Presenting a live 90-minute webinar with interactive Q&A Estate Tax Planning Opportunities in 2012 Maximizing Benefits Under Current Gift and Estate Tax Law: Portability, Lifetime Exemptions, Trust Use and More WEDNESDAY, AUGUST 1, 2012 1pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Steven J. Oshins, Member, Law Offices of Oshins & Associates, Las Vegas Robert S. Keebler, Partner, Keebler & Associates, Green Bay, Wis. Stephen J. Bigge, Partner, Keebler & Associates, Green Bay, Wis. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
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2012 Estate Tax Issues Robert S. Keebler, CPA, MST, AEP (Distinguished) 420 S. Washington St. Green Bay, WI 54301 Phone: (920) 593-1701 E-mail: robert.keebler@keeblerandassociates.com Stephen J. Bigge, CPA, CSEP 420 S. Washington St. Green Bay, WI 54301 Phone: (920) 593-1702 E-mail: stephen.bigge@keeblerandassociates.com Presented by: Steven J. Oshins, Esq., AEP (Distinguished) Oshins & Associates, LLC 1645 Village Center Circle, Suite 170 Las Vegas, NV 89134 Phone: (702) 341-6000 E-mail: soshins@oshins.com Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication, including attachments, was not written to be used and cannot be used for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. If you would like a written opinion upon which you can rely for the purpose of avoiding penalties, please contact us.
Course Outline 2010 Tax Relief Act Overview Portability Issues Estate Planning Opportunities in 2012 Other Planning Considerations Impact of Potential Future Legislation 6
2010 Tax Relief Act Overview 7
2010 Tax Relief Act Overview Summary of New Law On December 17, 2010, the President signed Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 ( 2010 Tax Relief Act ) into law Key estate/gift tax law provisions Reinstatement of estate and GST tax Higher exemption amounts Lower tax rates Portability of estate tax exemption 8
2010 Tax Relief Act Overview 2009 2010 (Prior Law) 2010 (New Law) 2011 2012 Top Estate Tax Rate 45% 0% 35% 35% 35% Exemption $3,500,000 N/A $5,000,000 $5,000,000 $5,120,000 Date-of-Death Basis Increase YES NO YES (unless estate tax is not elected) YES YES Carryover Basis NO YES NO (unless estate tax is not elected) NO NO Note: Under the current law in 2013 the exemption reverts to $1,000,000 9
2010 Tax Relief Act Overview Estate Tax 2011 Exemption = $5,000,000 Top marginal tax rate = 35% 2012 Exemption = $5,120,000 Top marginal tax rate = 35% 2013 (assuming no Congressional action) Exemption = $1,000,000 Top marginal tax rate = 55% 10
2010 Tax Relief Act Overview Gift Tax 2011 Exemption = $5,000,000 Top marginal tax rate = 35% 2012 Exemption = $5,120,000 Top marginal tax rate = 35% 2013 (assuming no Congressional action) Exemption = $1,000,000 Top marginal tax rate = 55% 11
2010 Tax Relief Act Overview Generation-Skipping Transfer (GST) Tax 2011 Exemption = $5,000,000 Top marginal tax rate = 35% 2012 Exemption = $5,120,000 Top marginal tax rate = 35% 2013 (assuming no Congressional action) Exemption = $1,000,000 (indexed for inflation) Top marginal tax rate = 55% 12
2010 Tax Relief Act Overview Portability of Estate Tax Exemption Allows the executor to either utilize the decedent s $5,000,000 estate tax exclusion amount or to transfer it to the decedent s surviving spouse However, the new law does not allow the decedent to transfer his/her unused GST tax exemption to the surviving spouse 13
Portability Issues 14
Portability Issues Overview Under the 2010 Tax Relief Act, in 2011 and 2012 an executor can either utilize a decedent s estate tax exclusion amount ($5,000,000 in 2011, $5,120,000 in 2012) or to transfer it to the decedent s surviving spouse 15
Portability Issues Key Concepts Basic Exclusion Amount (BEA) Deceased Spousal Unused Exclusion Amount (DSUEA) Last Deceased Spouse Privity 16
Portability Issues Basic Exclusion Amount (BEA) Prior to 2011, the basic exclusion amount for estate tax purposes (i.e. the portion of a decedent s estate exempt from estate tax) was referred to as the applicable exclusion amount In simple terms, the BEA is the minimum estate tax exclusion amount allowed for a single decedent In 2011, the BEA is $5,000,000 In 2012, the BEA is $5,120,000 Like the prior applicable exclusion amount, the BEA is reduced by prior taxable gifts 17
