returns... Third,... [i]n the present context,... there are countless other mechanisms in place to ensure that fiduciaries such as executors and administrators accurately report estate values. COMMENT: This case raises a red flag in connection with funding a charitable split-interest trust via a disclaimer when the noncharitable interest is held by a person who makes the disclaimer. An outright bequest to the charitable lead trust under the decedent' would have resulted in an estate tax charitable deduction under IRC 2055 (equal to the value of the charitable lead interest) in this case, given that a disclaimer would not have been required in order for the funds to pass to the charitable lead trust. More importantly, the case approves the use of defined value transfers in the context of a charitable lid plan, in which case a redetermination of the value of the gross estate by the IRS operates similar to a marital deduction formula clause, where an increase in value allocates a larger value to the surviving spouse but does not generate additional estate tax. This case allows a charitable deduction formula Nelson 178

181 SECTION I - EXHIBIT 27 clause, in this case activated by a disclaimer, to produce the same result, thereby providing a disincentive for the IRS to increase estate tax value. Such a formula can be utilized in the context of transfers to charitable organizations or charitable split-interest trusts. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Richard Fox CITE AS: LISI Estate Planning Newsletter #1560 (December 14, 2009) at http// Copyright 2009 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. CITES: Christiansen, Helen Est., (2008) 130 TC No 1, aff'd, No (8th Cir. 2009); IRC 2518; Reg (e)(3); Reg (b)(1); Proctor v. Commissioner, 142 F.2d 824 (4th Cir. 1944). Nelson 179

182 SECTION I - EXHIBIT 28 Berall: Problems Caused by Absence of Estate & GST Taxes and Reinstitution of Carryover Basis Steve Leimberg's Estate Planning Newsletter - Archive Message #1705 Date: From: 05-Oct-10 Steve Leimberg's Estate Planning Newsletter LISI has previously written on the planning issues caused by the carryover basis system, including Deborah Jacobs recent commentary on what members can do when working with clients on practical problems involving the carryover basis system. See Estate Planning Newsletter #1701. LISI Commentator Team Member Frank S. Berall now provides members with additional commentary on the above issues, including the repealed 1976 carryover basis provisions, the four known multi-billionaire deaths to date in 2010, with background information about the acquisition of the New York Yankees by the late George Steinbrenner, concluding with a request to readers to press Congress both to retroactively reinstitute the estate and GST taxes and repeal carryover basis. Frank S. Berall, principal of Copp & Berall, LLP and Senior Tax Consultant to Andros, Floyd & Miller, P.C., both of Hartford, CT, is Chair of the newly revived Federal Tax Institute of New England. He was Co-chair (from 1977 through 2009) with Prof. Regis Campfield, of the Notre Dame Estate and Tax Planning Institute, is on the editorial boards of the Connecticut Bar Journal, the Connecticut Lawyer and Estate Planning, was a former Regent of the American College of Trust and Estate Counsel, a past Vice President of the International Academy of Estate and Trust Law, Co-chair of the Hartford Tax Institute s Advisory Council for 10 years, and has been a part-time faculty member of the Yale Law School, the University of Connecticut Law School and the University of Hartford s Graduate Tax Program. Frank, a frequent speaker at many tax institutes, has published 131 articles, six pieces for Steve Leimberg s Estate Planning Newsletter, two articles on the Connecticut Bar Association s website, portions of 13 books and co-authored two Tax Management Portfolios. He is presently preparing another one on same-sex relationships. He has been recognized for his expertise in both trust and estate law as well as tax law in all 30 editions of the Best Lawyers in America, is one of the top 50 Connecticut Super Lawyers and the New York area s Best Lawyers. Here is Frank s commentary: EXECUTIVE SUMMARY: Congress has not yet dealt with the absence of the estate and generation skipping transfer taxes for estates of 2010 decedents, nor has it repealed the reinstitution of carryover basis for that year. Previous LISI newsletters have dealt with the history that led up to the absence of two of these three transfer taxes (all but the gift tax, which remains) in 2010 as well as techniques to cope with carryover basis. Nelson 180

183 SECTION I - EXHIBIT 28 This commentary deals with Congresses missed opportunity to remedy the situation before 2010, the current status and possibility of a remedy in a postelection lame duck session. It also covers the history of the revival of the illconceived and subsequently repealed carryover basis provisions of the 1976 Tax Reform Act, as well as problems which are now being experienced by estates of 2010 decedents, as well as possible solutions to the 2010 tax situation. FACTS: There are no estate or generation skipping transfer taxes for estates of decedents who die in While the difficult of complying with carryover basis rules exist for these estates, no serious attempts have been made by Congress to deal with these problems, nor has President Obama, despite demanding higher income taxes on the so-called rich, even mentioned them. Meanwhile, several billion dollars of transfer taxes may be lost, unless the estate and GST taxes are retroactively reinstated, and, their reinstatement is upheld by the courts. COMMENT: 1. There Are No Estate or Generation Skipping Taxes for 2010 Deaths, Including those of at Least Four Multi-Billionaires Although these taxes are not imposed on 2010 decedents, the gift tax remains. But they return in 2011, with only a $1 million exemption and rates ranging up to 55%. A House bill, pending since late 2009, would have extended the 2009 rates and exemptions, without carryover basis. However, the Senate passed Obama s health care bill on Christmas Eve 2009 and adjourned for the rest of that year without fixing the transfer taxes. Former Treasury official Professor Michael J. Graetz of Columbia Law School (previously of the Yale Law School), described this congressional failure to prevent the expiration of the estate and generation skipping transfer taxes as congressional malpractice. President Obama, while demanding higher income taxes on upper bracket taxpayers has said little or nothing about the absence of two of the three transfer taxes for 2010 deaths. The apparent inconsistency between his insistence that Congress raise income taxes on the wealthy, while failing at least to urge an extension of the 2009 federal estate and generation skipping transfer taxes for 2010 is hard to understand, as is his omission of comment on the automatic restoration after 2010 of the pre-2001 Bush estate and GST tax rates, for 2011 deaths. These will place a 55% rate on estates of $1 million or more. At least four multi-billionaires (and by now perhaps more) have died since the end of 2009, in addition to the deaths of many multi-millionaires. The first American billionaire s death in 2010 was that of Mary Janet Morse Cargill of the Minnesota family who founded Cargill Inc. She died at age 85 in February. Forbes Magazine figured her net worth at $1.6 billion.[1] Houston oilman Dan L. Duncan died at the age of 77 in March, leaving an estimated $9.8 billion fortune. His heirs may save over $4 billion in estate taxes. Nelson 181

184 SECTION I - EXHIBIT 28 His death was referred to in an August 2010 letter by liberal U.S. Senators Bernard Sanders, I-Vt., Tom Harkin, D-Iowa, and Sheldon Whitehouse, D-R.I. It called for estate tax reinstatement, retroactive to January 1, 2010, saying that [a]t a time when we have a record-breaking $13 trillion national debt and an unsustainable federal deficit, people who inherit multimillion- and billion-dollar estates must pay their fair share in estate taxes. The Senators then introduced a bill placing a 65% tax on big estates. New York Yankees owner, George Steinbrenner, died July 4, 2010 at the age of 80. Almost all his $1.15 billion estate was the estimated net value of his share of the New York Yankees. He had bought the team in 1973 from William Paley, the CEO of CBS, for under $10 million. He also owned the now highly leveraged Yankee Stadium and a regional cable network. Undoubtedly, tax and legal advisers have been working for years to minimize the estate tax from the deaths of these wealthy decedents. Steinbrenner was known to have suffered a number of health problems for a long time. Thus, likely strategies would have been the gradual transfer of economic interests to later generations of his family. In fact, the Yankees are now run by his two sons. Partnerships and other legal entities were no doubt used by all wealthy 2010 decedents to take advantage of valuation discounts for fractional ownership.[2] Steinbrenner was a legal resident of Florida, which has no income nor transfer taxes. Thus, his estate should be able to avoid most of New York s 16% highest state estate tax rate, although New York s Tax Department may try to claim he was domiciled in New York, if he had a place of abode there. His account of how he acquired the New York Yankees is classic. In a speech he gave to Culver alumni on October 4, 1997, during the 100th anniversary of Culver s Black Horse Troop, Steinbrenner, an extremely enthusiastic 1952 graduate of Culver Military Academy, residing in Cleveland, Ohio at the time of his Yankee acquisition said: After I was unable to acquire the Cleveland Indians, I heard that the New York Yankees were for sale. I had my chauffeur drive me in my Rolls Royce to Cleveland s airport, where my private jet was already fueled and waiting for me on the runway. At New York s LaGuardia airport, a chauffeur-driven limousine took me directly to Paley s CBS office in mid-town Manhattan. His secretary admitted me almost immediately. Paley was standing, looking out the window, with his back to his desk. After about a minute s silence and without turning around, he said: Steinbrenner..., you re a Culver graduate, aren t you? I said yes. Ten-minutes and $10 million later [actually it was only about $8.7 million], I had the New York Yankees. George Steinbrenner was a fascinating person. A second generation Culver Military Academy graduate in 1948, he had previously attended Culver s Woodcraft Camp in the summer of 1942 (where he met this commentary s author) and possibly for another year or two thereafter. He had both his daughter (who later served on the Culver Educational Foundation s Board of Trustees, after Nelson 182

185 SECTION I - EXHIBIT 28 him) and granddaughter attend Culver Girls Academy. He was most generous to Culver, with gifts supporting school teams and organizations, various facilities and student scholarships. One legendary story about him was that when he came to see his granddaughter in a play at Culver s Eppley Auditorium, the play was delayed due to insufficient backstage room for its rehearsal, because another production was taking place in that theatre. George was absolutely furious. Several million dollars later, Culver s addition to its Eppley Auditorium was named after Steinbrenner, its donor. In August 2010, California real estate mogul Walter Shorenstein died at the age of 95 with a net worth of about $1.1 billion.[3] Retroactive reinstatement of the federal estate and generation skipping transfer taxes could obtain all the potentially lost revenue from these and other 2010 decedents. But this may be unconstitutional. The few cases on this subject are split. Some older ones hold retroactive estate tax increases unconstitutional. A few recent ones uphold them. Thus, retroactive restoration of these taxes will no doubt lead to years of costly litigation between the affected estates and the I.R.S., until a final decision by the U.S. Supreme Court. This will mean years of uncertainty for 2010 estate fiduciaries and beneficiaries. 2. The Resurrected, Discredited and Previously Repealed Basis Concept Besides the transfer taxes, 2010 decedents estates must deal with new and very complicated carryover basis rules. In many respects they are worse than those enacted in 1976 and repealed in 1980.[4] During Congressional hearings from 1977 through 1980, along with many other people, the author of this commentary worked to obtain their repeal. A key example used in the testimony involved the stamp collection of the late Dean Irwin Griswold of the Harvard Law School. A former Solicitor General of the United States, he knew early in his career that he would be in and out of the government during most of his life. Therefore, he wanted to avoid any conflict of interest problems that might arise if he invested in public or even privately traded companies. Thus, instead of investing in securities, he acquired a large and very valuable postage stamp collection. Like almost all collectors, he had few if any records of his acquisition costs for single stamps, sets, blocks, sheets, new issues and purchases of portions of other peoples collections that he had made on numerous occasions over his lifetime. Similar problems exist today for many 2010 decedents estates holding objects of art, antiques, stamps, coins, other collectibles and even real estate on which they made improvements, as well as many other assets. The Carter Administration was extremely opposed to carryover basis repeal. Several now deceased former Treasury officials, all of whom were outstanding tax attorneys and had chaired the ABA s Tax Section, including former I.R.S. Commissioner Donald Alexander, former Deputy Assistant Secretary of the Treasury John Nolan and distinguished tax attorney, James Lewis, who had Nelson 183

186 SECTION I - EXHIBIT 28 previously served at a somewhat lower level in the Treasury, favored a compromise. This was introduced by Democratic Representative Fisher, to avoid complete repeal. During the November 1979 final key hearings in the House Ways and Means Committee, this author appeared on behalf of the American College of Probate Counsel (now the American College of Trust and Estate Counsel), urging complete repeal, in the face of opposition from these very prominent tax lawyers. The late Democratic Representative Sam Gibbons of Florida (a junior Infantry officer who parachuted into Normandy on D Day) said he was a reformed sinner, having made the mistake of voting for carryover basis in He now believed carryover basis to be extremely poor tax policy. Thus, he used his influence to persuade enough Democrats, along with all the Republicans on the committee, led by Minority Counsel, Representative Barber Conable, of upstate New York (who became President of the World Bank after retiring from Congress) to convince a committee majority to vote against the Fisher Bill s compromise. This occurred over the objections of Committee Chairman Al Ullman of Oregon and most of the committee s other Democrats. While the Senate Finance Committee agreed to repeal carryover basis, the Carter Administration threatened to veto its repeal. An end run was made. Due to OPEC s machinations, gasoline shortages and extremely high gas prices then existed in the United States. President Carter was persuaded that a crude oil windfall profits tax was needed to ease the situation. Carryover basis repeal was attached to this bill and President Carter decided he had to sign it. Details of the above and an extensive analysis of the present carryover basis rules appear in a recent article.[5] The Internal Revenue Service has not yet issued nor apparently even designed the form required by law to report large transfers at death. Estates must file this by the earlier of the date required to file a 2010 decedent s final income tax return (April 15, 2011) unless the estate requests an automatic extension to October 15, This form s delay has added additional problems to the costs of administering 2010 decedents estates. 3. Possible Solutions to the 2010 Tax Problems A compromise that might prevent litigation over retroactive restoration of the transfer taxes could be a combination of a retroactive repeal of carryover basis with reinstitution of the estate and generation skipping transfer taxes. Then estates of 2010 decedents would be allowed an election either to pay estate and generation skipping tax or comply with the carryover basis provisions. But the latter should also be retroactively repealed for all other estates, too. Arizona Republican Senator John Kyl and Arkansas Democratic Senator Blanche Lincoln proposed a 35% estate tax with a $5 million exemption. This probably would pass both Houses. However, Senate Majority Leader Harry Reid of Nevada and House Speaker Nancy Pelosi of California will not allow it to come Nelson 184

