Sunday, June 10, 2012

Planning for Advanced Asset Protection

Asset protection is vitally important in our ever more litigious society, and more wealth planning teams are needed who understand the intricacies of this area and can collaboratively implement advanced strategies. Whether creating an entire plan for the client or creating additional asset protection measures added on to an existing plan, you want to know with a high degree of certainty that the plan will be effective if an attack ever comes.

Asset protection planning is designed to provide increasing levels of protection, starting with where the client is today and moving to where he or she would like to be. Planning appropriately includes making sure there is neither too little nor too much planning.

In this issue of The Wealth Counselor, we will review and build on a prior issue (“Asset Protection Planning — Teamwork Is Required for Success”). We will also include some specific advanced asset protection strategies that will strengthen the plans you and your colleagues create for your mutual clients.

The Advisor Team Approach: The Three-Meeting Strategy
Asset protection planning is advanced. It is anything but “one size fits all”! Therefore, it requires both an in-depth understanding of the client and a collaboration of all the professionals involved. Therefore, we highly recommend that an asset protection engagement proceed deliberately and with a structure agreed to in advance by the client and the team members. The recommended and proven structure is:

1. Initial Meeting with Advisors and Client: The purpose of this meeting is to gather financial and objective information and to build a relationship with the client. To preserve the attorney/client privilege, it may be necessary to excuse non-attorney advisors from part of the meeting so the client and attorney can talk freely. It is also important to set some reasonable expectations and explain what asset protection is, how the laws work, and what the client can expect.

2. Advisors’ Meeting: After the initial meeting, the client’s involved advisors (attorney, CPA, financial advisors, insurance advisors, etc.) meet without the client present to review the client’s objectives, discuss various legal and financial solutions, and determine a consensus solution. During this meeting, it is important to lean on the expertise of specific advisors to determine a comprehensive solution. All potential ideas and concerns should be discussed and explored and differences of opinion ironed out here, not in front of the client.

3. Client Solution Meeting: Here the advisor team presents a unified solution plan, including all legal and financial components, to the client and gets the clients’ approval to proceed with plan implementation.

Talking Points for the Initial Meeting
It is important to explain to clients that asset protection is not about hiding or concealing assets. Rather, it is using existing laws appropriately to obtain the best possible level of protection for their assets. The goal is to take advantage of planning opportunities in a way that they can be as defensible as possible if and when the time comes that they are needed.

Client objectives typically include:
* High degree of certainty of the outcome. While there may be circumstances that neither client nor advisors can control, the end result should be considerably better than if the client had done no planning at all.
* Maintain control of their assets and their destiny. This is typically especially important to professionals and entrepreneurs.
* Discourage lawsuits from the outset. Rearranging business affairs and asset ownership can make clients less likely to be personally liable. For example, rental properties that are owned individually or in a revocable living trust can be moved to an asset protected arrangement like a limited liability company (LLC).
* Avoid liability “traps” like partnerships and joint ownership. It’s one thing to be responsible for your own actions, but quite another to have your assets vulnerable to the actions of another.

Types of risks faced by clients often include:
* Professional liability: As a general rule, you cannot limit your own professional liability. Also, most states do not permit nonprofessionals to own a portion of a professional practice. Professional liability protection therefore begins with adequate malpractice or errors and omissions insurance coverage.
* Professional liability of a partner or employee: In a partnership, each professional is exposed to liability for the malpractice of every other partner and employee. The practice can be legally structured in such a way that each professional is protected from personal liability for the errors of others.
* Non-practice personal liabilities: These could come from business deals that have gone bad or tort claims (auto accidents, etc.). Within the practice, there could be non-professional liabilities from employment practices, employment discrimination, premises liability, and sexual harassment claims. Again, structures can be set up that isolate clients and client assets from these risks.
* Estate planning risks: These can include unnecessary or excessive income and estate taxes; a partner’s next spouse who might be a problem with ownership interests; children’s spouses and their behavior which can lead to loss of family assets, etc. These can be dealt with in general estate planning.

The best and most effective time to plan is before a claim arises, when there are only unknown potential future creditors. But even with an existing claim, some options (such as making a contribution to an ERISA qualified plan or doing a Roth conversion) may still be available to shield assets.

Planning Tip: Be aware of potentially fraudulent transfers. Also, because clients often submit incomplete information, obtain a solvency certificate and seek permission to independently investigate their financial situation through online/court house records and other advisors.

Levels of Asset Protection
Level 1: Exemptions: Certain assets are automatically protected by state or federal exemptions. State exemptions include personal property, life insurance, annuities, IRAs, homestead, joint tenancy or tenancy by the entirety. Different states protect assets differently and amounts of the exemptions will vary greatly. Federal exemptions include ERISA which covers 401(k), pension and profit sharing plans. The Pension Protection Act protects up to $1 million in IRAs for bankruptcy purposes.

Planning Tip: Sometimes it is possible to convert non-exempt assets into exempt assets. For example, cash can be used to pay down a mortgage to increase home equity. An IRA that is not well protected under state law could be put into an ERISA qualified retirement plan that is absolutely protected from creditors. Outside cash can be used to pay taxes on a Roth conversion, thereby increasing the net protected asset pool.

Level 2: Transmutation agreements (in community property states): Separate property assets of the “safe spouse” generally are not reachable to pay certain creditors of the “at risk spouse.” Community property assets can be converted to separate property for the spouse not at risk, but once transmuted, the property may not become community property again in some states.

Planning Tip: Commutation of community property to separate property will have consequences, including the loss of stepped-up basis on the death of the non-owner spouse. Also, in the event of a future divorce, these assets would already be owned by the “safe spouse.” It is important to explain these implications and possible consequences to the clients in writing. Be sure to evaluate commutations from a fraudulent transfer perspective before the transfer.

Level 3: Professional entity formation (PA/PC/PLLC): State laws will vary, but if available, a PLLC is usually more desirable than other forms of entity because of the charging order limitations that prevent a creditor from seizing the creditor’s ownership interest in a multi-member entity. Instead, the creditor is often limited to the distributions that would have been made to the affected member. Income tax consequences for the creditor and debtor must also be considered. Using a jurisdiction that makes the charging order the sole creditor remedy is highly desirable.

Planning Tip: Using separate entities or a PLLC can limit liability for a partner’s malpractice claims.