Portability Issues Deceased Spousal Unused Exclusion Amount (DSUEA) Beginning with the 2011 tax year, a decedent no longer needs to utilize his/her applicable exclusion amount (now BEA). Instead, the deceased spouse may transfer his/her unused estate tax exclusion to his/her surviving spouse (i.e. Deceased Spousal Unused Exclusion Amount or DSUEA) The DSUEA cannot exceed the lesser of the following: The BEA (i.e. $5,000,000 in 2011; $5,120,000 in 2012) OR The excess of: The BEA of the last deceased spouse of the surviving spouse, over The amount on which the tentative tax on the estate of the last deceased spouse is determined 18
Portability Issues Last Deceased Spouse At a decedent s (D2 s) death, if the decedent s spouse (D1) predeceased him/her and that decedent (D1) did not use his/her estate tax exclusion, the surviving decedent (D2) may be permitted to take advantage of the predeceased spouse s (D1 s) unused exemption (i.e. DSUEA) To assure that the decedent s (D2 s) estate will only benefit from one such DSUEA, and to provide clarity as to which DSUEA can be utilized, only the DSUEA of the last deceased spouse can be used In other words, the surviving decedent s estate cannot pick which prior decedent spouse s DSUEA to use 19
Portability Issues Last Deceased Spouse Example H1 and W1 are married at the time H1 s death in 2011. Although H1 s taxable estate is $5,000,000, the executor of H1 s estate transfers the entire estate to W1 (via the unlimited marital deduction) and elects to transfer H1 s entire estate tax exclusion amount ($5,000,000) to W1 (i.e. DSUEA). W1 then marries H2. In 2012, H2 dies with a taxable estate of $3,000,000, whereby the executor of H2 s estate chooses to utilize $3,000,000 of H2 s $5,120,000 estate tax exclusion amount. Based on these facts, the DSUEA available to W1 is $2,120,000 (i.e. H2 s remaining estate tax exclusion amount). 20
Privity The use of the DSUEA requires marriage. Thus, a spouse of a surviving spouse cannot use that surviving spouse s prior DSUEA if the surviving spouse dies before the taxpayer in question Portability Issues In other words, a decedent cannot aggregate the DSUEAs of prior deceased spouses 21
Portability Issues Privity Example H1 and W1 are married at the time H1 s death in 2011. The executor of H1 s estate transfers the entire estate to W1 (via the unlimited marital deduction) and elects to transfer H1 s entire estate tax exclusion amount ($5,000,000) to W1 (i.e. DSUEA). W1 then marries H2. In 2012, W1 dies with a taxable estate of $3,000,000, whereby the executor of W1 s estate chooses to utilize $3,000,000 of W1 s $5,120,000 estate tax exclusion amount. Based on these facts, the DSUEA available to H2 is $2,120,000 (i.e. H2 s remaining estate tax exclusion amount). 22
Privity Example (cont.) While W1 had a $10,120,000 total estate tax exclusion amount ($5,000,000 DSUEA from H1 + $5,120,000 BEA), only $3,000,000 was used Of the $3,000,000 estate tax exclusion that was used, the entire amount was attributable to W1 s BEA Therefore, only $2,120,000 of W1 s total estate tax exclusion amount (i.e. $5,120,000 BEA - $3,000,000 BEA used) may be utilized by H2 Portability Issues It is important to note that the remaining $5,000,000 estate tax exclusion amount (passing from H1 to W1) is completely lost and cannot be used by H2 23
Portability Issues Indexing of Basic Exclusion Amount (BEA) Beginning with the 2012 tax year, the basic exclusion amount (BEA) will be indexed for inflation Thus, in 2012 the BEA will be $5,120,000 However, the deceased spousal unused exclusion amount (DSUEA) does not get indexed for inflation 24
Portability Issues Key Issues Election to transfer the unused estate tax exemption amount must be made on a timely-filed estate tax return No election can be made on a late-filed return Statute of limitations remains open for the decedent spouse s estate tax return until the statute of limitations has run on the surviving spouse s estate tax return The adequate disclosure rules (applying to post-1997 gifts) does not apply Thus, the IRS can audit the deceased spouse s estate tax return (even after the normal statute of limitations has run) and add any increase in tax to the surviving spouse s estate tax return 25
Portability Issues Tax Return Filing Issue If the filing of an estate tax return (IRS Form 706) is not otherwise required for the decedent s estate, not filing a timely and complete estate tax return will effectively prohibit the surviving spouse s use of the decedent unused exemption. 26
Portability Issues Opt Out Issues If the executor of the decedent s estate chooses not to transfer the decedent s estate tax exclusion to the surviving spouse, for transfer tax purposes the executor should then do one of the following: Attach a statement to the Form 706 indicating that the decedent s estate is not making the election under IRC 2010 (c)(5); OR Enter NO ELECTION UNDER SECTION 2010(c)(5) across the top of the first page of IRA Form 706 27