187 SECTION I - EXHIBIT 28 to a vote. In mid-september 2010, Senator Reid blocked a vote on this Kyl-Lincoln compromise. It was an amendment to the Democrats Small Business Bill. This action by the Senate Majority Leader and the Speaker of the House was in this author s opinion, outrageous, even though the proposed amendment evidently did not include retroactive reinstatement of the estate tax or repeal of carryover basis. President Obama s apparent lack of interest in this matter is odd, while he has called for the Bush income tax cuts to be allowed to expire and wants enactment of higher investment income taxes. His absence of any leadership to rectify the situation for 2010 deaths, besides exhibiting a lack of understanding of tax policy is surprising. The fresh start rule of the 1976 carryover basis provisions exempted prior appreciation. It increased or decreased, as the case might be, the basis of inherited property to its December 31, 1976 value. But no such fresh start exists in the present carryover basis provisions. However, even then, carryover basis was so complicated that Jonathan Blattmachr co-authored a book about it.[6] Section 1014(f)[7] makes section 1014(a) s basis adjustment to the date at death or alternate valuation date inapplicable to 2010 decedents estates. Subsequent decedents, after expiration of EGTRRA in 2011, will be entitled to the previously allowed section 1014 basis adjustment, as though EGTRRA had never been enacted. EGTRRA s legislative history indicates that the nature of any gain or loss that would have been realized by the decedent s sale of inherited property also carries over to his estate, but it is not clear that this is supported by the statute. When property is treated as received by gift, this does not determine the character of the donee s property or of the donee s gain. Thus, inventory property in the hands of a donor may be a capital asset for the donee. In an attempt to ease the application of 2010 s carryover basis for small and medium size estates, a basic basis increase of $1.3 million is allowed for the estates of U.S. citizens or residents estates, up to their fair market value,[8] augmented by certain loss carryovers. In most cases, the latter makes it unnecessary to sell assets to realize losses to preserve them for the modified carryover basis system prior to death. There is a $3 million qualified spousal basis increase up to date of death fair market value.[9] Qualified spousal property includes outright transfers to a surviving spouse, unless they are terminable interest, as well as QTIPs.[10] For decedents in civil law jurisdictions, such as Louisiana and Puerto Rico, a usufruct for life will qualify.[11] But no QTIP election is required to make property qualified spousal property. Life estates, legacies for a term of years, annuities, patents and copyrights, unless in QTIP form, will probably not qualify for the $3 million spousal increase.[12] One apparent problem in determining allocation of the $3 million spousal basis increase is how to identify assets if an estate is still open and if not all assets that could be distributed to the surviving spouse or to a QTIP trust have been distributed. Furthermore, neither the $1.3 million basic basis increase (including Nelson 185

188 SECTION I - EXHIBIT 28 unused losses) nor the $3 million spousal basis increase can raise an asset s basis above its fair market value at death. The executor must determine which assets to use and the extent to which to give each one a basis increase. If there is insufficient appreciation to use these adjustments, the excess is lost. Obviously, the 2010 carryover basis rules have complicated estate administration. Determining optimum allocation may not be the fairest way of allocating basis adjustments in accord with general fiduciary principles. Disputes over fairness will probably arise and possibly be litigated between beneficiaries. Even relatively small estates will have to appraise hard to value and not readily marketable assets. The absence of basis records for the latter will require extra time for basis reconstruction. The reporting requirements, even after the I.R.S. designs and issues the information return required to report large transfers at death,[13] and the inevitable disputes expected to arise between beneficiaries over allocations may increase the risk of surcharge actions, malpractice suits or suits for violation of fiduciary duties. Executors who are also beneficiaries will have conflicts of interests in making allocations of potential basis increases and may be accused of violations of their duty of loyalty to the estate. No doubt the I.R.S. will have enforcement problems. Questions will arise after sales, perhaps even decades after a decedent s 2010 death, as to whether the seller can rely on the as yet undesigned return s data. The I.R.S. could apparently question disclosures on this information return, even many years after the estate was closed and the executor discharged, dead or out of business. Several unresolved questions include: 1) Whether the basis of 2010 inherited assets can be adjusted to date of death fair market value after EGTRRA expires in 2011, 2) Whether the tax laws then will apply as if section 1014 s step up or down of basis to date of death or alternate valuation date had never been temporarily repealed, and 3) Whether a decedent s gain (either ordinary income or capital gain) can be carried over. Retroactive repeal of carryover basis could be done whether or not the estate and GST taxes are also reinstated. If carryover basis is not retroactively repealed, the cost of administering it, both to the I.R.S. and the affected estates, may very well exceed its revenues. Therefore, readers of this commentary are requested to urge their Senators and Representatives to retroactively reinstate the estate tax and generation skipping taxes and repeal carryover basis. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Nelson 186

189 SECTION I - EXHIBIT 28 Frank Berall CITE AS: LISI Estate Planning Newsletter #1705 (October 5, 2010) at Copyright 2010 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. CITATIONS: [1] Material on her death and those of three other multi-billionaires was initially edited from page 2 of the September 2010 client newsletter of Czepiga Daly Dillman LLC, with permission from Paul Czepiga of Newington, CT. It was supplemented by an article in Forbes Magazine and expanded from a blog on Forbes Millionaires, of July 13, 2010, as posted by William P. Barrett. [2] Id. [3] Id. [4] See Carryover Basis: A Discredited Concept in Estate Planning, Estate Planning, April 2010, page 3 by Frank S. Berall, Jonathan Blattmachr, Lauren Y. Detzel and Ellen K. Harrison [5] [6] Id. McGrath and Blattmachr, Carryover Basis of the 1976 Tax Reform Act, published by the Journal of Taxation in [7] EGTRRA, 542. [8] [9] [10] [11] [12] [13] Section 1022(b)(2)(B). Section 1022(c). Section 1022(c)(5). Section 1022(c)(B)(i). Section 1022(c)(4)(B). See section Copyright 2010 Leimberg Information Services Inc. Nelson 187

190 SECTION II CURRENT LEGAL AND ETHICAL DEVELOPMENTS IN ASSET PROTECTION PLANNING STRATEGIES By Barry A. Nelson, Esq. PART 1: Olmstead: Supreme Court Decision and Concerns for Florida LLCs PART 2: New Fla Statute (3): Great Tax and Asset Protection Opportunities PART 3: Solow - What Not To Do: A Pyramid of Ethical Asset Protection Possibilities NELSON & NELSON, P.A Sunny Isles Boulevard, Suite 118 North Miami Beach, Florida info@estatetaxlawyers.com T F Nelson 188

191 CURRENT LEGAL AND ETHICAL DEVELOPMENTS IN ASSET PROTECTION PLANNING STRATEGIES These materials cover three hot topics within Asset Protection Planning: (i) Olmstead v. FTC; (ii) Inter Vivos QTIP Trusts; and (iii) SEC v. Solow. First, Olmstead: Right Result, Wrong Reason, critically analyzes why Florida's Supreme Court in June 2010 held that a charging order was not the exclusive remedy for a judgment creditor against a judgment debtor's interest in a single-member LLC. The Olmstead analysis addresses the possibility that Florida (as well as states with similar provisions) multimember LLCs could be vulnerable based upon Olmstead and suggests legislative options. ACTEC Fellow Susan Smith informed me several years ago of a then recent statute enacted in Arizona that assures favorable estate tax and asset protection benefits for Inter Vivos QTIP Trusts. After Arizona s legislation, Michigan and Delaware followed. Then following considerable analysis, Florida adopted similar legislation effective July 1, Inter Vivos QTIP Trust planning is enhanced in Florida after the enactment of the legislation described below. This outline includes Florida s new statute, the White Paper explanation submitted as part of Florida s legislative process and an article describing the benefits of using Inter Vivos QTIP planning. Also included is an example of the benefits of Inter Vivos QTIP Trust planning for a married couple with a net worth of $13.5 million who want to take advantage of their respective unified credit exemptions (assuming the estate taxes are reinstated) and do not want to have assets exposed to creditors. The case of SEC v. Solow described below shows how the timing of asset protection transfers can encourage courts to create exceptions to asset protection exemptions and utilize contempt orders to imprison debtors. The court held that an SEC disgorgement order effectively trumps Florida's protection of tenants by the entirety property. The basic facts and professional responsibility implications of Solow are covered in the materials by Gideon Rothschild, but the time line described below, along with the Pyramid of Effective Asset Protection Planning, shows where the debtor went wrong. What can we learn from Olmstead, QTIP planning, and Solow? These materials exemplify how asset protection techniques have become entrenched within diverse legal disciplines. For example, immediately after Olmstead was decided, a Florida Bar committee was appointed to consider whether legislation should be proposed to avoid potential adverse consequences for all Florida LLCs. Committee members included leaders of the Business, Tax and Real Property, Probate and Trust Law sections of the Florida Bar, each having a significantly different practice emphasis. The asset protection concerns resulting from the Olmstead decision have become paramount in re-drafting Florida's Limited Liability Company Act. Inter Vivos QTIP Trust planning described herein reflects the need for attorneys to consider whether states asset protection remedies could nullify the anticipated estate and gift tax benefits otherwise provided by the Internal Revenue Code and Regulations. Solow exemplifies the type of aggressive planning that some attorneys critical of asset protection planning refer to when questioning the ethics of asset protection planning by attorneys. These materials provide examples, including a pyramid of legal and ethical techniques, that should be considered to integrate asset protection planning, estate planning, and business planning. Barry Nelson Miami, FL Nelson 189

192 SECTION II - PART 1 Olmstead: Right Result, Wrong Reason By Barry A. Nelson* Copyright 2010, all rights reserved Florida s Supreme Court held in Olmstead v. FTC, 1 that a court may order a judgment debtor to surrender all right, title and interest in the debtor's single-member limited liability company ( LLC ), organized under Florida law, to satisfy an outstanding judgment. The Florida Supreme Court said: [s]pecifically, we conclude that there is no reasonable basis for inferring that the provision authorizing the use of charging orders under section (4) establishes the sole remedy for a judgment creditor against a judgment debtor s interest in single-member LLC. 2 This article summarizes the majority and minority opinions in Olmstead and explains why multimember LLCs may also be vulnerable to attack. To assist the reader and limit confusion, an explanation of basic terms such as charging order and exclusive remedy is provided. Since Florida s next legislative session will begin in March, 2011 (assuming no special session is called), even if legislation is enacted in 2011, by the time the governor signs it into law the effective date would probably be July 1st or later. It is possible that any new law will be applied retroactively, but due to uncertainty as to whether or when legislation will be enacted, members of Florida LLCs may want to take action now as described below. Earlier attempts by several Florida Bar committees over recent years to provide exclusive remedy protection for LLCs have met opposition and never reached the Florida Legislature. Any state that has disparity in its creditor remedies for LLCs and partnerships could face similar challenges; the so called warning bell has sounded to consider whether exclusive remedy and foreclosure restrictions should be uniform. A suggestion for new legislation is provided that would make charging orders the exclusive remedy and prohibit other remedies such as foreclosure for LLCs. Many states such as Delaware do not differentiate between charging order protection for single-member and multimember LLCs. 3 Among the alternatives, the Florida Legislature could provide charging order protection to: (i) single-member LLCs as well as multimember LLCs (as provided under Wyoming law); 4 (ii) all LLCs, without specific reference to single-member or multimember LLCs (as provided under Delaware law); 5 or (iii) only *This article was submitted to the BNA Tax Management s Estates, Gifts and Trusts Advisory Board on August 23, 2010, and is scheduled for publication in the September 2010 edition of the Estates, Gifts and Trusts Journal. The assistance of Michael Sneeringer in preparation of this article is acknowledged and appreciated. Thanks to my friends and colleagues Jerome Hesch, Richard Comiter, and Thomas O. Wells for their insightful comments Fla. LEXIS 990, 35 Fla. L. Weekly S 357 (Fla. June 24, 2010). 2 Id. at * Del. C : (a) On application by a judgment creditor of a member or of a member's assignee, a court having jurisdiction may charge the limited liability company interest of the judgment debtor to satisfy the judgment. To the extent so charged, the judgment creditor has only the right to receive any distribution or distributions to which the judgment debtor would otherwise have been entitled in respect of such limited liability company interest. (b) A charging order constitutes a lien on the judgment debtor's limited liability company interest. (c) This chapter does not deprive a member or member's assignee of a right under exemption laws with respect to the judgment debtor's limited liability company interest. (d) The entry of a charging order is the exclusive remedy by which a judgment creditor of a member or of a member's assignee may satisfy a judgment out of the judgment debtor's limited liability company interest. (e) No creditor of a member or of a member's assignee shall have any right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the limited liability company. 4 Wyo. Stat (e) ( A limited liability company or one (1) or more members whose transferable interests are not subject to the charging order may pay to the judgment creditor the full amount due under the judgment and thereby succeed to the rights of the judgment creditor, including the charging order ). (g) This section provides the exclusive remedy by which a person seeking to enforce a judgment against a judgment debtor, including any judgment debtor who may be the sole member, dissociated member or transferee, may, in the capacity of the judgment creditor, satisfy the judgment from the judgment debtor's transferable interest or from the assets of the limited liability company. Other remedies, including foreclosure on the judgment debtor's limited liability interest and a court order for directions, accounts and inquiries that the judgment debtor might have made are not available to the judgment creditor attempting to satisfy a judgment out of the judgment debtor's interest in the limited liability company and may not be ordered by the court. 5 6 Del. C , supra note 3. Nelson 190