Level 4: Equipment and Premises Leasing LLCs: LLCs can be created to own specialized or valuable equipment and/or real estate to remove these assets from the business or professional practice. Lease agreements can then be created between the professional practice and the asset holding LLCs. It is important to segregate real estate, equipment and securities accounts from malpractice exposure and it may be desirable to separate them from each other. The state in which the LLC is formed is very important, as a jurisdiction that allows the charging order as the sole remedy is highly desirable.

Planning Tip: Accounts receivable, which can be significant, can be protected by pledging them to a friendly creditor or factoring them. In the event an unfriendly judgment creditor appears in the future, the unfriendly creditor will not be able to attach to the receivables because they are already pledged or factored to another creditor.

Planning Tip: One structure to consider is creating an irrevocable life insurance trust (ILIT) and funding it with a life insurance policy that is designed to have significant cash build up over time. Using a conventional trust structure that works in every jurisdiction, the insured is not a beneficiary, but the spouse and descendants can be. (If the insured is to be a beneficiary, a self-settled asset protection trust would need to be used.) The ILIT trustee (an independent party) can use discretion and enter into a credit line arrangement with the insured (the business owner/professional). In exchange for granting the credit line access to the cash value of the insurance policy, the insured would need to pledge significant assets to secure the potential drawdown. These pledged assets can include accounts receivable. There are turnkey accounts receivable protection plans that include bundling (creation and funding of the ILIT with a particular insurance product, along with the proper documentation) or the advisor team can create one. Either way, be sure to document carefully.

Level 5: FLP/FLLC to own non-practice assets: Consider forming a family limited partnership (FLP) or family limited liability company (FLLC) to own non-practice assets. These can include personal use real estate, investment accounts, cash or bank accounts, investment real estate and highly valued collectibles (vehicles, artwork, etc.). These can be leased back to an individual for personal use. Again, a favorable jurisdiction that has the charging order as the sole remedy is preferred.

Planning Tip: Ownership interests can be gifted, often at discounted values, and the current $5.12 million gift tax exemption provides an exceptional opportunity to transfer assets this year. Should this exemption decrease to $1 million in 2013, as the law currently states, the ability to make lifetime gifts will be significantly affected.

Planning Tip: With a personal residence, one option would be to borrow the maximum on the mortgage (through a home equity line of credit) and transfer the loan proceeds to an asset protection trust (APT) which then becomes a member of the FLP/FLLC. (Establish the APT first for interim protection.) A second option would be to sell the residence to an intentionally defective grantor trust (IDGT) in exchange for a note that is structured in such a way that it would be unattractive to a creditor.

Planning Tip: A qualified personal residence trust (QPRT) can also be used. Under a QPRT, the grantor retains the right to live in the home for a pre-determined number of years. At the end of the term, the home is owned by the trust beneficiaries, which can include the descendants of the grantor. Because it is a self-settled irrevocable trust, some states have limitations that can reduce its effectiveness for asset protection during the primary term. Also, the funding of a QPRT when there is a known claim could be considered a fraudulent transfer. However, there may be other reasons to use a QPRT, including the ability to do significant gift planning and asset value freezing.

Level 6: Domestic asset protection trusts: Non-practice or leasing LLC assets transferred to a DAPT before any claim arises may provide additional charging order protection. The downsides include having to fund the trust in the jurisdiction that allows it (e.g., Nevada, Delaware, Wyoming, Alaska, etc.) and the need to have a resident trustee in that jurisdiction, which may be a significant ongoing cost. There is also the risk under the Bankruptcy Act of a 10-year clawback for transfers to a DAPT.

Planning Tip: The creator of a non-APT trust cannot be a beneficiary and still achieve asset protection. However, the spouse and children can be the beneficiaries. A flight provision can be included so the assets could go to another jurisdiction if the trust is attacked. A trust protector can oversee the trustee, change the trustee, direct the trustee to move the trust to another jurisdiction, and even be able to decant and move the assets to another trust for the benefit of the same beneficiaries. The alternative is to establish a DAPT in a jurisdiction that allows them, so that the grantor can be a discretionary beneficiary and still achieve asset protection. (Alaska, Delaware, Nevada and Wyoming are often the most popular.)

Level 7: Offshore asset protection trusts: These are established under the laws of a foreign jurisdiction. With an offshore trust, the assets are in the hands of a foreign trustee and are outside the reach of any U.S. court. However, there may be tax issues. Also, if the court orders the assets repatriated and they can’t be, the client could be cited for civil contempt and even jailed. In addition, offshore trusts are expensive to establish and maintain.

The Risks of Doing Asset Protection
Proceed with caution when doing asset protection planning for your clients. Be aware of potentially fraudulent transfers, concerns of solvency, and that there may be creditors you don’t find out about. It will be much better for you if the client will let you do some level of due diligence. Make sure your client understands the issues and has some reasonable expectations of what the asset protection planning may or may not accomplish. Sometimes the advisors will conclude that it may not be possible to do everything the client wants to do.

Asset protection planning is a challenging and rewarding area in which the advisor team has many opportunities to work together for the mutual benefit of their clients and themselves.

Thursday, June 7, 2012

Planning with the $5 Million Gift Tax Exemption

In the last issue of The Wealth Counselor, we took a closer look at the new tax law in effect for 2011 and 2012, examining some of the opportunities and challenges that face estate planning professionals as we incorporate these changes and uncertainties into our client's estate plans.

In this issue, we will look more closely at the powerful planning opportunities that exist for the next two years with the $5 million gift tax exemption. Let's begin with a quick review of the new law.

Gift, Estate and GST Exemptions and Tax Rates
In 2011 and 2012, the gift, estate and generation-skipping transfer tax exemptions are all $5 million and the tax rate is 35%. If Congress does not act again, in 2013 the exemption will be $1 million and the top tax rate will be 55%. This is the current law and must be considered in all planning. The portability of the gift and estate tax exemption between spouses was also introduced, but only for spouses who both die between January 1, 2011, and December 31, 2012.

Planning Tip: Note that, unlike a surviving spouse's ability to use a predeceased spouse's unused unified credit, the new law does not allow a surviving spouse to use the unused GST tax exemption of a predeceased spouse. This is just one weakness of the new portability provision.

Planning Tip: Be cautious when deciding how to plan for insurance needs, disclaimers and how to fund the bypass trust, considering whether to plan for a $5 million exemption or some lower (e.g., $1 million) exemption. Also, the portability of exemption between spouses may not be around after 2012. Be sure your clients understand the exemption is scheduled to revert to $1 million in 2013, that these uncertainties exist, and that their planning will need to be updated as the laws change.