Portability Issues Recordkeeping Issues Estate tax returns making the portability election, along with all supporting documentation should be saved indefinitely because of the unlimited statute Track any last deceased spouse s unused exemption amount and its use to document how much was used and when. Use of GST exemption will have to be monitored carefully since it will differ from the use of estate exemption since GST is not portable When practitioners are preparing gift tax returns they should expressly inquire as to whether any DSUEAs exist and document the existence or lack of any It may be advisable to attach a schedule to any gift tax return listing the source of all prior DSUEAs and their use to assure that the records are available and not lost 28 28
Portability Issues Analyzing the Portability Election Utilizing the estate tax exemption at first spouse s death vs. transferring the exemption to the surviving spouse Size of combined estate Anticipated growth of the surviving spouse s estate Changes in the future estate tax law Asset protection issues Additional basis step-up of property in surviving spouse s taxable estate Malpractice risks for advisors 29
Portability Issues Analyzing the Portability Election Example #1 John and Jane have a combined estate of $5,000,000. Assume that John dies first and that, at Jane s death, the value of the total estate is worth $6,000,000. OPTION 1-100% Marital Deduction OPTION 2 - Utilize Full Exemption at First Death John Jane TOTAL John Jane TOTAL FMV of Gross Estate $ 3,000,000 $ 2,000,000 $ 5,000,000 $ 3,000,000 $ 2,000,000 $ 5,000,000 Marital Deduction (3,000,000) 3,000,000 - - - - Subtotal $ - $ 5,000,000 $ 5,000,000 $ 3,000,000 $ 2,000,000 $ 5,000,000 Appreciation in Gross Estate at Second Death - 1,000,000 1,000,000-400,000 400,000 Subtotal $ - $ 6,000,000 $ 6,000,000 $ 3,000,000 $ 2,400,000 $ 5,400,000 Less: Estate Tax Exemption - (10,000,000) (10,000,000) (3,000,000) (7,000,000) (10,000,000) Net Taxable Estate $ - $ - $ - $ - $ - $ - FMV of Property at Second Death $ - $ 6,000,000 $ 6,000,000 $ 3,600,000 $ 2,400,000 $ 6,000,000 Less: Cost Basis - (6,000,000) (6,000,000) (3,000,000) (2,400,000) (5,400,000) Net Capital Gain $ - $ - $ - $ 600,000 $ - $ 600,000 Estate Tax @ 35% $ - $ - $ - $ - $ - $ - Capital Gains Tax @ 15% - - - 90,000-90,000 Total Taxes $ - $ - $ - $ 90,000 $ - $ 90,000 30
Portability Issues Analyzing the Portability Election Example #2 Mike and Mary have a combined estate of $10,000,000. Assume that Mike dies first and that, at Mary s death, the value of the total estate is worth $12,000,000. OPTION 1-100% Marital Deduction OPTION 2 - Utilize Full Exemption at First Death Mike Mary TOTAL Mike Mary TOTAL FMV of Gross Estate $ 5,000,000 $ 5,000,000 $ 10,000,000 $ 5,000,000 $ 5,000,000 $ 10,000,000 Marital Deduction (5,000,000) 5,000,000 - - - - Subtotal $ - $ 10,000,000 $ 10,000,000 $ 5,000,000 $ 5,000,000 $ 10,000,000 Appreciation in Gross Estate at Second Death - 2,000,000 2,000,000-1,000,000 1,000,000 Subtotal $ - $ 12,000,000 $ 12,000,000 $ 5,000,000 $ 6,000,000 $ 11,000,000 Less: Estate Tax Exemption - (10,000,000) (10,000,000) (5,000,000) (5,000,000) (10,000,000) Net Taxable Estate $ - $ 2,000,000 $ 2,000,000 $ - $ 1,000,000 $ 1,000,000 FMV of Property at Second Death $ - $ 12,000,000 $ 12,000,000 $ 6,000,000 $ 6,000,000 $ 12,000,000 Less: Cost Basis - (12,000,000) (12,000,000) (5,000,000) (6,000,000) (11,000,000) Net Capital Gain $ - $ - $ - $ 1,000,000 $ - $ 1,000,000 Estate Tax @ 35% $ - $ 700,000 $ 700,000 $ - $ 350,000 $ 350,000 Capital Gains Tax @ 15% - - - 150,000-150,000 Total Taxes $ - $ 700,000 $ 700,000 $ 150,000 $ 350,000 $ 500,000 31
Portability Issues Planning Considerations What should moderate wealth taxpayers consider? This will be the most complex and difficult strata of clients to plan for State estate tax in decoupled states (e.g. only $1 million exemption in New York) will remain a substantial cost Inflation may push their estates above the thresholds for taxation 2013 may really bring a $1M exclusion Wait and see may translate into Wait and pay Creative and flexible planning, with a more economical price tag will be the winning approach Asset protection and related concerns for this wealth strata may be significant 32