193 SECTION II - PART 1 multimember LLCs (to conform Florida statutes to the Olmstead decision). Based upon the uncertainty resulting from Olmstead, legislative clarification is necessary as soon as possible. Olmstead Could Render Florida (and Possibly Other States) Multimember LLCs Vulnerable The fact that the Florida Supreme Court held that a single-member LLC was not provided charging order protection was not a surprise. The majority opinion referred to In re Albright 6 where a Colorado Bankruptcy Court rejected the argument that a bankruptcy trustee should be entitled to only a charging order with respect to a debtor s ownership of a single-member LLC. It held: [b]ecause there are no other members in the LLC, the entire membership interest passed to the bankruptcy estate. 7 As discussed below, the Florida Supreme Court s reasoning in Olmstead could apply equally to multimember LLCs. The majority opinion states: [o]n its face, the charging order provision establishes a nonexclusive remedial mechanism. There is no express provision in the statutory text providing that the charging order is the only remedy that can be utilized with respect to a judgment debtor s membership interest in an LLC. 8 Judge Lewis dissenting opinion creates even greater concern to members of multimember Florida LLCs. Judge Lewis wrote: [T]he principals used [by the majority] to ignore the LLC statutory language under the current factual circumstances apply with equal force to multimember LLC entities and, in essence, today s decision crushes a very important element for all LLCs in Florida. If the remedies available under the LLC Act do not apply here because the phrase exclusive remedy is not present, the same theories apply to multimember LLCs and render the assets of all LLCs vulnerable. 9 Judge Lewis continued: By relying on an inapplicable statute [Florida s Revised Uniform Limited Partnership Act of 2005 and the Revised Uniform Partnership Act of 1995], the majority ignores the plain language of the LLC Act and the other restrictions of the statute, which universally apply the use of the charging order to judgment creditors of all LLCs, regardless of the composition of the membership. The majority opinion now eliminates the charging order remedy for multimember LLCs under its theory of nonexclusivity which is a disaster for those entities. 10 Understanding Essential Terms While this article is not intended to be a comprehensive analysis of charging orders, it is helpful to provide a general understanding of the essential terms that are the subject of the Olmstead case, such as what a charging order is, and how some states have specifically legislated to provide clarity within the law to avoid Olmstead type litigation. Generally, [a] charging order is a statutory procedure whereby a creditor of an individual member can satisfy its claim from the member s interest in the limited liability B.R.538 (D. Colo. 2003). 7 Id. at Olmstead, 2010 Fla. LEXIS 990, 35 Fla. L. Weekly S 357 at *13. 9 Id. at * Id. at * The minority opinion may be overly alarming in concluding that Olmstead s majority opinion also eliminates the exclusive charging order protection for members of multimember LLCs. However, the fact that Judge Lewis so concluded in his minority opinion provides creditor attorneys reason to explore this possibility. Nelson 191

194 SECTION II - PART 1 company as a protection of the other partners of the partnership or other members of the LLC. 11 Both the Uniform Limited Partnership Act and the Revised Uniform Limited Liability Company Act, drafted by the National Conference of Commissioners on Uniform State Laws, provide for charging orders and specifically permit foreclosure. 12 Judge Lewis dissenting opinion provides the following historical summary of charging orders: The language of the charging order provision in the Revised Uniform Limited Partnership Act (1976), as amended in 1985, is virtually identical to that used in the Uniform Limited Liability Company Act, as well as in the Florida LLC Act. The Uniform Limited Partnership Act of 2001 significantly changed this provision by explicitly allowing execution upon a judgment debtor s partnership interest.however, the Florida Partnership [Revised Uniform Limited Partnership] Act provides that a charging order is the exclusive remedy for judgment creditors (stating the charging order provision provides the exclusive remedy by which a judgment creditor of a partner or partner s transferee may satisfy a judgment out of the judgment debtor s interest in the limited 13 partnership or transferable interest ). The charging order discussion provided in Olmstead falls short in explaining the disconnect of Florida law on the treatment of charging orders under Florida s Revised Uniform Limited Partnership Act of 2005, 14 Florida s Revised Uniform Partnership Act of 1995, 15 and Florida s Limited Liability 11 Black's Law Dictionary 266 (9th ed. 2009). 12 See REV. UNIF.LTD.LIAB.CO. Act 503 (c) (2006) Upon a showing that distributions under a charging order will not pay the judgment debt within a reasonable time, the court may foreclose the lien and order the sale of the transferable interest. The purchaser at the foreclosure sale obtains only the transferable interest, does not thereby become a member, and is subject to Section 502. UNIF.LTD.P SHIP ACT 703 (b) (2001) A charging order constitutes a lien on the judgment debtor s transferable interest. The court may order a foreclosure upon the interest subject to the charging order at any time. The purchaser at the foreclosure sale has the rights of a transferee. See also Fla. Stat , infra note 14 (indicating Florida s approach to charging orders and limited partnerships); Fla. Stat , infra note 16 (indicating Florida s approach to charging orders and LLCs). In both cases Florida did not adopt the express authority for a foreclosure remedy as provided in the uniform laws. 13 Olmstead, 2010 Fla. LEXIS 990, 35 Fla. L. Weekly S 357 at * Fla. Stat sub-section (1), for Florida Limited Partnerships, states: On application to a court of competent jurisdiction by any judgment creditor of a partner or transferee, the court may charge the partnership interest of the partner or transferable interest of a transferee with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of a transferee of the partnership interest. (3) states: This section provides the exclusive remedy which a judgment creditor of a partner or transferee may use to satisfy a judgment out of the judgment debtor's interest in the limited partnership or transferable interest. Other remedies, including foreclosure on the partner's interest in the limited partnership or a transferee's transferable interest and a court order for directions, accounts, and inquiries that the debtor general or limited partner might have made, are not available to the judgment creditor attempting to satisfy the judgment out of the judgment debtor's interest in the limited partnership and may not be ordered by a court. 15 Fla. Stat for Partnerships other than Limited Partnerships, states: (1) Upon application by a judgment creditor of a partner or of a partner's transferee, a court having jurisdiction may charge the transferable interest of the judgment debtor to satisfy the judgment. The court may appoint a receiver of the share of the distributions due or to become due to the judgment debtor in respect of the partnership and make all other orders, directions, accounts, and inquiries the judgment debtor might have made or which the circumstances of the case may require. (2) A charging order constitutes a lien on the judgment debtor's transferable interest in the partnership. The court may order a foreclosure of the interest subject to the charging order at any time. The purchaser at the foreclosure sale has the rights of a transferee. (3) At any time before foreclosure, an interest charged may be redeemed: (a) By the judgment debtor; (b) With property other than partnership property, by one or more of the other partners; or (c) With partnership property, by one or more of the other partners with the consent of all of the partners whose interests are not so charged. (4) This act does not deprive a partner of a right under exemption laws with respect to the partner's interest in the partnership. Nelson 192

195 SECTION II - PART 1 Company Act. 16 Section of Florida s Revised Uniform Limited Partnership Act of 2005 states that a charging order is the exclusive remedy by which a judgment creditor of a partner may satisfy a judgment and provides that other remedies, including (but not limited to) foreclosure on the partner s interest in the limited partnership, are not available and may not be ordered by a court. 17 Florida Bar members with different areas of specialty worked on the drafting of the Florida Revised Uniform Limited Partnership Act of Based upon my review at that time of various state laws, I proposed that the drafting committee include the exclusive remedy and foreclosure prohibition provisions that were enacted. These provisions were based in significant part on the Alaska Uniform Limited Partnership Act. 18 A Summary and Report submitted to describe the proposal to enact the Florida Revised Uniform Limited Partnership Act of 2005 stated: Drafting Committee changed the uniform act provisions to further clarify the rights of judgment creditors and to emphasize that the charging lien is the exclusive remedy by which a judgment creditor of a partner may satisfy a judgment out of the judgment debtor s interest in the partnership; the supplemental language also clarifies that other remedies (including but not limited to foreclosure on the partner s interest) are not 19 available and may not be ordered by a court. The exclusive remedy and foreclosure prohibition language described above was included in the Florida Revised Uniform Limited Partnership Act of 2005 affirming existing Florida case law, holding that a creditor of a partner could only pursue a charging order against that partner s interest in the partnership and could not pursue foreclosure against such interest. 20 It should be noted that the Florida Revised Uniform Limited Partnership Act of 2005 and the Alaska Uniform Limited Partnership Act both state that the charging order provides the exclusive remedy of a judgment creditor. 21 Florida s Act states which a judgment creditor of a partner may use to satisfy a judgment out of the judgment debtor s interest in a limited partnership. 22 The Alaska Uniform Limited Partnership Act is almost identical to the Florida Act but Alaska s states that a judgment creditor of a general or a limited partner may use to satisfy a judgment. 23 Both the (5) This section provides the exclusive remedy by which a judgment creditor of a partner or partner's transferee may satisfy a judgment out of the judgment debtor's transferable interest in the partnership. 16 Fla. Stat sub-section (4), for Limited Liability Companies, states: On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the limited liability company membership interest of the member with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of such interest. This chapter does not deprive any member of the benefit of any exemption laws applicable to the member's interest. 17 Fla. Stat (3), supra note Alaska Stat (b) This section provides the exclusive remedy that a judgment creditor of a general or limited partner or of the general or limited partner's assignee may use to satisfy a judgment out of the judgment debtor's interest in the partnership. Other remedies, including foreclosure on the general or limited partner's partnership interest and a court order for directions, accounts, and inquiries that the debtor general or limited partner might have made, are not available to the judgment creditor attempting to satisfy the judgment out of the judgment debtor's interest in the limited partnership and may not be ordered by a court. See also Alaska Stat (dealing with LLCs). (c) This section provides the exclusive remedy that a judgment creditor of a member or a member's assignee may use to satisfy a judgment out of the judgment debtor's interest in the limited liability company. Other remedies, including foreclosure on the member's limited liability company interest and a court order for directions, accounts, and inquiries that the debtor member might have made, are not available to the judgment creditor attempting to satisfy a judgment out of the judgment debtor's interest in the limited liability company and may not be ordered by a court. 19 SUMMARY AND REPORT: FLORIDA REVISED UNIFORM LIMITED PARTNERSHIP ACT (2005) AND AMENDMENTS TO OTHER FLORIDA BUSINESS ENTITY STATUTES 8 (Fla. 2005), 20 In re Stocks, 110 B.R. 65 (Bankr. N.D. Fla 1989); Givens v. National Loan Investors L.P., 724 So. 2d 610 (Fla. 5th DCA 1998). 21 Alaska Stat (b), supra note 18; Fla. Stat , supra note Fla. Stat , supra note Alaska Stat (b), supra note 18 (emphasis added). Nelson 193

196 SECTION II - PART 1 Alaska and Florida Acts state that the charging order provides the exclusive remedy which a judgment creditor of a partner (both general and limited partners) may use to satisfy a judgment out of the judgment debtor s interest in a limited partnership. Florida s Act uses the word partner while Alaska s refers to a general or limited partner. The Florida Act does not reference specifically to a general or limited partner because partner is defined in section (13) as a limited or general partner. 24 Where an individual serves as general partner of a Florida limited partnership, such individual s creditors would be limited to a charging order against his or her general partnership interest. However, if the general partner of a Florida limited partnership is a single-member LLC owned by an individual debtor, then the debtor would not be protected by section (3) as that section only provides the exclusive remedy protection to a judgment creditor of a partner. 25 Where the general partner of a limited partnership is an LLC, the creditors of the LLC members are not creditors of the partnership. As such, the LLC member s creditors would be subject to the charging order provisions of section of Florida s Limited Liability Company Act. Based upon Olmstead, no charging order protection is available to the sole member of an LLC. Accordingly under Olmstead, an individual general partner of a Florida limited partnership who has creditors is protected under section (3), whereas an LLC general partner of a Florida limited partnership, whose sole member may be an individual who has creditors, would not be protected by section A well drafted limited partnership agreement will: (i) restrict an LLC general partner from conveying its membership interests, without the consent of the limited partners; and/or (ii) provide that a charging order against a member of the general partner LLC will cause the LLC to be disassociated from the limited partnership as a general partner. Both alternatives will avoid the creditor from becoming a member of an LLC that is the sole general partner of a limited partnership, and thereby gaining control of the LLC general partner. Until legislative action is taken to resolve the exclusive remedy issue created by the Olmstead decision, owning a general partnership interest directly may be better than owning said general partnership interest indirectly through an LLC. However, tax and other issues may render individual ownership of a general partnership interest in a Florida limited partnership less desirable than ownership through an LLC. Florida limited partnerships having a Florida LLC general partner may benefit from restructuring, described below (such as moving the situs of the LLC to a state where a charging order is the exclusive remedy against the owner of an LLC). As of August 19, 2010, eight states have exclusive remedy language and prohibition of foreclosure as part of their LLC Acts and/or Limited Partnership Acts. 27 Prior Attempt to Create Continuity in Florida between Charging Order Protection for LLCs, Limited and General Partnerships was Unsuccessful In 2007 the Asset Preservation Committee of the Real Property, Probate and Trust Law Section of the Florida Bar attempted to introduce exclusive remedy and prohibition against foreclosure language 24 Fla. Stat (13). 25 Fla. Stat , supra note It should be noted that if the individual general partner becomes a debtor in bankruptcy or executes an assignment for the benefit of creditors, the general partner would be dissociated from the limited partnership as a general partner. See Fla. Stat (6). In such event if there is no other general partner, all of the limited partners may consent to continue the partnership and admit at least one general partner. However, if the individual general partner is also a limited partner, the requirement to obtain the consent of all the limited partners is unlikely to be satisfied. Therefore, it may still be preferable to use an LLC as a general partner provided the LLC is created in a jurisdiction where charging orders are the exclusive remedy. 27 See Alaska Stat ; N.J. Stat. 42:2B-45; 18 Okl. St. 2034; S.D. Codified Laws 47-34A-504; Tex. Business Organizations Code ; Wyo. Stat , for LLC states Alaska, New Jersey, Oklahoma, South Dakota, Texas, and Wyoming. See LP Code of Ala. 10-9C-703; Alaska Stat ; Fla. Stat ; S.D. Codified Laws ; Tex. Business Organizations Code , for LP Act states Alabama, Alaska, Florida, South Dakota, Texas. Note, while some states do not have exclusive remedy and foreclosure prohibition in their LLC statutes, court decisions in such states (including Delaware) have interpreted state law to provide such protection. See infra note 40, for articles providing a summary of each state s charging order provisions; infra note 35, for articles by various authors relating to charging orders and state statutory language. Nelson 194