Income Tax
We also have lower income tax rates for the next two years, but President Obama has made it clear he wants higher tax rates in 2013. Unless there are changes in the next two years, in 2013 the long-term capital gains rate will increase to 20%, the maximum tax on qualified dividends will go back to 39.6%, and the additional 3.8% surtax will be introduced.

Planning Tip: Take advantage of the lower income tax rates that we have for the next two years, and look for opportunities to accelerate income into 2012. Choose an 11/30 year-end for any estates currently being administered to maximize the lower income tax rates for as long as possible.

2010 Planning Revised
The estate tax was reinstated for 2010, with a $5 million exemption and 35% tax rate. Estates may elect out and pay no estate tax, but the modified carryover basis rules would apply. The gift tax exemption in 2010 remains at $1 million with a 35% gift tax rate.

Planning Tip: Because of the "sunset," there may be only a two-year window of opportunity to make substantial gifts using the $5 million gift exemption.

Tax Planning Opportunities in 2011 and 2012
With the gift tax exemption at $5 million per person, we can expect a huge transfer of wealth over the next two years. Those who have already used their $1 million exemption now have an additional $4 million to use for gifts. And while we cannot be absolutely certain that the $5 million gift tax exemption will be honored if it returns to $1 million in 2013, it would certainly make sense for Congress to do so. Let's look at some of the planning opportunities that will immediately maximize these transfers.

Planning Tip: Start meeting with your wealthier clients now to discover which properties they could give away now that will be relatively painless for them.

Spousal Access Trusts
The general concept of a Spousal Access Trust is that one spouse can transfer up to $5 million in trust for the benefit of his/her spouse, children and future generations. Benefits include asset protection, estate tax protection, direct descendent protection (property stays within the bloodline) and income shifting. Risks are the reciprocal trust doctrine and grantor trust rules.

In U.S. Estate of Grace, 395 US 316 (1969), the Supreme Court developed a two-part test to determine whether trusts will be ignored because they are "reciprocal": a) the trusts must be inter-related and b) the trust creation and funding must leave the grantors of the trusts in essentially the same economic position as they would have been in if they had created the trusts naming themselves as life beneficiaries. If both parts are met, the IRS and/or the courts will uncross the trusts and include the value in each of the grantor's gross estate, nullifying their careful planning.

Planning Tip: To avoid the reciprocal trust doctrine, the lawyer on the planning team must take care to draft outside of the Grace doctrine and not make the trusts identical. Be sure to file the gift tax return and allocate the GST exemption if desired rather than rely on the automatic allocation rules.

Gifts to an Irrevocable Life Insurance Trust
Life insurance can be used to provide income for a family, pay estate taxes, and as an income tax shelter. If structured properly so that the trust maker does not have any incidents of ownership, none of the assets (policy proceeds) of an irrevocable life insurance trust (ILIT) will be included in the trust maker's taxable estate, making them free of both income and estate taxes. ILITs will become more popular as income tax rates increase, in 2013, from the current 35% rate to39.6% or even to 43.4% for clients subject to the 3.8% surcharge.

The general concept is that the ILIT is the owner and beneficiary of the policy on the trust maker's life. The trust maker makes gifts to the trust to cover the insurance premiums, and the trustee makes the premium payments. At the trust maker's death, the proceeds are paid to the trustee who can use the funds to purchase assets from the estate and provide liquidity for estate taxes and other expenses. The trustee can make discretionary distributions of income and principal during the lifetime of the trust's beneficiaries, which can include the trust maker's spouse, children and future generations. Assets that remain in the trust are not included in the beneficiaries' estates and are protected from creditors.

Planning Tip: Using the $5 million gift and GST exemption amounts can provide substantial amounts of life insurance (think single or 2-pay premium) and benefit the grantor's children without future estate, gift and/or GST tax.

Planning Tip: Be very cautious about canceling existing insurance policies now. If possible, wait until 2013 nears, when we will know what the exemption will be at that time.

Dynasty Trusts
Generally, a dynasty trust is one that benefits multiple generations, and none of the trust assets are included in the trust maker's or any of the beneficiaries' taxable estates. Not being taxed at each generation (historically at 45-55%) allows the assets to grow tremendously over the years.

However, there is a generation-skipping transfer tax that applies when a transfer is made by the grantor to a "skip person" (grandchild, great-grandchild, or other person more than 37.5 years younger than the grantor). Currently, each grantor is allowed a lifetime GST exemption on the first $5 million of taxable transfers directly to a skip person or to a trust that could benefit a skip person. A husband and wife can combine their GST exemptions. This perhaps temporary GST exemption increase will make dynasty trusts even more popular over the next two years.

The dynasty trust established in the right jurisdiction can theoretically go on forever, with the trustee making discretionary distributions for the lifetime of each beneficiary in each generation. Advantages include creditor protection, divorce protection, estate tax protection, direct descendent protection, spendthrift protection and consolidation of capital, which typically results in higher returns and better management options.

Planning Tip: The choice of situs is critical. Choose a state with no income tax, good creditor and divorce protection, and no Rule against Perpetuities. Make sure you file a gift tax return. If the trust maker allocates enough GST exemption to cover the entire gift, neither the gift nor any distribution from the trust will ever be subject to the GST tax.

Planning Tip: Be aware of the President's budget proposal to limit GSTT-exempt trusts to 90 years, regardless of the applicable rule against perpetuities. While this was introduced in 2011 and will not likely gain support in the current Congress, this may gain support in the future.

Income-Shifting Trusts
The concept here is to shift income to younger family members to reduce income taxes. Parents can move up to $10 million ($5 million each) in income-producing assets gift tax-free to their children who can then use the income to invest or purchase insurance.

Example: A husband and wife gift $10 million of non-voting S-Corporation stock to their four children (15% each) via using Qualified Sub-Chapter S Trusts. There is no gift tax because the parents use both of their $5 million gift tax exemptions. After the gift, 15% of the income generated by the S-Corporation will pass through to each child.

Benefits include creditor protection on the assets; estate tax savings because the assets are being transferred to the children and out of the parents' estates; and income tax savings because the children will pay income taxes at a lower rate than their parents. Over time, this can save a tremendous amount in income taxes.