Portability Issues Planning Considerations Few clients will really care Only 5,600 estate tax returns/year will be due and pay a federal tax in 2011-2012 Moderate wealth clients are the main portability planning target: Consider all the pros/cons of bypass versus portability planning State estate tax in decoupled states, e.g. $1 million in exemptions Client tolerance for planning cost and complexity will be lower Income tax planning (maximizing income tax basis step up) will be significant if unlikely to face a federal estate tax 33
Portability Issues Planning Considerations Asset protection Physicians and other mid-wealth clients worried about asset protection have a historic opportunity to shift wealth into protective structures No state death taxes Less concern about bypass trust planning if safely under federal exemption Large IRAs Portability will certainly help families with large IRAs. The spousal rollover will continue to be an option. 34
Estate Planning Opportunities in 2012 35
Estate Planning Opportunities in 2012 Lifetime gifting Grantor Retained Annuity Trust (GRAT) Dynasty trust Intentionally Defective Grantor Trust (IDGT) Installment sales Self-Canceling Installment Note (SCIN) 36
Estate Planning Opportunities in 2012 Lifetime Gifting Annual Exclusion Gifts Each year a taxpayer may gift up to a specified amount ($13,000 in 2012) to another person (a.k.a. donee ) without the gift being subject to gift tax This transfer is referred to as an annual exclusion gift For married taxpayers, the annual exclusion gift per each donee is basically doubled (i.e. $26,000 per donee in 2012) Neither the gift, nor the future appreciation on the gift is included in the taxpayer s gross estate 37
Estate Planning Opportunities in 2012 Lifetime Gifting Annual Exclusion Gift Example A married couple makes annual exclusion gifts to their three children. The table below illustrates the total amount that is removed from their combined gross estate over a period of time: Total Wealth Removed From Gross Estate* 0% Growth Rate 4% Growth Rate 8% Growth Rate Year 5 $ 390,000 $ 422,473 $ 457,595 Year 10 $ 780,000 $ 936,476 $ 1,129,952 Year 20 $ 1,560,000 $ 2,322,690 $ 3,569,433 *NOTE: Assumes the annual exclusion gift amount of $13,000 does not change 38
Estate Planning Opportunities in 2012 Lifetime Gifting Lifetime Gift Exemption Gifts During a taxpayer s lifetime, he/she may make taxable gifts (i.e. gifts that exceed the annual exclusion gift amount) up to a specified amount ($5,120,000 in 2012) without having to pay gift tax This transfer is referred to as an lifetime gift exemption gift For married taxpayers, the aggregate lifetime gift tax exemption is basically doubled (i.e. $10,240,000 in 2012) 39
Estate Planning Opportunities in 2012 Lifetime Gifting Lifetime Gift Exemption Gift Example A single taxpayer makes a $5,000,000 taxable gift to a trust for the benefit of his children. The table below illustrates the total amount that is removed from the taxpayer s gross estate over a period of time: Total Wealth Removed From Gross Estate 0% Growth 4% Growth 8% Growth Rate Rate Rate Year 5 $ 5,000,000 $ 6,083,265 $ 7,346,640 Year 10 $ 5,000,000 $ 7,401,221 $ 10,794,625 Year 20 $ 5,000,000 $ 10,955,616 $ 23,304,786 40
Estate Planning Opportunities in 2012 Lifetime Gifting Tax-Exclusive Nature of Gift Tax To the extent that a taxpayer makes a gift in excess of his/her annual exclusion gift amount and his/her lifetime gift tax exemption amount, he/she will incur a gift tax The gift tax due on the taxable gift (in excess of the lifetime gift tax exemption amount) is calculated on a tax-exclusive basis In this case, the gift tax is calculated only on the value of the amount transferred (i.e. the gift) For estate tax purposes, the estate tax is calculated not only on the value of the amount transferred, but also the tax that is paid n the transfer (i.e. tax inclusive ) The post-gift future appreciation is not included in the taxpayer s gross estate 41
Estate Planning Opportunities in 2012 Lifetime Gifting Tax-Exclusive Nature of Gift Tax Example Estate Tax Gift Tax Total Taxable Estate / Gift $ 10,000,000 $ 10,000,000 Effective Tax Rate* 35.00% 25.93% Total Tax $ (3,500,000) $ (2,592,593) Savings $ - $ 907,407 * Effective Gift Tax Rate = 35%/135% 42
Estate Planning Opportunities in 2012 Lifetime Gifting Estate Inclusion Issue To the extent that a taxpayer pays gift tax on a taxable gift, his/her gross estate must include the value of the gift tax paid if the taxpayer dies within 3 years of the gift The effect is to gross up the taxpayer s gross estate as if the original gift didn t take place 43