197 SECTION II - PART 1 provisions, almost identical to those in section of the Florida Revised Uniform Limited Partnership Act of 2005, for LLC s and Florida general partnerships. 28 The proposal was supported by the Executive Counsel of the Real Property, Probate and Trust Law Section of the Florida Bar. 29 The explanation attached to the Legislative Position Request Form included a section entitled: Extension of Charging Lien Limitation and Foreclosure Prohibition Against Partner and Member Interests in Other Partnerships and in Limited Liability Companies. The White Paper attached to the Florida Bar s Legislative Position Request Form describing the proposed legislation stated: The same policy concerns that caused the adoption of the limited remedy of a charging lien and prohibition of foreclosure apply equally to partner interests in general partnerships and in limited liability partnerships and member interests in limited liability companies. Accordingly, the proposed legislation would extend those features to the 30 general and limited liability partnership and limited liability company statutes. The proposal was withdrawn when opposition to the policy being extended was expressed by those representing creditors, and this issue was never considered by the Florida Legislature. Based upon discussions with the Florida Bar s Chapter 608 LLC Drafting Task Force Chair Louis T. M. Conti and committee member Richard Comiter, in addition to the above described proposal initiated by the Florida Bar s Asset Protection Subcommittee, the Business Law Section Drafting Committee in 2006 proposed Amendments to the LLC Act that initially included exclusive remedy language to the LLC Act. The Business Law Section also decided not to proceed to the Florida Legislature in order to assure that other non controversial revisions to the LLC Act would be enacted. Inconsistent Statutory Treatment for Limited Partnerships, General Partnerships, and LLCs May Have Caused Confusion in the Olmstead Majority Opinion. One significant reason provided in the Olmstead majority opinion supporting its conclusion was that Florida s Revised Uniform Limited Partnership Act of 2005 specifically provided that a charging order is the exclusive remedy and foreclosure is not an available remedy, and the Revised Uniform Partnership Act of 1995 specifically provided that the remedies described in section were exclusive, but no such exclusive language was provided in the Florida Limited Liability Company Act. 31 The majority opinion said: In this regard, the charging order provision in the LLC Act stands in stark contrast to the charging order provisions in both the Florida Revised Uniform Partnership Act and the Florida Revised Uniform Limited Partnership Act.[and] [a]lthough the core language of the charging order provisions in each of the three statutes is strikingly similar, the absence of an exclusive remedy provision set the LLC Act apart from the other two 32 statutes. Based upon the disparity between the LLC and limited partnership law, the majority opinion states: [w]here the legislature has inserted a provision in only one of two statutes that deal with closely related subject matter, it is reasonable to infer that the failure to include that provision in the other statute was deliberate rather than inadvertent. 33 That might be a reasonable inference, but the justices did not have 28 See Legislative Position Request Form Submitted By Real Property, Probate & Trust Law Section, Jan. 5, 2006, available at [hereinafter Legislative Position]. 29 Id. 30 Id. 31 Olmstead, 2010 Fla. LEXIS 990, 35 Fla. L. Weekly S 357 at * Id. 33 Id. at *15. Nelson 195

198 SECTION II - PART 1 access to nor were they aware of the real story. For example, as discussed above, Florida s Legislature never had the opportunity to determine whether LLCs should have the same charging order exclusive remedy provisions as were enacted as part of the Florida Revised Uniform Limited Partnership Act of Had the 2006 legislative proposal from the Real Property, Probate and Trust Law Section or similar proposals from the Business or Tax Law Sections of the Florida Bar, that would provide charging order exclusive remedy protection for LLCs as described above, been put before the Florida Legislature, the majority opinion would have been correct; assuming the charging order protection was not provided to members of single-member LLCs by the Florida Legislature after due consideration. However, because the above described legislative proposals were never submitted to the Florida Legislature, the majority s conclusion is misguided because the omission of exclusive remedy language in the LLC statute was never considered. Olmstead Decision Could Have Consequences Throughout the United States There is confusion in the courts and with practitioners throughout the United States on whether charging orders are the exclusive remedy based upon applicable state law. 34 In recent years, a number of articles have been written suggesting the best states to form limited partnerships and LLCs, taking into account asset protection. 35 Since legislation is continually changing on a statewide basis, many recent articles may already be outdated. For example, Wyoming and Texas enacted protective charging order laws in and respectively. The fact that a state may have favorable charging order protection within its limited partnership act does not necessarily mean that the state s LLC laws are equally beneficial. In Florida for example, although the Florida Revised Uniform Limited Partnership Act of 2005 has favorable exclusive remedy 38 and foreclosure provisions and is mentioned by a number of authors as one of the Magnificent Seven, Olmstead is sure to put Florida in the cellar when it comes to protection of LLC members. Prudent practitioners should consider suggesting a jurisdiction where a charging order is the exclusive remedy and foreclosure is prohibited. 39 Carter Bishop, a Professor of Law at Suffolk University Law School, has written extensively on charging order issues. 40 He has summarized the laws of each state and has 34 See Nigri v. Lotz, 453 S.E. 2d 780 (Ga. Ct. App. 1995) (explaining that under the Georgia Limited Partnership statute, a financial interest of a limited partner could be reached by garnishment as well as by a charging order, where the Georgia statute did not contain exclusivity language). 35 See Marc Merric, Bill Comer, & Mark Monasky, Forum Shopping for Favorable FLP and LLC Law: 2010 LLC Asset Protection Planning Table (Steve Leimberg's Asset Protection Planning Newsletter #154) May 25, 2010, available at Mark Merric, Bill Comer, & Daniel G. Worthington, Charging Order: What does sole or exclusive remedy mean?, TRUSTS &ESTATES (Apr. 2010); Daniel G. Worthington & Mark Merric, Which Situs is Best?, TRUSTS & ESTATES 54 (Jan. 2010); Barry A. Nelson, Asset Protection for Estate Planners, Address at the 43rd Annual Heckerling Institute on Estate Planning (Jan. 2009), in 43rd Annual Heckerling Institute on Estate Planning at (Matthew Bender, Pub., 2009); Amy P. Jetel, Asset Protection in the Context of LPs and LLCs, (Steve Leimberg's Asset Protection Planning Newsletter #121) Jan. 31, 2008, available at Mark Merric & William Comer, Searching for Favorable FLP & LLC Law Part III, (Steve Leimberg's Asset Protection Planning Newsletter #117) Dec. 19, 2007, available at 36 Wyo. Stat (effective July 1, 2010). 37 See Tex. Business Organizations Code (effective September 1, 2009); Tex. Business Organizations Code (effective September 1, 2009). 38 Mark Merric, Bill Comer, & Daniel G. Worthington, Charging Order: What does sole or exclusive remedy mean?, TRUSTS &ESTATES(Apr. 2010). 39 Marc Merric, Bill Comer, & Mark Monasky, Forum Shopping for Favorable FLP and LLC Law: 2010 LLC Asset Protection Planning Table (Steve Leimberg's Asset Protection Planning Newsletter #154) May 25, 2010, available at 40 See Carter G. Bishop, Fifty State Series: LLC & Partnership Transfer Statutes (Suffolk University Law School Research Paper No ), available at Carter G. Bishop, Fifty State Series: LLC Charging Order Case Table (Suffolk University Law School Research Paper No ), available at Carter G. Bishop, Fifty State Series: LLC Charging Order Statutes (Suffolk University Law School Research Paper No ), available at Carter G. Bishop, A Jurisdictional & Governing Law Quagmire: LLC Charging Orders (Journal of Business Entities, Forthcoming; Suffolk University Law School Research Paper No ), available at Carter G. Bishop, Reverse Piercing: A Single Member LLC Paradox, 54 S.D. L. REV. 199 (2009); Carter G. Bishop, Through the Looking Glass: Status Liability and the Single Member and Series LLC Perspective, 42 SUFFOLK U. L. REV. 459 (2009); Carter G. Bishop & Daniel S. Kleinberger, The Next Generation: The Revised Uniform Limited Liability Company Act, 62 BUS. LAWYER 515 (2007); Carter G. Bishop, Thomas Geu, & Daniel S. Kleinberger Charging Orders and the New Uniform Limited Partnership Act: Dispelling Rumors of Disaster, 18 PROB. &PROP. 30 (2004); Carter G. Bishop, Unincorporated Limited Liability Business Organizations: Limited Liability Companies and Partnerships, 29 SUFFOLK U. L. REV. 985 (Winter 1995). Nelson 196

199 SECTION II - PART 1 distinguished those states that specify that a charging order is the exclusive remedy, those that are silent, and those that provide protection beyond exclusive remedy language (e.g., by stating that remedies such as foreclosure are specifically prohibited). 41 The Bishop articles referenced list a number of states that have favorable exclusive remedy and foreclosure limitation provisions. However in light of the pace of legislative changes in this area, no decision should be made in selecting a situs until current state law is verified. What Should States Do Now? As a result of Olmstead, the Florida Legislature should include exclusive remedy protection to the Florida Limited Liability Company Act or any update thereof, and remedies such as foreclosure should be expressly prohibited. In light of Olmstead and until Florida legislation is enacted, it would be prudent to form both single-member and multimember LLCs in states such as Texas, Alaska, Wyoming and Delaware if protection of membership interests is an objective. The more difficult question is whether to provide exclusive remedy and foreclosure protection for both single-member and multimember LLCs. Carter Bishop s conclusion, as described below, provides helpful insight: The sensible statutory restrictions applicable to transfers of a membership in a multiple member limited liability company are justified and intuitive. Specifically, the rules that permit a member to freely transfer economic rights to future distributions while at the same time requiring the consent of the remaining members to admit the transferee as a member are appropriate to balance the reasonable expectations of members of a close business association. However, when applied to a SMLLC [ single-member LLC ], the same rules create a perverse and unexpected result.there are no other remaining partners to protect as in the case of a muti-member limited liability company. Ultimately, these perverse results are best cured by statutory amendment. Preferably, every state would amend its SMLLC legislation to provide that upon the voluntary or involuntary transfer of the only economic interest in the SMLLC, the transferee will be admitted as a substituted member, with or without the consent of the only member. 42 Based upon Bishop s analysis, the Olmstead court did, as far as single-member LLCs go, reach the right result, but for the wrong reasons. Florida s Legislature never had the opportunity to determine whether to extend the same protection provided in the Florida Revised Uniform Limited Partnership Act of 2005 to LLCs or general partnerships, but had they been given the choice, based upon the discussion above, they may not have provided such protections to single-member LLCs. Currently, only Wyoming specifically provides exclusive remedy protection to a judgment debtor who is the sole LLC member by stating that its protection includes any judgment debtor who may be the sole member of an LLC. 43 Other states, such as Delaware that have exclusive remedy protection, are silent as to whether their protection extends to single-member LLCs. A reasonable argument can be made that because no exclusion is provided in statutes such as Delaware for single-member LLCs, that exclusive remedy protection applies to them as well. Yet, as previously quoted from Carter Bishop, with a single-member LLC there are no remaining partners (or members) to protect. Those considering proposed legislative responses to Olmstead should be aware of the possibility of aggressive asset protection that could result if single-member LLCs had equal exclusive charging order protection as multimember LLCs. Single-member LLCs could be formed and the sole member could contribute all of 41 See id. 42 Carter G. Bishop, Reverse Piercing: A Single Member LLC Paradox, 54 S.D. L. REV. 199, (2009). 43 Wyo. Stat (e), supra note 4. Nelson 197

200 SECTION II - PART 1 his or her business and personal assets (other than Florida Homestead) thereto. Would the sole member then benefit from the exclusive remedy charging order protection? 44 Examples of Potential Abuse if Single-Member LLCs are Provided Equal Protection The examples below provide insight as to potential asset protection planning if single-member and multimember LLCs are treated the same, and applicable state law provides a charging order as the exclusive remedy and prohibits other remedies including but not limited to foreclosure of the charging order. Example 1: Mike is the sole owner of a manufacturing business that has been operating as a single-member LLC for the past five years. The LLC elects to be taxed as an S Corporation. The single-member LLC has annual sales of $50 Million and net profits of $5 Million Example 2: Sal, a real estate developer, forms multiple single-member LLCs to hold various commercial real estate properties valued in the aggregate at $10 Million. Each single-member LLC owns a separate property. Example 3: Jose, a surgeon practicing without malpractice insurance, has no existing or known contingent creditors. He forms a single-member LLC and conveys title to his entire $5 Million marketable security portfolio thereto. Jose forms a second singlemember LLC and conveys his $4 Million Aspen ski condominium thereto. He forms a third single-member LLC and conveys his art collection, his jewelry and his collection of sports memorabilia (having an aggregate value of $3 Million thereto). Assume the single-member LLC owners in examples 1 through 3, above, subsequently become subject to a judgment arising out of events occurring post single-member LLC formation and funding, resulting from an automobile accident that disabled a prominent forty-five year old Florida attorney with four children ranging from ages eight to fifteen, rendering the attorney unable to continue his law practice. What remedies should be available to the disabled attorney in trying to collect on his judgment against Mike, Sal and Jose in the above examples? Ultimately, the attorney will obtain a charging order against Mike s LLC interest. If a charging order is the exclusive remedy against Mike s LLC interest, Mike can reinvest the operating profits and pay himself significant but reasonable compensation (wages). The disabled attorney would have no remedy other than to wait for a distribution or negotiate a settlement with Mike. The same results would occur with respect to Sal and Jose in examples 2 and 3 above unless a judge takes the position that the protection afforded by a single-member LLC is not available with respect to personal assets. As reflected in the examples above, providing exclusive remedy protection for single-member LLCs and prohibiting other remedies such as foreclosure, could create a lock box for the debtor/owner. As the sole member, the debtor/owner has no fiduciary duty to any other LLC members, and as such, has power to control the timing and character of all distributions. The policy of protecting the other LLC members from a judgment creditor does not apply in the case of a single-member LLC. If exclusive remedy and foreclosure prohibition is provided for the sole member of a single-member LLC, creation of single-member LLCs may be as effective, at least for purposes of negotiation, as using a domestic or foreign self-settled asset protection trust in jurisdictions that sanction such trusts. Furthermore, the restrictions and administrative burdens of self-settled asset protection trusts (e.g., the need to have a 44 In Florida, homestead protection could be lost for property tax purposes and asset protection if the homestead was conveyed to a Florida partnership or LLC. See Nelson, supra note 35, at Nelson 198