Long-Term Tax Planning Opportunities
Lifetime Gifting
After the $5 million exemption has been used, it may be advantageous to give away more and pay the gift tax at the current 35% gift tax rate. Also, the gift tax is "tax-exclusive" while the estate tax is "tax-inclusive." A taxable gift of $1.00 makes the donor liable for a $0.35 gift tax, for a total of $1.35. On the other hand, $1.35 in a decedent's estate taxed at 35% nets only $0.88 to the heirs.

Planning Tip: As was the case in 2010, gifting can be a wait and see scenario. As we get closer to 2013, we hope to know what the 2013 gift tax rate will be. If the rate is moving to 55%, it would be advantageous to make additional gifts and pay the 35% gift tax in 2012 rather than wait and pay a 55% gift or estate tax in 2013.

Grantor Retained Annuity Trusts (GRATs)
The creator of a GRAT retains an annuity payout for a fixed term. At the end of the annuity term, any residual assets remaining in the trust pass to the remainder beneficiaries, such as the trust creator's children, free of any gift and estate tax (but not free of GST tax exposure).

The tax treatment of a GRAT is based on the assumption that the GRAT assets will grow at exactly the Section 7520 rate in effect at the time the GRAT was established (2.4% in January, 2011). If the GRAT assets outperform the 7520 rate, there will be a larger than anticipated (for tax purposes) balance to transfer to the trust's remainder beneficiaries at the end of the annuity term. In addition, all income earned by the GRAT during its term is taxed to the trust's creator because the trust is "defective" for income tax purposes, allowing for an enhanced probability of having a tax-free gift to the remainder beneficiaries.

Planning Tip: GRATs are currently most effective for property that is extremely volatile or is difficult to value, or for large estates that have already used their $5 million exemption. Unlike a dynasty trust, a GRAT can only create a one-generation transfer unless GST exemption is allocated to it based on the actual value of the trust assets at the end of the annuity term.

Intentionally Defective Grantor Trusts (IDGT)
An IDGT is a trust that is a grantor trust for income tax purposes, but not for gift, estate, and GST tax purposes. IDGTs are especially powerful right now for wealthy clients because of the $5 million gift and GST tax exemptions and historically low interest rates.

Using an IDGT, a married couple can currently gift up to $10 million in undivided interests in highly appreciating assets, then sell additional interests in the same assets to the IDGT. The value of both the donated and the sold assets can be discounted due to minority interest. If the assets are wrapped in an LLC or limited partnership, their value may also be adjusted for lack of marketability and lack of control. The trust then pays an installment note back to the trust maker. Assuming the growth rate on the assets sold to the IDGT is higher than the interest rate on the installment note, the difference is passed on to the trust beneficiaries free of any gift, estate and/or GST tax.

Also, because the IDGT is a grantor trust (i.e., "defective" trust for income tax purposes), no capital gains tax is due on the installment sale, the interest income on the installment note is not taxable to the grantor, and all income earned by the trust is taxed to the grantor, effectively allowing for a tax-free gift to the trust's beneficiaries equal to the tax burden borne by the grantor. Discretionary distributions of income and principal are made to the trust beneficiaries during their lifetimes, and all assets in the IDGT remain outside of their taxable estates.

Planning Tip: The grantor should make an initial gift of at least 10% of the total transfer value to the IDGT or have other security for the financed sale so that the IDGT has sufficient capital to make its purchase of assets from the grantor commercially reasonable.

Estate planning professionals have an exceptional window for transfer opportunities in 2011 and 2012 with the $5 million estate, gift, and GST tax exemptions; lower income and estate tax rates; and still-depressed property values. And, as is often the case, these opportunities provide excellent opportunities to work with a team of advisors to provide the best possible results for mutual clients.

Using a Limited Liability Company (LLC) to Transfer a Family Business

Most of us have at least one client who has a family-owned or closely held business that is a major part of their estate, yet they have done nothing to plan for the succession of that business. Business exit/succession planning can be challenging because of the tax issues, family dynamics and egos. But it can also be very rewarding. As we help our clients solve these issues, we develop a closer relationship with them, and we begin to build a relationship with the next generation. This planning also strengthens our professional relationships, as we must work together with other professionals to bring about the best results for our mutual clients.

In this issue of The Wealth Counselor, we will examine a case study that uses a Limited Liability Company (LLC) in the transfer of a family business to the next generation.

Case Study Facts
Frank (age 62) is married to Betty (age 58). Frank has an older son, Tom, from a previous marriage who is active in Frank's business. Betty has a daughter, Susan, from her previous marriage. Together they have a son, Charlie, who is a minor. Betty, Susan and Charlie are not involved in Frank's business.

Frank owns 100% of an S-corporation. It has a fair market value of $10 million and generates very good cash flow. Frank and Betty have significant other assets, including a home and investments. They own some jointly and Frank brought some into the marriage - they are held in his individual name. Their $5 million lifetime gift/estate/GSTT exemptions are fully available.

Consequences of No Planning
If Frank does nothing, according to the probate laws of the state in which they live, Betty will receive 50% of Frank's estate including the business; his son Tom will receive 25% of Frank's estate including the business; and Charlie will receive 25% of Frank's estate including the business. Because Charlie is a minor, Betty will control his share until he is 18. So, in effect, Betty will control 75% of the business if Frank dies intestate. Susan, Betty's daughter, will receive nothing.

Planning Objectives
Frank would like to ensure that ownership of the business will go to his son Tom, and Tom would like the security of knowing that one day the business will be his. Tom does not have the cash to buy the business. Frank would also like to control the timing of the transfer of the business and he would like to treat his stepdaughter and younger son fairly. He is concerned about maintaining enough cash flow to support himself and Betty now, and providing for Betty if he dies first. And he would like to minimize estate taxes.

Recommended Plan
Phase 1: Reorganize and Recapitalize the S-Corporation
In a tax-free reorganization, the S-corporation is converted to an LLC that is taxed as an S-corporation. The LLC is organized under the laws of a "charging order only" state. Frank's ownership is changed from 100% voting shares in the corporation to 1% voting and 99% non-voting memberships in the LLC. Frank still effectively owns and controls 100% of the business, but now it is comprised of 10 LLC membership units (1%) that are voting units and 990 (99%) that are non-voting units.

Phase 2: Create Dynasty Trusts
Frank next establishes three irrevocable trusts, one for each child, in a jurisdiction that permits perpetual trusts. The trusts (irrevocable grantor trusts, aka intentionally defective grantor trusts) are disregarded by the IRS for income tax purposes, but not for estate and gift tax purposes. (Alternatively, one trust with three separate shares can be established.) The trusts are also designed to own life insurance on Frank's life.