Estate Planning Opportunities in 2012 Grantor Retained Annuity Trust (GRAT) A Grantor Retained Annuity Trust (GRAT) is a type of trust that benefits the grantor s future generations (i.e. children) without the imposition of estate or gift tax To the extent that the actual rate of return on the trust s assets exceeds the IRS s rate (a.k.a. IRC 7520 rate), the excess is transferred to the trust s beneficiaries free of any estate and/or gift tax All income earned by the trust is taxed to grantor because the trust is defective for income tax purposes, thus allowing for a tax-free gift to the trust s beneficiaries NOTE: The IRC 7520 rate for May 2012 is 1.6% 44
Estate Planning Opportunities in 2012 Grantor Retained Annuity Trust (GRAT) Overview Grantor (Lead Beneficiary) Transfer of assets Annuity payments over a fixed term GRAT Payment of gift tax on present value of remainder interest transferred to children (should be at or near $0) At end of term, any residual assets remaining in the trust pass to the children free of any gift tax IRS Children* (Remainder Beneficiaries) * Instead of naming the children as outright remainder beneficiaries of the GRAT, a grantor trust could be used (thus producing a greater estate tax benefit) 45
Estate Planning Opportunities in 2012 Grantor Retained Annuity Trust (GRAT) Example Year Assumptions FMV of assets transferred $10,000,000 IRC 7520 rate 1.60% Term (years) 10 Annual % increase in periodic payment 0% Payment period Annually Payment timing End of period Beginning Balance Taxable Income Annual 10.00% Payment Ending Balance 1 $ 10,000,000 $ 1,000,000 $ (1,090,096) $ 9,909,904 2 $ 9,909,904 $ 990,990 $ (1,090,096) $ 9,810,798 3 $ 9,810,798 $ 981,080 $ (1,090,096) $ 9,701,782 4 $ 9,701,782 $ 970,178 $ (1,090,096) $ 9,581,864 5 $ 9,581,864 $ 958,186 $ (1,090,096) $ 9,449,955 6 $ 9,449,955 $ 944,995 $ (1,090,096) $ 9,304,854 7 $ 9,304,854 $ 930,485 $ (1,090,096) $ 9,145,244 8 $ 9,145,244 $ 914,524 $ (1,090,096) $ 8,969,672 9 $ 8,969,672 $ 896,967 $ (1,090,096) $ 8,776,543 10 $ 8,776,543 $ 877,654 $ (1,090,096) $ 8,564,102 BENEFIT: $8,564,102 transferred to beneficiaries estate/gift tax-free 46
Estate Planning Opportunities in 2012 Grantor Retained Annuity Trust (GRAT) Why GRAT Works Payment of trust income taxes by the grantor Valuation adjustments Difference between actual rate of return and IRC 7520 rate 47
Estate Planning Opportunities in 2012 Grantor Retained Annuity Trust (GRAT) Advantages Annuity payments provide income stream to the grantor Ability to make gifts of substantial amounts of property tax-free Grantor pays income tax on trust income, leaving more assets in the GRAT for remainder beneficiaries Reduces the taxable estate of the grantor Valuation adjustments increase effectiveness of sale for estate tax purposes 48
Estate Planning Opportunities in 2012 Grantor Retained Annuity Trust (GRAT) Disadvantages If the grantor dies before the end of the GRAT term, the assets in the GRAT are included in the grantor s estate The remainder beneficiaries will have the same basis in the property transferred to the GRAT as the grantor had at the time the property was transferred (no step-up in basis) Risk that rate of return will not exceed interest rate resulting in no assets being transferred to remainder beneficiaries 49
Estate Planning Opportunities in 2012 Dynasty Trust A dynasty trust is a type of trust which benefits multiple generations where none of the assets held by the trust are included in either the grantor s taxable estate or any of the beneficiaries taxable estates. However, under the tax law, whenever a transfer is made by the grantor to a skip person (e.g. grandchild, great-grandchild, etc.) or a trust for their benefit (e.g. dynasty trust), a second level of tax is imposed on the transfer (in addition to gift tax) Notwithstanding, a grantor is allowed a lifetime GST exemption on the first $5,120,000 of taxable transfers to skip persons 50
Estate Planning Opportunities in 2012 Dynasty Trust Overview Grantor Advantages Creditor protection Divorce protection Estate tax protection Direct decedent protection Spendthrift protection Consolidation of capital * Gift should take advantage of any remaining lifetime gift exclusion and lifetime GST exclusion Gift* No transfer tax paid. No transfer tax paid. No transfer tax paid. No transfer tax paid. Dynasty Trust Discretionary Distributions to Children for Life Discretionary Distributions to Grandchildren for Life Discretionary Distributions to Great-Grandchildren for Life Future Generations 51