201 SECTION II - PART 1 trustee in the jurisdiction) could be avoided by using a single-member LLC in a jurisdiction that provides exclusive remedy and foreclosure prohibition, where the sole owner could serve as the sole manager, as long as there is at least some nexus within the jurisdiction in which the LLC is formed. It should be noted that if a self-settled asset protection trust is respected, a judgment creditor generally will have no interest therein. Yet, the trustee could have discretion to make distributions for the benefit of a debtor beneficiary and upon the beneficiary s death, the beneficiary could have a power to designate successor beneficiaries through a testamentary special power of appointment. Upon the death of the debtor beneficiary without exercising the power of appointment, the assets of the self-settled trust would pass to the remainder beneficiaries of such trust, free and clear of any creditors of the debtor. However, with LLCs, even if the charging order is the exclusive remedy, once distributions are made to the LLC member, creditors would recover as a result of the charging order. Furthermore, upon the death of the judgment debtor, his or her LLC membership interests remain an asset that will be subject to creditor s claims; although, subject to continued charging order protection. The practical consequences of the charging order protection being the exclusive remedy for an LLC or limited partnership is that creditors are being encouraged to negotiate a settlement with the debtor if the judgment creditor is unable to force distributions to the LLC member or limited partner through the courts. The sole member of an LLC will have exclusive authority to decide on the timing of distributions. As a result, the charging order protection for single-member LLCs will also serve to safeguard the debtor s LLC assets and bring creditors to the negotiating table. There is a great disparity in the approach states have taken with respect to LLC charging orders. Robert H. Leonard, a Wyoming attorney active in his state s LLC legislation, said that Wyoming seeks to be considered as a premier venue for estate planning. Wyoming has self-settled asset protection trust legislation and restated its entire LLC Act effective July 1, Leonard said the recent LLC changes were intended to clarify prior state law that provided charging order protection as the exclusive remedy for LLCs, without differentiating between single-member and multimember LLCs. 45 Leonard believes that single-member LLCs that are operating businesses, real estate holding companies, or even LLCs owning solely a vacation home, would be protected by Wyoming s exclusive remedy statute. Leonard also indicated that notwithstanding Wyoming law, it may be possible for a judge faced with a singlemember LLC holding exclusively personal assets (such as jewelry and art) to provide remedies beyond a charging order due to lack of a business purpose. 46 Based upon the discussion and examples above, a statutory distinction could be made between single-member and multimember LLCs so that the exclusive remedy protection is not available to the owner of a single-member LLC but is available to multimember LLCs. Alternatively, LLC legislation similar to Wyoming can be enacted to specifically provide charging order protection to single-member and multimember LLCs. 47 While drafting a statute to distinguish between single-member LLCs and multimember LLCs and providing exclusive remedy and foreclosure protection to only multimember LLCs does not seem be a daunting task, implementation is likely to be a challenge. As an example, how would a multimember LLC be defined? 48 Could an LLC with a 99.99% member and a.01 % member qualify as a multimember LLC? How could a statute be drafted that requires at least two significant or meaningful members that will not result in vast litigation? Should a safe harbor interest be provided that 45 Wyo. Stat , supra note It should be noted that neither Florida, nor Wyoming requires a business purpose. See Fla. Stat ( A limited liability company may be organized under this chapter for any lawful purpose [emphasis added]); Wyo. Stat (b) ( A limited liability company may have any lawful purpose, regardless of whether for profit [emphasis added]). Both Florida and Wyoming require that an LLC may be organized for any lawful purpose. 47 Wyo. Stat , supra note See Fla. Stat (21) (defining an LLC member as any person who has been admitted to a limited liability company as a member in accordance with this chapter and has an economic interest in a limited liability company which may, but need not, be represented by a capital account ). Due to the difficulties in statutorily defining what constitutes a member, it may be best to leave this issue to the courts, on a case bycase-basis, if single-member and multimember LLCs are provided different charging order protection. Nelson 199

202 SECTION II - PART 1 will create a statutory multimember LLC? Would the statute need to look through any business entity LLC members to determine whether beneficial ownership is entirely in one LLC member? Should the statute refer to a de minimis percentage of an LLC that would be disregarded in determining whether a single-member LLC exists? Should exclusive remedy protection be provided to single-member LLCs, but be subject to court oversight as provided, by way of example, in the revised Uniform Limited Liability Company Act which allows a court to foreclose and order the sale of the transferable interest? 49 Would such court discretion create uncertainty? The answers to the questions raised in this section are left to those who will need to devote significant time and effort to find an effective statutory solution. Each state will need to weigh its desire to be a business friendly jurisdiction against any policies to limit creditor protection. Any state law that differentiates between single-member and multimember LLCs may find it difficult to establish guidelines that would define single-member and multimember LLCs in such a way as to not be subject to manipulation by creative debtors and their lawyers. What is clear is that providing exclusive remedy and foreclosure protection for single-member LLCs is likely to result in an unanticipated asset protection vehicle that could exceed the asset protection benefits contemplated. States considering whether to enact provisions similar to Wyoming may want to establish reasons, such as lack of business purpose, to protect creditors. Possibly, states without domestic selfsettled asset protection trust legislation may have an overall state policy against asset protection that would make it unlikely for such a state to pass legislation providing enhanced asset protection for singlemember LLCs. Legislative Fix May Be Years Away In light of the Florida Supreme Court s Olmstead decision, members of Florida LLCs should consider restructuring their LLC ownership. Florida Bar committees have been meeting regularly to determine how to address legislatively the consequences of Olmstead. Having recently returned from a combined meeting of Florida Bar committees that included the Chapter 608 LLC Drafting Task Force and an Olmstead Patch Committee held on August 5th, 2010, and an August 17th follow up telephone conference, some of the best and brightest members of the Business Law Section, the Tax Law Section, and the Real Property, Probate and Trust Law Section of the Florida Bar have been trying to decide what approach should be proposed to remedy the Olmstead decision. Among the options were to propose legislation that would: (i) provide that the charging order is the exclusive remedy that could be utilized for multimember LLCs and specify that foreclosure is specifically prohibited; or (ii) provide exclusive remedy protection for all LLCs (i.e., including both single-member and multimember LLCs), and specify that foreclosure is prohibited for all LLCs (i.e., single-member and multimember LLCs). Meetings are ongoing with the goal to have some resolution submitted to the Florida Legislature for the 2011 session. Until the proposal is submitted, approved and becomes effective, for those who want greater certainty that interests in multimember Florida LLCs will be protected by having charging orders considered as the exclusive remedy for a judgment debtor s membership interests, action should be considered now (e.g., moving the LLC to a state that has provided clear statutory language that a charging order is the exclusive remedy and foreclosure is prohibited). 50 Conclusion The Olmstead decision will require states like Florida to reexamine their laws to determine remedies for judgment creditors against interests in single-member and multimember LLCs. There are plenty of 49 REV. UNIF.LTD.LIAB.CO. Act 503 (c) (2006), supra note See Alaska Stat ; N.J. Stat. 42:2B-45; 18 Okl. St. 2034; S.D. Codified Laws 47-34A-504; Tex. Business Organizations Code ; Wyo. Stat , for examples of states that provide statutory language that clearly provides that a charging order is the exclusive remedy and other remedies, such as foreclosure, are not available for creditors of LLCs. Other states, such as Delaware, have exclusive remedy statutes but have only case law and legislative history prohibiting foreclosure. See New Times Media LLC v. Bay Guardian Co., 2010 U.S. Dist LEXIS (D. Del. June 28, 2010). Nelson 200

203 SECTION II - PART 1 landmines in this analysis. The discussion above shows how the lack of continuity between Florida s Limited Liability Company Act, Florida s Revised Uniform Limited Partnership Act of 2005, and Florida s Revised Uniform Partnership Act of 1995 has resulted in Florida s Supreme Court making an inaccurate assumption. Olmstead s tentacles will reach many practice areas, and Florida is likely to have a leadership role by having its Business Law, Tax Law and Real Property, Probate and Trust Law committees consider how to best resolve the existing uncertainty created by Olmstead. Practitioners need to carefully monitor this fluid situation. Nelson 201

204 SECTION II - PART 2 Inter Vivos QTIP Trust Planning TABLE OF CONTENTS I. Revisions to Florida Statutes Section II. Article written by Barry Nelson and Richard Gans Describing Inter Vivos QTIP Legislation III. White Paper on Proposed Revision to Florida Statutes Section IV. Example of Benefits of Using Inter Vivos QTIP Trusts Nelson 202

205 SECTION II - PART 2 SECTION I REVISIONS TO FLORIDA STATUTES IT IS HEREBY PROPOSED THAT SECTION , FLORIDA STATUTES, BE AMENDED TO READ AS FOLLOWS: Creditors' claims against settlor.-- (1) Whether or not the terms of a trust contain a spendthrift provision, the following rules apply: (a) The property of a revocable trust is subject to the claims of the settlor's creditors during the settlor's lifetime to the extent the property would not otherwise be exempt by law if owned directly by the settlor. (b) With respect to an irrevocable trust, a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or for the settlor's benefit. If a trust has more than one settlor, the amount the creditor or assignee of a particular settlor may reach may not exceed the settlor's interest in the portion of the trust attributable to that settlor's contribution. (c) Notwithstanding the provisions of paragraph (b), the assets of an irrevocable trust may not be subject to the claims of an existing or subsequent creditor or assignee of the settlor, in whole or in part, solely because of the existence of a discretionary power granted to the trustee by the terms of the trust, or any other provision of law, to pay directly to the taxing authorities or to reimburse the settlor for any tax on trust income or principal which is payable by the settlor under the law imposing such tax. (2) For purposes of this section: (a) During the period the power may be exercised, the holder of a power of withdrawal is treated in the same manner as the settlor of a revocable trust to the extent of the property subject to the power. (b) Upon the lapse, release, or waiver of the power, the holder is treated as the settlor of the trust only to the extent the value of the property affected by the lapse, release, or waiver exceeds the greater of the amount specified in: 1. Section 2041(b)(2) or s. 2514(e); or 2. Section 2503(b), but if the donor was married at the time of the transfer to which the transfer applies, twice the amount specified in Section 2503(b), of the Internal Revenue Code of 1986, as amended. 3. Subject to the provisions of s , for purposes of this section, the assets in: (a) a trust described in section 2523(e) of the Internal Revenue Code of 1986, or a trust for which the election described in section 2523(f) of the Internal Revenue Code of 1986 has been made; and (b) another trust, to the extent that the assets in the other trust are attributable to a trust described in (a), shall, after the death of the settlor s spouse, be deemed to have been contributed by the settlor s spouse and not by the settlor. Nelson 203

206 SECTION II - PART 2 SECTION II Steve Leimberg's Estate Planning Newsletter - Archive Message #1665 Date: 24-Jun-10 From: Steve Leimberg's Estate Planning Newsletter Subject: Nelson & Gans: Inter Vivos QTIP Legislation Approved in Florida As LISI has reported, the Florida Legislature has been quite busy lately. In LISI Estate Planning Newsletter #1659, Bruce Steiner described for members how Florida recently enacted legislation giving the courts flexibility in construing wills in the absence of a Federal estate tax or GST tax. See Florida Statutes & Now, Barry Nelson and Rick Gans report that the Florida Legislature recently amended the Florida Trust Code by adding Section (3), which clarifies that assets passing in trust for the settlor of a so-called Inter Vivos QTIP Trust, after the death of the settlor s spouse, are not considered to be held in a self settled trust, but only if the initial transfer was not a fraudulent conveyance under applicable law. Barry A. Nelson, a Florida Bar Board Certified Tax and Wills and Trusts and Estates Attorney, is a shareholder in the North Miami Beach law firm of Nelson & Nelson, P.A. He practices in the areas of tax, estate planning, asset protection planning, probate, partnerships and business law. He provides counsel to high net worth individuals and families focusing on income, estate and gift tax planning and assists business owners to most effectively pass their ownership interests from one generation to the next. He assists physicians, other professionals and business owners in tax, estate and asset protection planning. As the father of a child with autism, Mr. Nelson combines his legal skills with compassion and understanding in the preparation of Special Needs Trusts for children with disabilities. Mr. Nelson is a Fellow of the American College of Trust and Estate Counsel (ACTEC) and serves as Chairman of its Asset Protection Committee. He has been listed consecutively in The Best Lawyers in America since 1995 and is a Martindale-Hubbell AV-rated attorney. He has been listed as a top Florida attorney in Florida Super Lawyers since 2006, The South Florida Legal Guide since 2005, Florida Legal Elite from and in Chambers USA Mr. Nelson served as an adjunct professor for the University of Miami School of Law LL.M. in Taxation program from He served as an adjunct professor at the University of Miami s Graduate Department of Accounting from Barry is active in professional organizations and frequently serves as a consultant for other attorneys and certified public accountants on complex tax issues. He lectures extensively for the Florida Bar, Florida Institute of Certified Public Accountants (FICPA) and has presented at the University of Miami Heckerling Institute on Estate Planning, the Notre Dame Tax and Estate Planning Institute, the Southern Federal Tax Institute and the American College of Trusts and Estates Counsel (ACTEC). Mr. Nelson is a co-founder of the Victory Center for Autism and Behavioral Challenges (a not-for-profit corporation) and served as Board Chairman from He served as the Mayor of the Town of Golden Beach, Florida from Richard R. Gans is a shareholder in the Sarasota, Florida, firm of Fergeson, Skipper, Shaw, Keyser, Baron & Tirabassi, P.A Mr. Gans serves as the probate and trust column Nelson 204