Frank makes an initial gift of $600,000 to each trust. These are taxable gifts that must be reported on Form 709, but no gift tax will be due because it will be applied to Frank's and Betty's lifetime gift tax exclusions. $600,000 of their generation skipping transfer tax (GSTT) exclusions will also be allocated to each trust, giving each a zero inclusion ratio - so that it is not subject to GSTT in the future.

The trustee of Susan's and Charlie's trusts uses their initial gifts to purchase life insurance policies on Frank and/or Betty, providing substantial assets upon Frank's or their deaths.

Phase 3: Tom's Trust Buys All Non-Voting Units with an Installment Note
A business valuation is performed to determine the fair market value of Frank's business. As part of this process a qualified valuator first values the assets the business owns (real estate, equipment, good will, inventory, etc.). The valuator then determines whether and to what extent the value of the assets should be adjusted due to lack of control, liquidity and marketability.

When these valuation adjustments are applied to non-voting interests in an LLC, the fair market value is often depressed by a significant amount when compared to the fair market value of the entire business: in this hypothetical case, 40%. In other words, the non-voting units will each have a value of $6,000, making the total value of the 990 non-voting units $5,940,000. Alternatively, voting units will have a premium value to reflect the control value. In this hypothetical case, the voting units have an appraised value of $12,000 per unit, making the total value of the 10 voting units $120,000.

Tom's dynasty trust buys Frank's 990 non-voting units for $5,940,000 using a 20-year installment note, payable annually. Based on the current IRS published interest rates, the trust will pay Frank $447,197 every year for 20 years. The note is adequately secured by the LLC units and the $600,000 of other assets in Tom's trust. The cash flow from 99% of the business is more than sufficient to cover the note payments.

Planning Tip: The installment note should be handled just like an installment sale to a non-family member or a loan from a bank. A pledge or security agreement should be signed, required taxes should be paid, required filings should be made, etc. A fully documented paper trail should exist for the transaction and the payments made on the note.

Why Reorganize the Corporation to an LLC?
Corporate stock is freely transferable, making it very easy for a judgment creditor to foreclose on corporate stock and become a shareholder. In most states, the percentage required for shareholder voting to liquidate a corporation is less than 100%, generally ranging from 51% to 80%. If a judgment creditor forecloses on enough shares of stock to allow the creditor to liquidate the corporation, the creditor would be able to seize the assets of the corporation to satisfy the claim.

Alternatively, LLC interests are usually not transferable without the consent of all members. Due to this limitation on transferability, an LLC offers much greater asset protection from creditors. Many states limit a creditor's remedy to a "charging order" on distributions to LLC members. (Only when a distribution is made will it go to the creditor; when the claim has been repaid, the charging order is stopped.) The creditor can never become a substitute member, and will only become an assignee with no ability to vote on admission of new members or the liquidation of the LLC. In most states, it takes a 100% vote of all members to liquidate an LLC. Because a creditor can never become a member, it can never vote on liquidation of the LLC.

Outcome of the Planning
Frank owns the 10 voting units, giving him 100% control of the business and 1% of the equity. Tom's dynasty trust owns 990 non-voting units, giving Tom no control over the business and 99% of the equity. Tom's trust also has $600,000 in cash that Frank gifted to it as seed capital. This cash is invested, and the income tax attributes of income, gains and losses are passed through to Frank to be reported on his tax return, as is the income, gains and losses attributable to Tom's trust's 99% ownership in the business.

Income Tax Reporting
As long as Frank is deemed the owner of Tom's dynasty trust for purposes of reporting trust income, the dynasty trust does not have to file a Form 1041 fiduciary income tax return. A corporate income tax return (1120S and K-1) is filed for the business and Frank reports the trust's income on his tax return.

Income Tax Effect of Sale of Units
Because Frank is the deemed owner of the trust for income tax purposes, the sale of the LLC units to Tom's trust is a non-recognition event; i.e., a sale by Frank to himself. No gain or loss is recognized on the sale. No interest income is recognized on the installment note payments and no interest deduction is allowed to the trust.

Planning Tip: Include a "toggle" provision to turn each dynasty trust's grantor status off or on as needed, so that the income being taxed to Frank can be stopped if that should become undesirable later. Consider giving this power to a trust protector.

Pass Through Dynasty Trust Income
Income from the LLC will be allocated to the unit holders based on their ownership percentages. Let's assume the business has $500,000 in net income. Frank owns 10 voting units, equal to 1% of the equity, so he will be allocated $5,000 on the 1120S as K-1 income. Tom's dynasty trust owns 990 non-voting units, which is equal to 99% of the equity. So Frank, on behalf of the trust, will also be allocated $495,000 on the 1120S as K-1 income.

Because the dynasty trusts are grantor trusts for income tax purposes, Frank must pay the income tax on all their income, including the S-corporation income that is allocated to Tom's trust. But that is what he was doing before the sale, so he is paying the same income tax before and after.

Planning Tip: Frank's payment of income taxes in dynasty trust income is not an additional gift to the trusts, so every year he is effectively transferring additional estate assets to the trusts for the children without additional transfer tax.

How the Dynasty Trust Makes the Required Note Payments
In this case study, we assume that the LLC will have $500,000 per year of cash flow to distribute to the unit holders. Tom's dynasty trust will receive a cash distribution of $495,000 ($500,000 times 99% = $495,000). At the end of the first year, it will have $1,095,000 in cash ($495,000 from the LLC plus $600,000 that Frank gifted to it as seed capital). The trustee uses this money to pay the $447,197 note payment to Frank.

Planning Tip: If the business does not make enough income to pay the note, the payment can be deferred until the business recovers or the term or interest rate of the note can be adjusted.

Results after One Year
At the end of the first year, the note has been reduced to $5,745,847 and Tom's trust has a cash balance of $647,803. This cash can be invested and saved, distributed to Tom (gift tax-free), or used to buy and pay for a life insurance policy on Frank's life.

Frank has received $5,000 from the LLC and $447,197 from the note payment for a total of $452,197 in income. He pays income taxes on the full $500,000 of S-corporation income. If, after all deductions, he has a 25% effective income tax rate, he would pay $125,000 in income taxes, leaving him with $327,197 in income to support his and Betty's lifestyle.