Estate Planning Opportunities in 2012 Dynasty Trust Estate Erosion Example W ealth of Parents $ 1,000,000 $ 1,000,000 $ 1,000,000 Estate Tax Rate 35% 35% 35% Estate Tax $ 350,000 $ 350,000 $ 350,000 W ealth of Children $ 650,000 $ - $ - Estate Tax Rate 35% 35% 35% Estate Tax $ 227,500 $ - $ - W ealth of Grandchildren $ 422,500 $ 650,000 $ - Estate Tax Rate 35% 35% 35% Estate Tax $ 147,875 $ 227,500 $ - Wealth of Great-Grandchildren $ 274,625 $ 422,500 $ 650,000 % of Original Wealth Passing to Great-Grandchildren 27.4625% 42.2500% 65.0000% 52
Estate Planning Opportunities in 2012 Dynasty Trust Estate Tax Savings Example 5% Growth 7% Growth 9% Growth Value of Trust in 20 years $ 13,266,489 $ 19,348,422 $ 28,022,054 Estate Tax Savings @ 45% $ 5,969,920 $ 8,706,790 $ 12,609,924 Value of Trust in 40 years $ 35,199,944 $ 74,872,289 $ 74,872,289 Estate Tax Savings @ 45% $ 15,839,975 $ 33,692,530 $ 33,692,530 Value of Trust in 60 years $ 93,395,929 $ 289,732,134 $ 880,156,460 Estate Tax Savings @ 45% $ 42,028,168 $ 130,379,460 $ 396,070,407 Value of Trust in 80 years $ 247,807,205 $ 1,121,171,938 $ 4,932,758,341 Estate Tax Savings @ 45% $ 111,513,242 $ 504,527,372 $ 2,219,741,253 Initial investment of $5,000,000 53
Estate Planning Opportunities in 2012 Intentionally Defective Grantor Trust (IDGT) An Intentionally Defective Grantor Trust (IDGT) is a type of dynasty trust where all income earned by the trust is taxed to the grantor because the trust is defective for income tax purposes, thus allowing for a tax-free gift to the trust s beneficiaries. 54
Estate Planning Opportunities in 2012 Installment Sale to IDGT A type of transaction whereby a grantor sells a highlyappreciating asset to an IDGT in exchange for an installment note To the extent that the growth rate on the assets sold to the IDGT is greater than the interest rate on the installment note taken back by the grantor, the excess is passed on to the trust beneficiaries free of any gift, estate and/or GST tax No capital gains tax is due on the installment sale and no income tax is due on the interest paid because the trust is defective for income tax purposes 55
Estate Planning Opportunities in 2012 Installment Sale to IDGT Overview Grantor Gift & sale of highlyappreciating assets Installment note(s) IDGT Discretionary distributions of income and principal during the lifetime of the trust s beneficiaries Assets outside of the taxable estates of beneficiaries Children, Grandchildren, Great-Grandchildren & Future Generations 56
Estate Planning Opportunities in 2012 Installment Sale to IDGT May 2012 AFRs Short-Term AFR (3 years or less).28% Mid-Term AFR (over 3 years, up to 9 Years) 1.30% Long-Term AFR (over 9 years) 2.89% 57
Estate Planning Opportunities in 2012 Installment Sale to IDGT Example Year Assumptions FMV of assets transferred $10,000,000 Interest rate (AFR) 2.89% Term (years) 10 Payment structure Interest-only w/balloon payment Payment period Annually Payment timing End of period Beginning Balance Taxable Income Annual 10.00% Payment Ending Balance 1 $ 10,000,000 $ 1,000,000 $ (289,000) $ 10,711,000 2 $ 10,711,000 $ 1,071,100 $ (289,000) $ 11,493,100 3 $ 11,493,100 $ 1,149,310 $ (289,000) $ 12,353,410 4 $ 12,353,410 $ 1,235,341 $ (289,000) $ 13,299,751 5 $ 13,299,751 $ 1,329,975 $ (289,000) $ 14,340,726 6 $ 14,340,726 $ 1,434,073 $ (289,000) $ 15,485,799 7 $ 15,485,799 $ 1,548,580 $ (289,000) $ 16,745,379 8 $ 16,745,379 $ 1,674,538 $ (289,000) $ 18,130,916 9 $ 18,130,916 $ 1,813,092 $ (289,000) $ 19,655,008 10 $ 19,655,008 $ 1,965,501 $ (10,289,000) $ 11,331,509 BENEFIT: $11,331,509 transferred to beneficiaries estate/gift tax-free 58
Estate Planning Opportunities in 2012 Installment Sale to IDGT Why IDGT Sale Works Back end-loading of installment payments Payment of trust income taxes by the grantor Valuation adjustments Difference between actual rate of return and AFR 59
Estate Planning Opportunities in 2012 Installment Sale to IDGT Advantages Freezes value of appreciation on assets sold in the grantor s taxable estate at the low interest rate on the installment note payable No capital gains tax due on installment sale Interest income on installment note is not taxable to the grantor Grantor pays income tax on trust income, leaving more assets in the IDGT for remainder beneficiaries 60
Estate Planning Opportunities in 2012 Installment Sale to IDGT Disadvantages Estate inclusion of note if grantor dies during term of installment note No step-up in basis at grantor s death Trust income taxable to grantor during his/her life could cause a cash flow problem if there is not sufficient income earned by the grantor Possible gift and estate tax exposure if insufficient assets are used to fund the trust Possible taxable gift for amount of loan Possible estate inclusion under retained life estate rules 61