207 SECTION II - PART 2 editor for The Florida Bar Journal. He is Chair of the RPPTL Section s Estate and Trust Tax Planning Committee, where he was primarily responsible for drafting Florida s disclaimer law, Chapter 739 of the Florida Statutes and Florida s insurable interest statute, F.S Mr. Gans also serves on the RPPTL IRA and Employee Benefits, Asset Preservation, and Charitable Organizations and Planning committees, and is a member of the Section s Executive Council. He is the author of the chapter IRA and Qualified Plan Benefits in The Florida Bar s volume entitled Asset Protection in Florida. Mr. Gans is a member and past President of the Southwest Florida Estate Planning Council, and of the Southwest Florida Planned Giving Council. He is Adjunct Professor at State College of Florida (formerly known as Manatee Community College), where he teaches the wills, trusts and estate course in SCF s paralegal certification program. Mr. Gans was appointed to CFO Alex Sink s Safeguard our Seniors task force, the goal of which is to promote legislation to protect Florida s citizens from financial exploitation. He speaks Mandarin Chinese. Mr. Gans is certified by The Florida Bar as a Board Certified Wills, Trusts and Estates Lawyer, and is a Fellow of the American College of Trust and Estate Counsel (ACTEC). Mr. Gans has been named in Florida SuperLawyers, as a Florida Trend Legal Elite, and as a Best Lawyer in America. Here is their commentary: EXECUTIVE SUMMARY: The Florida Legislature recently amended the Florida Trust Code by adding a provision clarifying that assets passing in trust for the settlor of a so-called Inter Vivos QTIP Trust, after the death of the settlor s spouse are not considered to be held in a self settled trust, but only if the initial transfer was not a fraudulent conveyance under applicable law. The new statute, which becomes effective July 1, 2010, follows the trend of similar provisions recently adopted in Arizona, Michigan, and Delaware. It enhances planning opportunities for legitimate asset protection for the benefit of the settlor of an Inter Vivos QTIP Trust and assures that assets, if held in further trust for the benefit of the settlor spouse after the death of the settlor s spouse, will not be subject to estate taxes upon the subsequent death of the settlor of the trust. FACTS: Background If and when federal estate taxes are reinstated, it will remain an important planning consideration that both husband and wife have sufficient assets to utilize their respective exemptions from the estate tax, whatever those exemptions may be. Estate planning and asset protection planning sometimes conflict. One common example of planning that may be favorable for estate tax savings and probate avoidance, but that may needlessly subject family wealth to creditor s claims, is the division of assets so each spouse owns, and has testamentary control over, approximately one-half of their combined wealth. If a spouse owns his or her share of the family s wealth in his or her own name, the assets comprising the share are not creditor-protected. Under the Uniform Trust Code, holding significant assets in a revocable trust does not enhance the situation because assets in a revocable trust are not protected from claims of the settlor s creditors. An alternative that Nelson 205

208 SECTION II - PART 2 is effective both for estate tax and asset protection planning is an Inter Vivos QTIP Trust. When assets are transferred to an Inter Vivos QTIP Trust, the assets in the trust generally are not subject to the claims of either the settlor s or the settlor s spouse s creditors, assuming the transfer to the trust was not a fraudulent conveyance as to the settlor. In addition, by virtue of the required election under Code Section 2523(f), the property in the Inter Vivos QTIP Trust is included in the gross estate of the settlor s spouse at his or her death under Code Section 2044(b)(1)(B). This, the Inter Vivos QTIP Trust allows for the funding of the spouse s estate tax exemption without exposing the trust assets to the claims of the spouse s creditors. Many settlors of Inter Vivos QTIP Trusts desire that upon the death of the settlor s spouse the assets remaining in the trust be held in further trust for the settlor s benefit, if he or she is living, rather than to be paid to or held in further trust for the settlor s children or other beneficiaries. If so structured, will the trust held for the benefit of the settlor after the death of his or her spouse be treated as a self- settled trust the assets of which can be reached by the settlor s creditors? For example, Florida Statutes Section (1)(b) provides that, with respect to an irrevocable trust, a creditor of the settlor can reach the maximum amount that could be distributed to or for the settlor s benefit. If the original settlor of the Inter Vivos QTIP Trust is also treated as the settlor of the trust for his her benefit after the death of the initial beneficiary spouse, under the Florida statute the settlor s creditors could reach the trust assets in satisfaction of their claims. If that is the case, the Inter Vivos QTIP Trust would not measure up as an estate planning and asset protection planning technique. If the creditors of the settlor of the trust can reach the assets held in trust for his or her benefit after the death of the spouse, those assets could be included in the settlor s estate under Code Section 2041, and the Inter Vivos QTIP will have resulted in no estate tax savings. Although Treasury Regulation Section (f)1(f), Example 11, provides that assets held in an Inter vivos QTIP Trust for the benefit of the settlor after the death of his or her spouse will not be includable in the settlor s taxable estate under Code Sections 2036 and 2038, this example does not address potential inclusion under Code Section As stated in an article written by Mitchell M. Gans, Jonathan G. Blattmachr, and Diana S. C. Zeydel: Is it nonetheless possible that the IRS could successfully argue that, because of the right of the wife s creditors to reach the trust s assets, she has a general power of appointment triggering inclusion in her estate under Code 2041? Although the QTIP regulations render Code 2036 and 2038 inapplicable in the wife s estate, they do not rule out the possible application of Code 2041.[1] The Treasury Regulations under Code Section 2523 and Example 11 do not address the question of whether estate tax inclusion could result under Code Section 2041 because the settlor s creditors can reach the assets held in a continuing trust after the death of the settlor s spouse. New Florida Statutes Section (3) resolves the question in Florida. Nelson 206

209 SECTION II - PART 2 New Florida Statutes Section (3) The statute provides as follows: (3) Subject to the provisions of s [This is a reference to Florida s fraudulent transfer statute], for purposes of this section, the assets in: (a) A trust described in s. 2523(e) of the Internal Revenue Code of 1986, as amended, or a trust for which the election described in s. 2523(f) of the Internal Revenue Code of 1986, as amended, has been made; and (b) Another trust, to the extent that the assets in the other trust are attributable to a trust described in paragraph (a), shall, after the death of the settlor s spouse, be deemed to have been contributed by the settlor s spouse and not by the settlor. If, as expected, Florida Statutes Section (3) is signed into law by the Governor, advisors can feel comfortable that the estate planning and asset protection benefits that Inter Vivos QTIP Trusts are intended to provide will be effective in Florida. For those in states without explicit legislation to the effect of the new Florida statute, there may be another solution. The terms of the Inter Vivos QTIP Trust may give the settlor s spouse a testamentary special power of appointment that can be exercised in favor of the settlor. If the donee spouse exercises the special power to create another trust for the settlor s benefit, it could be argued that the assets of the trust created by the exercise of the spouse s power of appointment will not be considered to be in a self- settled trust for the original settlor. However, in states that do not have laws similar to the new Florida statute, or other broader self-settled trust legislation, creditors could reasonably argue to the contrary: that the initial settlor was in fact the true settlor of the new trust created by the spouse s exercise of the power of appointment. The relation back doctrine gives lends support this argument. We have been unable to locate a case that applies the relation back doctrine to a matter similar to the QTIP trust planning described herein. In re, Estate of Wylie, an opinion addressing executor s fees stated: The relation back doctrine is nowhere better described than in the Restatement of the Law of Property: The donee of the power of appointment likewise has the power to create interest in other persons; but it is the underlying dogma of the law of power of appointment that such interest constitutes transfers from the donor of the power, not from the donee. 3 Restatement of Property (1940) 318 Comment (b)[2]. Once enacted in Florida, four states will have statutes clarifying the tax and asset protection benefits of Inter Vivos QTIP Trusts. Other states should consider enacting similar legislation. COMMENT: Nelson 207

210 SECTION II - PART 2 Inter Vivos QTIP Trusts can provide very effective tax planning and asset protection benefits, but only if there is certainty about the rights of the creditors of the initial settlor in the trust assets. Florida may be the best state in which to create such a trust, if a sufficient nexus exists to invoke Florida law.[3] Once the new statute takes effect, it will create certainty that the assets will not be subject to the creditors of the initial donor spouse; combine this with the fact that Florida has no state income or intangible taxes and you may have an unbeatable combination. Inter Vivos QTIP Trusts that can continue in trust for the benefit of the initial settlor after the death of a spouse can provide the following benefits: 1) Transfer of assets to the trust will reduce the settlor s taxable estate and enable the beneficiary spouse to take fuller advantage of the estate tax exemptions at the spouse s death. 2) The assets transferred to the Inter Vivos QTIP Trust can be protected from the claims of creditors of the both the settlor and the settlor s spouse. 3) Through the terms of the agreement creating the Inter Vivos QTIP Trust, the settlor can control the disposition of the trust assets. If desired, the settlor can assure that the trust assets will be continued in trust for his or her benefit after the death of the beneficiary spouse in a creditor-protected trust not subject to estate taxes at the subsequent death of the settlor. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Barry Nelson Rick Gans CITE AS: LISI Estate Planning Newsletter #1665 (June 24, 2010) at Copyright 2010 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. CITES: Florida Statutes Section (3) CITATIONS: [1] Mitchell M. Gans, Jonathan G. Blattmachr, & Diana S.C. Zeydel, Supercharged Credit Shelter Trust, 21PROBATE &PROP. 52, 64 (July/August 2007). [2] For a more thorough analysis of the relation back doctrine see Barry A. Nelson, Asset Protection for Estate Planners, Address at the 43rd Annual Heckerling Institute on Estate Planning (Jan. 2009), in 43rd Annual Heckerling Institute on Estate Planning at 18 (Matthew Bender, Pub., 2009). [3] See Fla. Stat Copyright 2010 Leimberg Information Services Inc. Nelson 208

211 SECTION II - PART 2 SECTION III WHITE PAPER ON PROPOSED REVISION TO FLORIDA STATUTES SECTION Real Property, Probate and Trust Law Section of The Florida Bar I. SUMMARY The proposed legislation is the product of study and analysis by The Estate and Trust Tax Planning Committee (the Committee ) of the Real Property, Probate and Trust Law Section of The Florida Bar (the RPPTL Section ). The Asset Preservation Committee of the RPPTL Section was also involved. The proposed legislation would amend Florida Statutes Section by adding new Sub-section (3) to provide that, for purposes of Florida Statutes Section , assets contributed to an inter vivos marital trust that are treated as qualified terminable interest property under Section 2523(f) of the Internal Revenue Code of 1986, as amended (the Code ), or to an inter vivos marital trust that is treated as a general power of appointment trust under Code Section 2523(e), are deemed to have been contributed by the settlor s spouse (and not the settlor) even if the settlor is a beneficiary of the trust following the death of the settlor s spouse; provided that the initial transfer is not a fraudulent conveyance (based upon Florida Statutes Section ). Therefore, assuming the initial transfer to the trust was not a fraudulent conveyance, the assets held for the benefit of the initial settlor after the death of his or her spouse would not be subject to Florida Statutes Section (1)(b), which, if applicable, would allow the settlor s creditors to reach the trust assets. II. CURRENT SITUATION Irrevocable inter vivos trusts created under Code Section 2523(e), known as general power of appointment trusts, and under Code Section 2523(f), known as qualified terminable interest property trusts, or QTIP trusts, will be used with greater frequency as a result of the increase in the federal estate tax exemption to $3.5 million for the year 2009 (and beyond?). In order for a married couple to take full advantage of the estate tax exemption, each spouse must have sufficient assets at his or her date of death. Under current law, the exemptions are not portable, so if one spouse underutilizes his or her exemption, the surviving spouse cannot enhance his or her estate tax exemption with any unused portion of the exemption of the first spouse to die. Many planners suggest the use of inter vivos QTIP trusts to allow for the full use of the donee spouse s estate tax exemption without compromising the ability of the donor spouse to control the disposition of the trust assets after the donee spouse s death. The assets in the inter vivos QTIP trust will benefit the donor s beneficiaries after the death of the donee spouse, and not the donee spouse s beneficiaries. To the extent of the estate tax exemption, assets in the inter vivos QTIP trust will pass free of estate and (probably) generation-skipping transfer taxes upon the death of the donee spouse. In some situations, the settlor of the trust will not take advantage of the estate planning benefits of a QTIP trust unless the trust is structured so that he or she could be a beneficiary of the trust if the settlor s spouse predeceases. Commonly, the inter vivos QTIP trust gives the donee spouse a non-general power to appoint the assets among the settlor s descendants and the settlor. This can be done without sacrificing the tax planning objectives sought to be accomplished by the trust. If the settlor has sufficient assets of his or her own, the QTIP trust assets can pass to the children of the initial settlor upon the death of the donee spouse. However, if the donee spouse believes that the donor may be in need of the assets in the QTIP trust, the spouse can exercise his or her testamentary power of appointment in favor of the donor, Nelson 209

212 SECTION II - PART 2 typically to create a trust that will not be included in the taxable estate of the initial settlor for gift and estate tax purposes. In this case, the donor spouse s creditors may argue that the donor was in fact the settlor of the new trust created by the exercise of the donee spouse s power of appointment. If this were so, under Florida Statutes Section (1)(b), the assets in the trust created by the exercise of the spouse s power of appointment would be considered as held for the benefit of the donor in a self-settled trust, and would not be protected from the claims of the donor s creditors after the donee spouse s death. There is theoretical support for this approach under the so-called relation back doctrine. 1 Other states have addressed this issue by providing broad creditor protection for certain self-settled trusts. 1 Arizona 1 and Michigan 1 have enacted legislation providing that the settlor of an inter vivos QTIP trust is not treated as the settlor of any trust created at the donee spouse s death for the benefit of the initial settlor. Florida law is presently unclear on this point; this uncertainty has a chilling effect on the use of this otherwise very effective planning technique. Florida residents who want a predictable outcome are forced to create inter vivos QTIP trusts in states, such as Arizona, that provide greater protection from the initial settlor s creditors. III. EFFECT OF PROPOSED CHANGES (DETAILED ANALYSIS OF PROPOSED REVISIONS) The legislative proposal would amend Florida Statutes Section to provide, in effect, assuming the initial transfer into the trust was not a fraudulent transfer under Florida Statutes Section , that, upon the death of the donee spouse, the donor of an inter vivos QTIP trust will not be treated as the settlor of that trust, but rather the settlor s spouse (the initial donee spouse) shall be deemed to have contributed the assets to such trust. Thus, the provisions of Section (1)(b) which provide that the creditors of the settlor of an irrevocable trust can reach the maximum amount that can be distributed to or for the settlor's benefit will not apply to the inter vivos QTIP trust because the donor will not be treated as the settlor of the trust upon the death of the initial donee spouse for purposes of the statute. Creditors rights, property interests and transfer taxes are frequently inter-related. An outcome as to one of these three areas frequently dictates the outcome of the other two; for example, if certain property is treated as subject to one s creditors, it is also treated as being owned by that person for purposes of transfer taxes. For example, Treasury Regulations Section (f)-1(f), Example 11 entitled Retention by donor spouse of income interest in property (as summarized below) provides that trust assets will not be includible in the settlor s estate under Code Section 2036 or 2038 in the following case: Settlor creates a trust with income payable to the Settlor s spouse for her life, and upon the spouse s death, income to the Settlor for his life, with the trust corpus payable to the Settlor s children upon the Settlor s death. If the Settlor elected to treat the trust property as qualified terminable interest property under Code Section 2523(f), the trust corpus will be includible in his spouse s estate at her death in accordance with Code Section Under Code Section 2044(c), property included in a decedent s estate under Code Section 2044 is treated as property passing from the decedent for estate and gift tax purposes. Therefore, the Settlor s spouse is treated as the transferor [i.e., the owner] of the trust property for estate and gift tax purposes. Thus, when the Settlor dies, the property will not be included in his estate. 1 Nelson 210