Planning Tip: A higher income tax rate means less net income, but the client can also receive additional (reasonable) compensation as an LLC manager or as a Director. If he needs less income, his salary can be reduced, but ensure that it is not so much that he loses benefits.

When Frank Dies
Frank and Betty also establish estate plans, so the assets in Frank's estate will pass as planned, not according to the state's default rules.

If Frank and Betty have consumed or gifted the net after-tax proceeds of each note payment from Tom's dynasty trust, only the unpaid balance of the note will be included in the value of his taxable estate. Tom's dynasty trust is GSTT exempt, so its assets will never be subject to estate, gift or GST taxes. Frank's estate plan leaves the 10 voting units to Tom's dynasty trust, giving Tom 100% ownership of the business. The dynasty trusts for Susan and Charlie are also GSTT exempt, and the life insurance proceeds will be exempt from probate and income, estate and GST taxes. Betty will continue to receive the remaining note payments for her support.

Estate Tax Results
Frank has removed 0.99 x $10,000,000 + 3 x $600,000 = $11,700,000 of appreciating assets from the value of his gross estate that, at his death, would have been subject to estate taxes. He and Betty have used $1,800,000 of their lifetime gift/estate/GST exemptions. (Remember, unless Congress acts before the end of 2012, the top estate tax rate in 2013 is scheduled to go back to 55% with a $1 million exemption.)

Frank has received an asset (the $5,940,000 note) that, in his estate, may have a discounted value due to lack of marketability, etc., and that will not appreciate; in fact, the note is depreciating because the principal will decrease over the 20-year term.

If Frank does not accumulate the note payments, at the end of the note term he will have completely removed the $10,600,000 and all future appreciation from his gross estate without making a taxable gift other than the initial $600,000 seed capital gifts to the dynasty trusts.

The trust assets are not subject to generation-skipping transfer tax, will be protected from creditors, and will not be included in the children's or grandchildren's or great-grandchildren's gross estates at their deaths.

Objectives Met
All of Frank's objectives have been met. His son Tom will receive the business without having to buy it, and Frank can control the timing of the business transfer. He was able to provide for his other children and his wife, and he saved substantial estate taxes.

While this kind of planning can be complicated, the above example demonstrates that the rewards are many. We have the opportunity to help our clients solve their problems, strengthen family relationships, save money and have peace of mind. At the same time, we have the opportunity to strengthen our relationships with clients, their children and the other planning professionals with whom we collaborate. This type of planning is truly a win-win opportunity.

Harnessing the Power of Trusts to Help Your Clients and Grow Your Practice

Trust planning is an area where the work of attorneys and financial advisors interfaces. It can be a powerful and effective tool in helping both disciplines to grow their practices.

In this issue of The Wealth Counselor, we will look at how estate planning is changing after TRUIRJCA 2010, what clients want in estate planning, and how incorporating trust planning will benefit clients, their families and the professional advisors who serve them.

Is There a Crisis in Estate Planning?
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRUIRJCA 2010), which the President signed on December 17, 2010, has had a major impact on estate planning.

TRUIRJCA 2010 increased the applicable exclusion amount to $5 million, made it portable for the first time, adjusts it for inflation starting after 2011, set the maximum estate tax rate at 35%, and restored the gift tax exemption at $5 million - but all only through 2012.

The result is that most families don't have an estate tax problem, at least not for now. Few families have net estates of more than $5 million; even fewer married couples have combined net estates of more than $10 million. This is causing a crisis for professionals who have promoted estate tax avoidance as the primary reason to do estate planning. Insurance advisors who for years have sold policies to fund estate tax liabilities are now finding fewer buyers for their products. Lawyers who have always sold planning as a way to pass wealth on instead of paying it to Uncle Sam are floundering.

The Danger and Opportunity Before Us
The danger is real. Prospective clients may think there is no need for them to plan because they are exempt from the estate tax, at least for now. They may be lulled into a false confidence that the estate tax does not affect them, when in reality it may in the near future. They may be forgetting that the current tax law is only a two-year deal that Congress made, and the law will change in 2013, or possibly sooner. Or they may be foolishly using "waiting to see what the Congress will do" as an excuse to postpone their planning.

The opportunity is real, too. As estate planners, we need to give up the "addiction" of relying on the estate tax as a primary business driver. We need to re-think our approach and remember why we became estate planners in the first place.

While some may view the new tax law as an end to estate planning as we know it, we can also see it as an opportunity to finally focus on what our clients really want.

What Clients Really Want
Essentially, clients want the same things we all want:

For Themselves -- Protection and Control. They want control over their assets and health care decisions. They want financial security. They want to be protected from the risks of life, which include lawsuits, disability and the cost of long-term care. Most have some philanthropic goals.

For Their Surviving Spouse -- Financial Security. They want to know that their hard-earned assets will not pass to a new spouse. And they want the surviving spouse protected from taxes, primarily from income tax.

For Their Children and Grandchildren -- An Education and Financial Security, including Asset Protection from Immaturity, Divorce and Lawsuits. A big motivator for planning can be protecting assets from gift, estate and income taxes for as long as possible, even for several generations. They want their family members to live successful lives that include a work ethic, integrity, faith, and appreciation and respect for family members. Above all, they want their family members to love each other, spend time together and avoid conflict. They do not want them to be harmed by the wealth that is left to them. This is often far more important than tax planning.

For Their Business or Farm -- Attract and keep quality talent and have protection from frivolous lawsuits. They want their business or farm to pass to family members who desire to own and operate it, while treating non-participating family members fairly, or they want to sell it to employees or outsiders.

What We Can Provide
These client needs are timeless. No Congress can ever legislate these needs away. Our solutions are also timeless. We need to build our practices around these needs and solutions, instead of having estate tax avoidance be the main need and motivator.

Planning Tip: Think about why you do what you do. People don't buy what you sell; they buy why you sell it. If you sell a product, they can always find someone who will sell it for less. If your "why" is protecting your clients, their families, their farm or business, etc., they will see that you are putting these needs first.

Five Ideas that Will Get Results...for You and Your Client
The following planning suggestions will work now for most of your clients, and can help you get on the right track in your practice.

Idea #1: Teamwork Produces Better Work
Use a two- to four-meeting process involving other professionals. This will allow you to provide more thoughtful solutions to your client's needs. It will also allow time for the team of advisors to meet without the client, discuss the situation and possible solutions, and make sure all advisors are on board so that the client hears a consistent message from each advisor. Also, having a team approach over time allows the client to see that recommended financial products (life insurance, annuities, trusts, long-term care insurance, etc.) are part of the total planning solution and not a sales pitch.