Estate Planning Opportunities in 2012 Self-Canceling Installment Note (SCIN) Transaction similar to an ordinary installment sale to an IDGT Cancellation-at-death feature added to note Premium must be paid, either in the form of additional principal or increased interest rate to compensate for the cancellation-at-death feature OBJECTIVE: Reduction of estate tax if premature death occurs 62
Estate Planning Opportunities in 2012 Self-Canceling Installment Note (SCIN) Interest Rates SINGLE LIFE Total Interest Rate Age 1 Age 2 JOINT LIFE Total Interest Rate Age SCIN Risk Premium AFR SCIN Risk Premium AFR 50 0.667% 2.890% 3.557% 50 50 0.040% 2.890% 2.930% 55 1.043% 2.890% 3.933% 55 55 0.094% 2.890% 2.984% 60 1.591% 2.890% 4.481% 60 60 0.208% 2.890% 3.098% 65 2.424% 2.890% 5.314% 65 65 0.453% 2.890% 3.343% 70 3.843% 2.890% 6.733% 70 70 1.028% 2.890% 3.918% 75 6.194% 2.890% 9.084% 75 75 2.280% 2.890% 5.170% Assumptions Interest Rate (AFR) 2.89% Term (years) 10 Payment structure Interest-only w/balloon payment Payment period Annually Payment timing End of period 63
Estate Planning Opportunities in 2012 SCIN Sale to IDGT Example (65-Year-Old Seller) Year Assumptions FMV of assets transferred $10,000,000 Interest rate (AFR + mortality risk premium) 5.314% Term (years) 10 Payment structure Interest-only w/balloon payment Payment period Annually Payment timing End of period Beginning Balance Taxable Income Annual 10.00% Payment Ending Balance 1 $ 10,000,000 $ 1,000,000 $ (531,400) $ 10,468,600 2 $ 10,468,600 $ 1,046,860 $ (531,400) $ 10,984,060 3 $ 10,984,060 $ 1,098,406 $ (531,400) $ 11,551,066 4 $ 11,551,066 $ 1,155,107 $ (531,400) $ 12,174,773 5 $ 12,174,773 $ 1,217,477 $ (531,400) $ 12,860,850 6 $ 12,860,850 $ 1,286,085 $ (531,400) $ 13,615,535 7 $ 13,615,535 $ 1,361,553 $ (531,400) $ 14,445,688 8 $ 14,445,688 $ 1,444,569 $ (531,400) $ 15,358,857 9 $ 15,358,857 $ 1,535,886 $ (531,400) $ 16,363,343 10 $ 16,363,343 $ 1,636,334 $ (10,531,400) $ 7,468,277 BENEFIT: $7,468,277 transferred to beneficiaries estate/gift tax-free 64
Estate Planning Opportunities in 2012 SCIN Sale to IDGT Why SCIN Sale to IDGT Works Back end-loading of installment payments Payment of trust income taxes by the grantor Valuation adjustments Cancellation-at-death feature Difference between actual rate of return and risk-adjusted AFR 65
Estate Planning Opportunities in 2012 SCIN Sale to IDGT Advantages Future appreciation above the note interest rate, including the risk premium, is removed from the grantor s estate Asset not included in grantor s estate in case of premature death during SCIN term Value of assets transferred out greatly exceeds value of payments coming back into the estate of the grantor if he/she passes away prematurely No gain or loss on sale Trust income taxable to grantor allows for greater appreciation to inure to future generations, thereby creating an additional tax-free gift 66
Estate Planning Opportunities in 2012 SCIN Sale to IDGT Disadvantages Complex calculation of risk premium Possible gift tax exposure if SCIN risk premium is inadequate Possible gift tax exposure if trust is insufficiently funded Possible estate inclusion under retained life estate rules No step-up in basis at grantor s death Possible acceleration of capital gain at grantor s death Trust income taxable to grantor during his/her life could cause a cash flow problem if there is there is not sufficient income earned by the grantor Possible upstream transfer if the grantor survives the term of note (or lives a significant portion of the term) 67
Estate Planning Opportunities in 2012 Comparison of Estate Planning Opportunities Example #1 Net Wealth to Family (Seller/Annuitant Dies Midway Through Term) $16,000,000 $14,969,612 $14,000,000 $12,000,000 $10,000,000 $8,000,000 $6,000,000 $10,468,315 $10,468,315 $11,987,569 No Planning GRAT Sale to IDGT SCIN to IDGT $4,000,000 $2,000,000 $0 Year 10 *Assumptions FMV of Assets Transferred $10,000,000 IRC 7520 Rate 1.60% AFR 2.89% Term / Life Expectancy 10 Years Payment Frequency Annually Type of Payment (Installment Note/SCIN) Interest Only with Balloon Payment Age of Seller / Annuitant 65 Estate Tax Rate 35% 68
Estate Planning Opportunities in 2012 Comparison of Estate Planning Opportunities Example #2 Net Wealth to Family (Seller/Annuitant Survives Term) $25,000,000 $20,000,000 $19,856,762 $20,825,354 $19,473,223 $16,859,326 $15,000,000 No Planning GRAT Sale to IDGT $10,000,000 SCIN to IDGT $5,000,000 $0 Year 10 *Assumptions FMV of Assets Transferred $10,000,000 IRC 7520 Rate 1.60% AFR 2.89% Term / Life Expectancy 10 Years Payment Frequency Annually Type of Payment (Installment Note/SCIN) Interest Only with Balloon Payment Age of Seller / Annuitant 65 Estate Tax Rate 35% 69