213 SECTION II - PART 2 The proposed legislation brings the Florida creditor protection aspects of the type of inter vivos QTIP trust discussed above in line with the federal tax treatment of the trust. Under the proposed legislation, a settlor who establishes a Code Section 2523(e) inter vivos trust, or a trust as to which the QTIP election under Code Section 2523(f) is made, and who, upon the death of the settlor s spouse, becomes a beneficiary of the trust, will not be treated as the settlor of the trust for purposes of Florida Statutes Section Instead, the initial settlor s spouse will be treated as the settlor of the trust, just as the donee spouse is treated as the owner of the trust assets for federal tax purposes. If the donor spouse simply gives his or her spouse assets through an outright gift, and if, after the donee spouse s death, those assets are used to fund a spendthrift trust for the benefit of the surviving spouse, few would take seriously the proposition that the assets in the trust would be subject to the donor / surviving spouse s creditors. 1 There is nothing about an inter vivos general power of appointment or QTIP trust that compels a different result. Finally, assuming the initial transfer was not fraudulent as to present and future creditors under Florida Statutes Section , if the assets in the inter vivos marital QTIP or general power of appointment trust held for the initial settlor after the donee spouse s death are subject to the claims of the settlor s creditors, the favorable result provided in Treasury Regulations Section (f)-1(f) may be inapplicable. If the assets of a trust settlor can be reached by the settlor s creditors, those assets will likely be included in his or her estate for federal estate tax purposes, which entirely defeats one of the primary purposes of establishing the trust. There is no compelling benefit to be derived by putting Floridians at such an estate tax planning disadvantage. IV. FISCAL IMPACT ON STATE AND LOCAL GOVERNMENTS Adoption of this legislative proposal by the Florida Legislature should not have a fiscal impact on state and local governments; rather, it should be revenue neutral. V. DIRECT IMPACT ON PRIVATE SECTOR The proposed legislation will lend clarity to an uncertain area of the law, and will enable Floridians to obtain finality and predictability of results in connection with a useful estate planning technique. VI. CONSTITUTIONAL ISSUES The Committee believes that the legislative proposal does not violate any of the provisions of the Constitution of the State of Florida or of the United States Constitution. VII. OTHER INTERESTED PARTIES Other groups that may have an interest in the legislative proposal include the Tax Section of The Florida Bar and the Florida Bankers Association. Nelson 211

214 SECTION II - PART 2 Exhibit 1 Bob and Judy Tenancy by the Entireties Plan House Protected Homestead Brokerage TOTAL Bob s Gross Estate Assuming He Dies First MARITAL DEDUCTION Bob Judy T by E $3.5 M $10 M $13.5 M Bob s Taxable Estate $0 Bob s Tax $0 $6.75 M $6.75 M Bob Judy T by E UPON JUDY S DEATH Judy s Gross Estate $13.5 M Less Unified Credit Equivalent Amount ($3.5 M) Judy s Taxable Estate $10 M Judy s Tax $4.5 M Assets subject to creditors while both married and living $0 Assets subject to creditors upon death of 1 st spouse or divorce $10 M Nelson 212

215 SECTION II - PART 2 Exhibit 2 Bob and Judy CPA s Tax Savings Plan Bob s Revocable Trust Judy s Revocable Trust T by E House Protected Homestead $3.5 M Brokerage $5 M $5 M TOTAL $5 M $5 M $3.5 M Bob s Gross Estate Assuming He Dies First $6.75 M Bob s Share of Homestead to Judy Outright ($1.75 M) Marital Trust ($1.5 M) MARITAL DEDUCTION $3.25 M Bob s Taxable Estate $3.5 M Less Unified Credit Equivalent Amount ($3.5 M) Bob s Tax $0 UPON JUDY S DEATH Judy s Gross Estate Bob s Revocable Trust $10 M Less Unified Credit Equivalent Amount ($3.5 M) Judy s Taxable Estate Judy s Tax Savings Compared to Tenancy by the Entireties $6.5 M $2.925 M $1.575 M Judy s Revocable Trust Homestead Judy s Rev Trust Marital Trust $3.5 M $ 5 M $1.5 M Assets subject to creditors while both married and living Assets subject to creditors upon death of 1 st spouse or divorce Assuming assets pass into spendthrift trust for surviving spouse upon death of 1 st spouse T by E $10 M $5 M Nelson 213

216 SECTION II - PART 2 Exhibit 3 Bob and Judy Inter Vivos QTIP Bob s QTIP Judy s QTIP T by E House Protected Homestead $3.5 M Brokerage $5 M $5 M TOTAL $5 M $5 M $3.5 M Bob s Gross Estate $6.75 M Assuming He Dies First Bob s Share of Homestead ($1.75 M) to Judy s Marital Deduction QTIP Marital Gift to Judy ($1.5 M) MARITAL DEDUCTION $3.25 M Bob s Taxable Estate $3.5 M Less Unified Credit Equivalent Amount ($3.5 M) Bob s Tax $0 Bob s QTIP Judy s QTIP T by E UPON JUDY S DEATH Homestead $3.5 M Marital Trust $1.5 M QTIP Trust from Bob $5 M Judy s Gross Estate $10 M Less Unified Credit Equivalent Amount ($3.5 M) Judy s Taxable Estate $6.5 M Judy s Tax $2.925 M Savings Compared to Tenancy by the Entireties $1.575 M Assets subject to creditors while both married and living $0 Assets subject to creditors upon death of first spouse or divorce $0 M Nelson 214

217 SECTION II - PART 2 Exhibit 4 Comparison of Benefits of Inter Vivos QTIP Winner & New Tenancy by the Entirety Plan Tax Plan Champion (QTIP Plan) Technique T by E Tax Savings Plan Funded Inter Vivos QTIP Securities Protected While Both Living $10 M $0 $10 M Securities Protected Upon Death of 1st Spouse $0 $5 M $10 M Tax Paid Upon Death of Spouse $4.5 M $2.925 M $2.925 M* * Tax savings compared to tenants by the entirety plan = $1,575,000, Nelson 215

218 SECTION II - PART 3 SOLOW-WHAT NOT TO DO: A PYRAMID OF ETHICAL ASSET PROTECTION POSSIBILITIES Introduction The January 2010 case of Jamie L. Solow ( Solow ) 1 should serve as a lesson to the estate planning community, or at the very least, encourage lawyers to rethink some of their asset protection planning techniques. The facts and timing of transfers in SEC v. Solow are suspect. Defendant Solow engaged in a fraudulent trading scheme involving inverse floating rate collateralized mortgage obligation, and subsequently, the Securities and Exchange Commission ( SEC ) obtained a jury verdict convicting Solow of violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5; Section 17(a) of the Securities Act of The jury verdict was rendered on January 31, 2008, and four days later, Solow s wife, Gina P. Solow, retained a law firm specializing in asset protection to execute a $1,187,500 mortgage on the couple s Fort Lauderdale residence and a $5,261,289 mortgage on their Hillsboro Beach residence. 3 Attached as Exhibit 1 is a timeline highlighting the significant events that occurred between the date of commencement of Solow s jury trial, his incarceration for contempt and his eventual release from prison subject to court ordered supervision.. The final judgment, issued on May 14, 2008, found Solow liable for disgorgement of 4 $2,646,485.99, together with prejudgment interest of $778,302.91, for a total of $3,424, The final judgment stated that Solow was liable for disgorgement of $2,646, representing profits gained as a result of the conduct alleged in the Complaint, together with prejudgment interest amounting to $778, When Solow didn't pay the judgment, the SEC filed an "Order to Show Cause why Defendant Jamie L. Solow" should not be held in contempt of court on June 4, 2009, alleging that Solow purposefully dissipated his assets in order to avoid paying the court s final judgment. 5 The court, in an opinion issued on January 14, 2010, by Judge Donald M. Middlebrooks, found Solow to be in Contempt of Court and ordered him to surrender to U.S. Marshals and be taken into custody by January 25, Judge Middlebrooks' opinion stated: disgorgement operate[s] to wrest ill-gotten gains from the hands of a wrongdoer, he stated that the [c]ourt has broad equitable powers to reach assets protected by state law to satisfy a disgorgement, Solow s contention that he was unable to pay the amounts ordered to the Court were disingenuous at best because the facts indicated that [b]etween January and April, 2008, Mr. Solow and his wife liquidated securities accounts totaling $1,546, Solow surrendered himself into custody on February 1, 2010, and remained incarcerated until June 4, He was released by court order dated June 4, 2010, attached as Exhibit 2. Solow also provides reasons to support those attorneys who have distaste for asset protection planning. However, Solow is extreme and follows prior cases where aggressive asset protection planning 9 was initiated after a judgment or shortly before. The following materials distinguish Solow's planning from the types of asset protection recommendations that are clearly ethical and are time tested. Based 1 SEC v. Solow, 682 F. Supp. 2d 1312 (S.D. Fla. 2010). See Gideon Rothschild, Rothschild on Solow- Another Asset Protection Planning Case Holding Debtor in Contempt, (Steve Leimberg's Asset Protection Planning Newsletter #151) Apr. 28, 2010, available at 2 Id. at Id. at Id. at 1314, Id. at Id. at Id. at , SEC v. Solow, Order Modifying Order of Civil Contempt and Directing Release from Incarceration, CIV-Middlebrooks/Johnson at 1 (S.D. Fla. June 4, 2010). 9 FTC v. Affordable Media, LLC, 179 F.3d 1228 (9th Cir. 1999). For a case history on the Stephen Lawrence litigation, see In re Lawrence, 279 F.3d 1294 (11th Cir. 2002); Lawrence v. Chapter 7 Trustee (In re Lawrence), 251 B.R. 630 (Bankr. S.D. Fla. 2000); Lawrence v. Goldberg (In re Lawrence), 244 B.R. 868 (Bankr. S.D. Fla. 2000); In re Lawrence, 238 B.R. 498 (Bankr. S.D. Fla. 1999); In re Lawrence, 235 B.R. 498 (Bankr. S.D. Fla. 1999); Goldberg v. Lawrence, 227 B.R. 907 (Bankr. S.D. Fla. 1998); In re Lawrence, 217 B.R. 658 (Bankr. S.D. Fla. 1998). Nelson 216

219 SECTION II - PART 3 upon the Solow facts, many attorneys would have concerns about commencing an asset protection engagement for the Solows. Yet, in fairness to the attorney who represented the Solows with their asset protection plan, if the court had accepted the argument that the tenancy by the entirety property owned by the debtor was already protected under Florida law, then the Solow s transfers from tenancy by the entirety to a foreign trust may not have been fraudulent based upon Sneed v. Davis. 10 A Practical Approach to Asset Protection A well planned estate combines asset protection and estate planning techniques so clients maintain significant protected assets during their lifetime, and at the same time, achieve gift and estate tax savings during life and upon death. These techniques are best illustrated through the following "Pyramids of Planning Possibilities analysis first presented at the 43rd Annual Heckerling Institute on Estate Planning in 2009, and attached as Exhibit 3. The pyramids below describe the categories of clients who may request, either directly or indirectly, legal advice for asset protection planning. Tier 1 is the stereotypical client who calls either just before or after a large judgment or after an auto accident, unanticipated complications or death after a medical procedure, or similar event where, while there may be no law suit filed, we all know what is coming. In these situations, certain (but not as comprehensive) asset protection planning can be initiated even on the eve of a bankruptcy proceeding (e.g., making sure potential future inheritance of debtor is restructured so it passes to an asset protected spendthrift trust for the debtor rather than outright to the debtor). Ethical Planning TIER 1 Existing mega judgment Protect debtor s potential inheritance via spendthrift or discretionary ry trust (e.g. wills, life insurance,, IRAs) from others.. Secure currently exempt assets such as tenants by the enti re ty to pre vent asset enhancement upon dea th of non-debtor joint owner (e.g. death of non-debtor). Transfer opportunities for future profits Fla. 271 (Fla. 1938). The Florida Supreme Court held that conversion from one exempt asset to another form should not be considered a fraudulent conveyance. Nelson 217

220 SECTION II - PART 3 Ethical Planning TIER 1 Consider spend down of assets of debtor spouse to pay family expenses, bank income from nondebtor spouse, at a t least for expenses relating to both spouses. Examine applicable domestic spendthrift trust t law to determine whether creditor claims such as child support, alimony, or tort claims can effecti vel y be paid from a trus t created by others for the beneficiary. Note: A transfer of exempt assets to another exempt form is not equivalent to a fraudulent transfer. A sale, gift or other disposition of property which is by law absolutely exempt from the payment of the owner's debts cannot be impeached by the creditors as in fraud of their rights. Creditors have no right to complain of dealings with property which the law does not allow them to apply on their claims, even though such dealings are with a purpose to hinder, delay or defraud them. 11 However, in In re Rasmussen, 12 the first case after the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 that addressed this issue, the court stated in dicta that homestead value acquired by a debtor from money attributable to exempt assets is not exempt if the homestead property was acquired within 1,215 days of filing for bankruptcy. The Rasmussen opinion states: "The only exception to the $125,000 cap is for money derived and rolled over from the sale of a prior homestead within the state The court then asserted that homestead value acquired by the debtor from money in excess of the exempt amount, other than a prior homestead, is not exempt Sneed v. Davis, 135 Fla. 271, 276 (Fla., 1938). See also Wolkowitz v. Beverly, 374 B.R. 221 (Bankr. App. 9th Cir., 2007); In re Goldberg, 229 B.R. 877 (Bankr. S.D. Fla., 1998); In re Kimmel, 131 B.R. 223 (Bankr. S.D. Fla., 1991); Dean v. Heimbach, 409 So. 2d 157 (Fla. 1st DCA 1982). 12 In re Rasmussen, 349 B.R. 747 (Bankr. M.D. Fla., 2006). 13 Id. at For a more in depth discussion of Rasmussen, see Barry A. Nelson, Rasmussen Court Allows Both Spouses $125,000 Exemptions and Protects Appreciation Within 1,215 Days of Bankruptcy, FLA.BAR J., (Jan. 2007). Nelson 218