Planning Tip: Ask for the name of any other persons the client will consult (friend, CPA, etc.) in making a decision, and get permission to talk with them before making recommendations to the client. Then have those talks and assure all will endorse the plan ahead of time. It will take more time on the front end, but will keep things from being sabotaged by someone you were not even aware of.

Idea #2: Use the $5 Million Gift Tax Exemption Now
We may only have this for a couple of years, but it could disappear even sooner than 2013 as Congress begins to focus on how to raise revenue and cut spending. Discounts may also go away. You can legitimately create a sense of urgency to use this exemption to start moving appreciation out of a potentially taxable estate.

Use the $5 million gift tax exemption to fund a large life insurance policy in an irrevocable life insurance trust (ILIT) that can build up cash value for a supplemental retirement fund or provide an alternative financial investment. A second-to-die policy to pre-fund estate taxes could also be purchased. The $5 million exemption can also be used to fund a GRAT or seed an IDGT sale using LP, LLC or C- or S-corp stock.

Planning Tip: There are two relatively easy ways to give clients access to insurance owned by an ILIT. First, set up the ILIT so that the trustee can make withdrawals or loans from the cash value of the policy and lend the proceeds to the grantor/insured. It can be an interest-only loan during the grantor's lifetime, with no additional income tax due; at the grantor's death, the loan can become a debt of the estate. (It must be a credible loan, fully documented, and the grantor must have the means to make the interest payments.) Alternatively, the distributions can be made to the insured's spouse, on the assumption that they will stay married and the spouse will "share" the proceeds with the insured.

Planning Tip: Remember that both GRATs and IDGT sales need insurance protection, and insurance is easier to fund with a $5 million gift exemption ($10 million if married). You may even be able to avoid Crummey gifts altogether.

Idea #3: Encourage Clients to Leave Assets in Trust
This is good for your clients, and for your clients' children and grandchildren. Assets kept in a trust are protected from predators (including the surviving spouse's next spouse), irresponsible spending, creditors, divorce, etc. Ask your client: "If you could protect the assets, why would you not?"

This is also good for you and for your team of advisors, as it keeps the assets under professional management and establishes a relationship with the next generation. This is an excellent way to protect the financial advisors' book of business against a very real threat.

Idea #4: Think Differently about Your Client's IRA and Other Tax Qualified Plans
Most clients want to maximize the stretch out on an IRA, but don't know how to do it. There's a way to maximize stretch out, provide long-term divorce and lawsuit protection, and create a large life insurance sale. And it will apply to many families with "average" sized estates and IRAs.

Step 1: Leave the IRA to a stand-alone IRA trust for younger generation family members (children or grandchildren). This will provide the maximum stretch out and protection from divorce and/or creditors. An outside trustee can prevent an early cash out and protect the intended stretch out.

Step 2: Use the required minimum distributions to purchase life insurance on the IRA account holder in an ILIT for the benefit of the surviving spouse. When the account holder dies, the surviving spouse will have lifetime access to the proceeds in the ILIT, tax-free. This can be a much better deal for the surviving spouse than becoming the successor to the IRA. The ILIT design provides for successor beneficiaries if the spouse dies first.

Planning Tip: To make the benefits clear for your client, run projections with the spouse as beneficiary of the IRA and a child/grandchild as the beneficiary. Remind your client that distributions from the IRA will be taxable, while the proceeds from the life insurance in the ILIT will be tax-free.

Planning Tip: For those who are charitably inclined, make a charity or church the beneficiary of the IRA; it will receive the proceeds tax-free. Again, use the required minimum distributions to purchase life insurance on the IRA account holder in an ILIT for the benefit of the surviving spouse.

Idea #5: Use Trusts to Help Clients Create a Non-Financial Legacy
Creating a non-financial legacy helps your clients become more connected to the estate planning process and empowers them. Have them write their motivations for the planning and explain discretionary guidelines. If there is heirloom property that is sentimental or historical, they can provide a handwritten note with a story or significance of the item(s).

Planning Tip: Arrange for family meetings after the trust has been signed. You can have them in person for those who live in the area and/or via Skype for out-of-towners. Talk about the planning that has been done and why. This is good for the beneficiaries, as it brings them into the process and helps them understand the motivations, the planning, and the intended results. It also gives the advisors opportunities to meet and become familiar with the next generation.

While TRUIRJCA 2010 has provided us with challenges and has forced us to re-think our approach to estate planning, it has also freed us to be able to do the estate planning that our clients really want without regard to the need for estate tax avoidance. Trust planning remains an integral and valuable part of estate planning, and is beneficial for the client and the professional team of advisors.

Working with Charities for Fun and Profit

Developing alliances between non-charitable advisors (attorneys, CPAs and financial advisors) and advisors to charities (e.g., development officers for non-profit organizations) can provide better service to the team's clients, make fundraising more effective for the charitable advisors, and thus be beneficial for all concerned.

In this issue of The Wealth Counselor, instead of focusing on the technical side of charitable planning (tax and estate planning), we will take a look at the marketing side. We will explore the various forms of fundraising, what fundraisers do for charities, how they are compensated, how they can become part of the estate planning team, and how working together will benefit all involved, professionals and clients alike.

Fundraising Overview
Fundraising, or the process of soliciting and gathering contributions, such as money or other assets and resources by requesting donations from individuals, businesses, charitable foundations or governmental agencies, is multi-faceted. Its major divisions are annual giving, capital campaigns, major gifts, and deferred (or "planned") giving.

Annual Giving
Annual giving focuses on donor acquisition, repeating the gift and upgrading the gift. Most first gifts are small, but annual giving creates the habit of regular giving and, typically, increasing gift size over time. Direct mail solicitations, telemarketing, e-solicitations and special events are most often the methods used to increase annual giving. The ultimate goal of annual giving is lead generation for the other categories of fundraising.

Capital Campaigns
Capital campaigns are the most common way charities raise the funds needed for special large projects, such as a new building or a permanent endowment. A capital campaign is an intensive, time-limited effort seeking a larger than usual sum of money from the charity's perspective. Most charities consider hiring an outside consulting firm for a capital campaign rather than hiring or using internal staff. Frequently the outside consultant will guide the existing staff.