Other Planning Considerations 70
Other Planning Considerations Irrevocable Life Insurance Trust (ILIT) Lifetime Qualified Terminable Interest Property (QTIP) Trust 71
Other Planning Considerations Irrevocable Life Insurance Trust (ILIT) A Irrevocable Life Insurance Trust (ILIT) is a type of trust which holds a life insurance policy on the grantor s life so as to benefit the grantor s children (and/or grandchildren and/or future generations) without the imposition of future estate, gift and/or GST tax To the extent that the grantor s estate has insufficient liquid assets to cover the estate tax liability, trust assets can be lent to the estate or used to purchase assets from the estate To the extent that the grantor does not hold any incidents of ownership, none of the trust assets will be included in his/her taxable estate 72
Other Planning Considerations Irrevocable Life Insurance Trust (ILIT) Overview Grantor (Insured) Annual gifts to cover life insurance premiums ILIT (Beneficiary) Payment of premiums Payment of death benefit proceeds at death of insured Life Insurance Company Discretionary distributions of income and principal during the lifetime of the trust s beneficiaries Children, Grandchildren & Future Generations Assets outside of the taxable estates of beneficiaries 73
Other Planning Considerations Irrevocable Life Insurance Trust (ILIT) Example #1 Internal Rate of Return (IRR) Example Year Death Benefit Cumulative Premium IRR 1 $ 1,000,000 $ 20,000 4900.00% 5 $ 1,000,000 $ 100,000 131.78% 10 $ 1,000,000 $ 200,000 33.22% 15 $ 1,000,000 $ 300,000 15.60% 20 $ 1,000,000 $ 400,000 8.80% 25 $ 1,000,000 $ 500,000 5.34% 74
Other Planning Considerations Irrevocable Life Insurance Trust (ILIT) Example #2 Estate Inclusion vs. ILIT Example OPTION 1 - Insurance Held Within Estate OPTION 2 - Transfer Insurance to ILIT Death Benefit (i.e. Estate Estate Tax Total Premiums (i.e. Gift Tax (@ Tax Year Inclusion) (@ 45%) Taxable Gifts) 45%) Savings 5 $ 1,000,000 $ 450,000 $ 100,000 $ 45,000 $ 405,000 15 $ 1,000,000 $ 450,000 $ 300,000 $ 135,000 $ 315,000 20 $ 1,000,000 $ 450,000 $ 400,000 $ 180,000 $ 270,000 25 $ 1,000,000 $ 450,000 $ 500,000 $ 225,000 $ 225,000 * This analysis assumes the entire lifetime gift tax exemption has been used on other prior taxable gifts and that the annual gift exclusion is not available. Further, this analysis assumes that the estate tax exemption is used for other assets included in the grantor s taxable estate. 75
Other Planning Considerations Lifetime QTIP Trust A Qualified Terminable Interest Property (QTIP) Trust is a type of trust which allows a person (i.e. grantor) to provide his/her spouse with a stream of income (and principal, if needed) during that spouse s lifetime At the spouse s death, the QTIP Trust assets pass to the grantor s named remainder beneficiaries (e.g. grantor s children) Thus, a QTIP Trust helps ensure that the grantor s intended beneficiaries are not disinherited Further, using a reverse QTIP election allows for the grantor to take advantage of his/her entire GST exemption 76
Other Planning Considerations Lifetime QTIP Trust Overview Grantor 1) Transfer of assets QTIP Trust 2) Mandatory distributions of income (and discretionary distributions of principal) to spouse during lifetime Spouse 3) At spouse s death, the QTIP Trust s remaining assets pass to the remainder beneficiaries (or trust(s)) for their benefit) Dynasty Trust (f/b/o Children, Grandchildren, Great- Grandchildren & Future Generations) NOTE: For estate tax purposes, the entire value of the QTIP Trust is included in the spouse s taxable estate (in that the grantor is allowed an unlimited marital deduction at the time the trust was created). However, for GST purposes (assuming a reverse QTIP election is made) the grantor is treated as transferor, thereby allowing the trust to be exempt from future GST tax. 77
Impact of Potential Future Legislation 78
Impact of Potential Future Legislation Starting as early as the 2012 tax year, there is a possibility that certain estate planning opportunities may be diminished or possibly eliminated. These opportunities include (albeit not all-inclusive): Decrease in lifetime gift exemption from $5,120,000 to $1,000,000 Decrease in GST exemption from $5,120,000 to $1,000,000 (increased for inflation) Mandatory minimum GRAT term of 10 years No zeroed-out GRATs Dynasty trusts limited to 90 years More limited valuation adjustments on transfers of closely-held interests 79
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