221 SECTION II - PART 3 Ethical Planning PLANNING Try to quantify exposure so clients conveyances nces do not result t in insolvency. n Use Tier 1 planning Use Tier 3 planning provided no fraudulent conveyances and client remains solvent. TIER 2 An existing or pending liability exists, but exposure is uncertain. Consider obtaining an opinion from attorney or appraiser (e.g. bank s appraisers) to document projected exposure. Value e real es tate to de te rmine ra tios of value to debt under exis ting market condition. If still solvent, consider planning. Planning in Tier 2 is less certain, but is does not appear that where a potential liability exists (whether or not the actual amount of liability is ascertainable) a potential debtor should be prohibited from planning with assets not anticipated to be necessary to satisfy the debt. Any decisions are likely to be scrutinized after the fact and the closer in time to the actual determination of the amount of the judgment the more likely that any planning after a potential claim exists may be set aside. Fraudulent Conveyance, 15 as defined under Fla. Statute section (1), is: a transfer made or obligation incurred by a debtor, whether the creditor's claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation: (1) With actual intent to hinder, delay or defraud any creditors; or (2) Without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor: (a) was engaged or was about to engage in a business or transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or (b) intended to incur, or believed, or reasonably should have believed that he would incur, debts beyond his ability to pay as they became due In addition, Florida Statute section provides the definition and treatment of Fraudulent Conversions. 16 Fla. Stat (1). Nelson 219

222 SECTION II - PART 3 Ethical Planning DIVERSIFY PLANNING Oh the techniques you can use when planning starts with a clean slate - no existing debt or contingent claims! TIER 3 No known existing or contingent creditors. The best asset protection plan is one where no claims are filed to test the structures that are put in place. Planning in Tier 3 highlights this advantage as where no known existing or contingent creditors exist, the techniques and planning possibilities are endless. Conclusion The Solow case is a prime example of the slogan: failure to plan is a plan to fail. Jamie Solow was doomed not only by his fraudulent conduct and SEC violations, but also by his subsequent postjudgment actions through his aggressive asset protection plan. The pyramids described above and the discussion of ethics included in Gideon Rothschild's materials provide an effective roadmap of how to avoid outcomes like Solow and Lawrence which have resulted in incarceration of debtors and ethical concerns with respect to attorneys. Nelson 220

223 SECTION II - PART 3 EXHIBIT 1 Timeline of Events in SEC v. Solow November 9, 2007 From this date until the commencement of the jury trial, Jamie Solow and his wife Gina P. Solow received deposits totaling $576, into their joint bank account at Bank of America ("BofA"). November 13, 2007 From this date until January 16, 2008, Mr. Solow paid his counsel $275,000 from the joint BofA account. The account was also used to pay the following expenses: $33, to Fettes College; $35, to American Express; $17, to Capital One; $27, to Lydian Bank; and $43, to Arbern for Jamie Solow's office rental. December 4, 2007 Mr. Solow signed a bill of sale for a 2004 Rolls Royce Phantom for $205,000 as "Vice President and Duly Authorized Agent of JSolow Limo, Inc." January 2, 2008 The Solows deposited a $46, cashiers check into their checking account. January 8, 2008 Highland Financial Group, Inc. ("Highland") wired an additional $400,000 to the same account. January 22, 2008 Civil trial commenced January 31, 2008 Civil trial ended and jury returned verdict. February 4, 2008 Mrs. Solow retains a law firm, Donlevy-Rosen & Rosen, P.A. ("Donlevy-Rosen Firm"), specializing in asset protection using offshore trusts in the Cook Islands. February 7, 2008 First of three transactions ("Checking Account Transactions") in which a total of $820,000 was deposited into the Solows checking account from Highland and Arlene Zayas, the wife of Highland's principal officer. February 8, 2008 The Commission filed, and served upon Solow's counsel, its motion for remedies, seeking judgment for penalties, disgorgement, and prejudgment interest totaling $6,214, February 11, 2008 Mrs. Solow pays the Donlevy-Rosen Firm $30,000 in legal fees and $5,350 for a "cost deposit" out of the Solow's joint checking account. February 12, 2008 $36,000 was transferred from the Solows' joint account at BofA into an account in the name of Gina P. Solow, and $27, was paid to Lydian Bank for the mortgage on the Hillsboro property. February 29, 2008 The second of the three Checking Account Transactions described above. Another series of transactions takes place. ("POD Account Transactions"). In these transactions, the Solows transfer $777,000 from their joint checking account to a checking account titled in the name of "Gina Pearl Solow POD Jamie Leigh Solow" (the "POD Account"). March 5, 2008 The Solows paid $556,632 to the Internal Revenue Service. *SEC v. Solow, 682 F. Supp. 2d 1312, (S.D. Fla. 2010). Timeline through December 23rd 2009, is taken from the Opinion issued January 14 th 2010 Nelson 221

224 SECTION II - PART 3 March 7, 2008 The third of the three Checking Account Transactions described above. By a corporate consent ("Corporate Consent") backdated to be effective March 3, 2008, Mrs. Solow authorizes a series of transaction that result in a $1,187,500 mortgage being placed on their Ft. Lauderdale residence in exchange for a certificate of deposit in the same amount to be assigned to the Gina P. Solow Trust, a Cook Islands International Trust. Mrs. Solow paid Donlevy-Rosen Firm $123, for a "Recording/Documentary Stamp." March 10, 2008 Second of the "POD Account Transactions." March 24, 2008 Mrs. Solow executes a mortgage on their Ft. Lauderdale residence in the amount of $1,187,500. Mr. and Mrs. Solow execute a mortgage on their Hillsborow Beach residence in the amount of $5,261,289. The lender for these two mortgages is the Federation Advances Corp., a Nevis limited liability company identified in the Cook Islands Trust scheme. April 8, 2008 Third of the "POD Account Transactions." April 9, 2008 The Court holds an evidentiary hearing on remedies to be imposed against Mr. Solow. April 18, 2008 Ms. Zayas transferred $279, to the POD account. Ms. Zayas also transferred $73, into the Solows' joint account at BofA. That same day, a check for $74,200 drawn on the Solows' joint account at BofA was written to Mr. Solow's attorney. April 21, 2008 Mrs. Solow visits bankers in Zurich, Switzerland for the purpose of depositing cash and jewelry in safe deposit accounts. April 23, 2008 Mrs. Solow transfers $50,000 from the POD account to an account in Mrs. Solow's name at Washington Mutual Bank. April 25, 2008 Jamie Solow deposited a cashier's check in the amount of $9,900 payable to himself into the Solows' joint account at BofA. April 28, 2008 Mrs. Solow transfers $20,000 from the POD account to an account in Mrs. Solow's name at Northern Trust Bank. May 7, 2008 Mrs. Solow transfers $4,900 from the Solow's joint checking account to the POD account, leaving $20.00 in the joint checking account. May 20, 2008 Mrs. Solow s their accountant requesting he provide a statement to Mr. Solow's attorney that "due to [Mr. Solow's] high expenses, he has depleted his asset base and savings." The accountant declined to make that statement. May 14, 2008 Final Judgment Issued September 10, 2008 office furniture. Mr. Solow made a partial payment of $ toward the judgment from the sale of December 3, 2008 Mr. Solow made a partial payment of $2, toward the judgment from the sale of a 2001 Ford Expedition titled to Jamie Solow. Mr. Solow made a third partial payment of $ derived from a US Treasury refund to JSolow Enterprises, Inc. August 14, 2009 First Show Cause Hearing. Nelson 222

225 SECTION II - PART 3 December 23, 2009 Mr. Solow attempts to access his children's accounts and his IRA account. January 14, 2010 Mr. Solow is found in contempt of court. February 1, 2010 Mr. Solow surrendered to the Bureau of Prisons for incarceration. June 4, 2010 Mr. Solow is released from incarceration. Nelson 223

226 SECTION II - PART 3 Case 9:06-cv DMM Document 213 Entered on FLSD Docket 06/04/2010 Page 1 of 2 Nelson 224

227 SECTION II - PART 3 Case 9:06-cv DMM Document 213 Entered on FLSD Docket 06/04/2010 Page 2 of 2 Nelson 225

228 SECTION II - PART 3 RECENT CHANGES IN CASE-LAW RELATED TO ASSET PROTECTION STRATEGIES 1) In re: Gorny, 2008 Bankr. LEXIS 3726 (Bankr. M.D. Fla. Aug. 29, 2008). In In re: Gorny, the debtor and his non-debtor wife filed a joint income tax return. The debtor listed the refund from the IRS as exempt tenants by the entirety property. It was held in In re: Freeman, 387 B.R. 871 (Bankr. M.D. Fla. 2008) and In re: Hinton, 378 B.R. 371 (Bankr. M.D. Fla. 2007) that married couples can own tax refunds as tenants by the entirety. The court held that the refund met the six unity requirements for tenants by the entirety (possession, interest, title, time, survivorship, and marriage) as set out in Beal Bank, and therefore the tax refund is exempt as tenants by the entirety property. However, the bankruptcy trustee may administer the tax refund for the benefit of the debtor and his wife s joint creditors. 2) In re: Earnest, 21 Fla. L. Weekly Fed. B 770 (Bankr. M.D. Fla. Mar. 26, 2009). In In re: Earnest, the Bankruptcy Court in the Middle District of Florida relied on the ruling in Davis to sustain the debtors homestead exemption claim for real property located outside a municipality on which the debtors had their residence, a warehouse (used for the debtors business) and another commercial building the debtors rented out. A fence was erected to separate the commercial part of the property from the residential; however, the county s comprehensive plan prohibited real property from being subdivided. Citing In re: Davis v. Davis, 864 So. 2d 458 (Fla. 1st DCA 2003), the Bankruptcy Court held that the limitation of the exemption to the residence of a debtor only applies to property within a municipality. Where the property is located outside a municipality, so long as it is less than 160 acres, both residential and commercial property is deemed exempt from creditors under Florida s homestead protection provisions. 3) In re: Pellegrino, 2009 U.S. Dist Lexis (S.D. Fla. May 15, 2009). In In re: Pellegrino, the debtor, a doctor that owned his own practice, claimed certain accounts were exempt from creditors reach as they are wage accounts. After review of account records, the Court determined that money taken did not appear to be wages and therefore the wages claimed as exempt were not exempt. Instead the money seems to be passive income and then was later deposited into a joint account with his mother which also tainted those accounts. Interestingly the debtor did take a W-2 showing the money as wages; however, the trustee was able to prove that this was merely a label and not reality. The court noted that an important factor was the fact that the debtor did not have an Employment Agreement, which appears to be a favorable factor for maintaining this exemption. 4) In re: Underwood, 22 Fla. L. Weekly Fed. B 202 (Bankr. M.D. Fla. Sept. 29, 2009). In In re: Underwood, a joint tax return refund was deposited half in the non-debtor-spouse s account and half in a joint account of the couple. The couple contended that the joint account was for survivorship purposes only, and the funds therein were not transferred to the debtor-spouse. The Court explained that since joint tax return refunds were tenancy by the entirety property ab initio, the transfer to the non-debtor spouse s account could not be a fraudulent transfer. The Court added that the debtor did not try to conceal the transfer, supporting the position that it was not an attempt to fraudulently convey the funds. 5) Pajares v. Donahue, 33 So. 3d 700 (Fla. 4th DCA 2010). In Pajares v. Donahue, the Florida Fourth District Court of Appeals ruled that where the decedent specifically instructed in her will for the personal representative to sell her homestead property and divide the proceeds to her beneficiaries, the homestead lost its protected status. Citing McKean v. Warburton, 919 So. 2d 341, 344 (Fla. 2005) (citation omitted), the Court emphasized that where the will directs the homestead be sold and the proceeds added to the estate, those proceeds are applied to satisfy the specific, general, and Nelson 226

229 SECTION II - PART 3 residual devises, in that order. Accordingly, the Pajares Court concluded that the proceeds from the sale of the homestead property would be subject to creditors claims. 6) In re: Williams, 427 B.R. 541 (Bankr. M.D. Fla. 2010). In In re: Williams, a mother transferred, by warranty deed, her home to her son, the debtor, subject to a life estate in herself. The son lived in the home with his wife and mother, as his primary residence, received mail there and had the address on his driver s license. The debtor asserted homestead protection applied against his creditors. The bankruptcy trustee argued that, since the son only held a remainder interest, the exemption does not apply. The Court disagreed, allowing the exemption in reliance upon the definition of property owned by a natural person, which the Court emphasized is the standard under Article X, Section 4 of the Florida Constitution. The Court held that since property in which a debtor holds a vested remainder is property owned by a natural person within the meaning of the Constitutional exemption, the exemption must be upheld. 7) In re: Ard, 2010 Bankr. LEXIS 2659 (Bankr. M.D. Fla. Aug. 18, 2010). In In re: Ard, the debtor filed a Chapter 7 Bankruptcy Petition, claiming that an IRA she inherited from her father was exempt from creditor s claims under Florida Statute (2). The bankruptcy trustee filed an objection and the court sustained the trustee s objection to the extent that the value of debtor s personal property exceeded the amount allowed pursuant to Florida Statute (1), (4), and Florida Constitution Article X, 4 (a)(2). The court found that money in the debtor s IRA was not exempt from creditors claims because the debtor was not the transferor s spouse. The court specifically found compelling the case of Robertson v. Deeb, 16 So. 3d 936 (Fla. 2d DCA 2009), among other cases, which similarly held that (2)(a) does not exempt an inherited IRA from the claims of a garnishing creditor of the non-spouse beneficiary. Nelson 227

230 SECTION III FLOWCHART ANALYSIS OF PREFERRED ESTATE AND ASSET PROTECTION HOLDINGS By Barry A. Nelson, Esq. NELSON & NELSON, P.A Sunny Isles Boulevard, Suite 118 North Miami Beach, Florida T F Nelson 228

231 SECTION III: Flowchart Analysis of Preferred Estate and Asset Protection Holdings Nelson 229