Major Gifts
Unlike annual gifts, which are typically made with cash, major gifts are often made in the form of publicly traded stock, bonds or other negotiable financial assets and, in some cases, real estate and valuable personal property, like art. Each charity establishes its own threshold for what is considered a "major" gift. For a religious denomination, it might be $25,000 or more, whereas a small local charity might set threshold at $1,000. Typically, making a "major" gift entitles the donor to special benefits, such as membership in a giving society (i.e., "Circle of Friends"), recognition in the charity's publications, or ticket priority for charity events.

Deferred ("Planned Giving") Gifts
Deferred gifts are gifts that a donor establishes now for the charity to receive at a future date. Most attorneys, CPAs and financial advisors are familiar with these. In some cases, the donor will receive income and tax benefits during his or her lifetime. Most are complicated and require planning; hence, the term "planned giving." Typical deferred gifts include Will bequests, post-death revocable living trust distributions, charitable remainder trusts, gift annuities, charity-owned life insurance, and pooled income funds. Although not completely "deferred" (the charity receives a benefit starting in the first year), most planners include charitable lead trusts in the category of deferred gifts.

Charities today also sometimes raise money by obtaining grants from individual or corporate private foundations or government agencies. Applying for such grants may be the assigned responsibility of a staff member or outside consultant.

What Charities Do with the Money They Raise
Charities are just like everybody else. They do two things with the money they get - spend it or save it for future use. Some contributions will be unrestricted and thus available to be used immediately for day-to-day expenses and charitable functions. Many charities also have an endowment fund in which gifts are set aside and held in a special fund to earn income that is used by the charity for general or special charitable purposes. Major gifts and deferred gifts other than for an identified purpose, e.g., a new building, typically go into the charity's endowment fund. The size of a charity's endowment fund is often used as a measure of its fundraising and overall success. Endowment funds are often divided into sub-funds to accommodate major contributors who wish to have their gift earmarked for a special purpose, such as scholarships.

How Charities Organize Their Fundraising Efforts
Many charities have at least one employee whose primary responsibility is fundraising. In smaller charities, a development officer may handle all of the facets of fundraising. Larger charities may have multiple fundraising staff members who are assigned to different fund raising functions within the charity's office. For example, one may be assigned specifically to developing deferred gifts.

How Development Officers Are Compensated
Development officers are paid a salary; it is unethical for them to receive a commission. Most are evaluated by their success in closing charitable gifts on an annual basis. Deferred giving officers are evaluated not on actual gifts received, but on expectancies, as they have no control over when a donor will die and thus when the gift will "mature."

How You Can Work Together
Development officers and other wealth planning professionals can work together primarily in the area of deferred giving and sometimes with major gifts, especially when gifts of property (real estate, stocks, etc.) are involved. For example, an attorney may be needed to draft the documents, a CPA for compliance and tax issues, and a financial advisor for a life insurance policy or securities transfers. All should be involved in the process as needed to make sure the gift makes sense for and provides the greatest benefit to their client, the donor.

What the Development Officer Can Bring to the Team
When a client wants to support a charity with a deferred gift, it makes sense to bring the charity's development officer onto the estate planning team. Some of the benefits he/she can bring to the process include:

  • Knowledge of the charity's needs and goals;
  • Making sure the gift is used the right way;
  • Hearing and responding to the donor's desires;
  • A general knowledge of planned giving.
Generally speaking, other advisors should not feel threatened by bringing a development officer onboard, as they won't go against investment advice, provide tax advice, or draft the needed documents. A development officer, however, will be a dedicated member of the team and can be valuable in helping to define the donor's desires and goals and align them with the charity's needs and goals. For example, a donor may be thinking he wants his gift to be used for scholarships, but the development officer, who knows that the scholarship fund has plenty of money, may be able to direct the gift toward a building that needs immediate repairs.

A Source of New Business for You
The client conversation that leads to a major or deferred charitable gift can start with either the planner or with the charity, and both are in the position to bring in other professionals to help with the process.

Occasionally a development officer will need to refer donors to attorneys, CPAs and financial advisors in order to complete gifts, and will generally give the donor two to three names from which to choose. A development officer will want to refer his or her donor to professionals who are reliable, have experience in planned giving, will be responsive and are in relatively close proximity to the client. It helps if the professional also personally has charitable intent, which gives him or her valuable insight into what a client/donor wants to accomplish.

A Source of New Business for the Charity
Your estate planning clients are also prospects for charitable giving, and they can be a source of additional business for you and for charities. Your clients and prospects generally of age 50 and older are the same audience the charity wants to reach. Make it a habit to ask if the client or prospect has any desire to support a charitable cause, either now or with a gift after death, and if so which one. Doing so can only enhance your status as the trusted, knowledgeable advisor. Include a question or two on your intake form or ask in your initial interview. When you get a positive response, take the opportunity to bring the development officer into the planning process.

Cultivating Development Officers as Referral Sources
The best way to meet development officers and have them become referral sources for you is old-fashioned networking. Here are some suggestions to help you get started.

Networking Tip #1: Get to know the nonprofits in your area and learn about the resources and services they offer to the community. If your client has charitable desires, it would be very helpful if you already know which organizations would fit well with your client's intentions and would benefit from your client's gift.

Networking Tip #2: Local and regional planned giving councils have regular meetings with guest speakers. You can join, attend, and even offer to speak at these. Regular attendance will yield the best results.

Networking Tip #3: Some national organizations (including The Advisors Forum and WealthCounsel) provide monthly webinars. You could host them at your office and invite local development officers, as well as other professionals with whom you would like to work.

Networking Tip #4: Ask other professionals with whom you already work if they know any development officers in your area. Ask for an introduction and/or a lunch meeting.

Networking Tip #5: Cold calling. Look up nonprofits in your area, then call the planned giving or fundraising office and explain that you would like to meet the development officer. It's not as good as a personal introduction, but it will get you noticed.

Networking Tip #6: Some nonprofits host their own "Get to Know Us" educational seminars as a way to attract potential volunteers and donors. Attending one is a great way to show your interest, learn about the nonprofit first-hand and meet the development officers.

Networking Tip #7: Offer to provide free seminars for the nonprofit's donors (and potential donors) on estate planning, planned giving or other current financial planning topic. It's a great way to find new leads for the nonprofit and for you. Repeating seminars at the same time and location will make it easy for attendees to bring or refer others.

Developing alliances between attorneys, CPAs, financial advisors and development officers for non-profit organizations is an excellent way to expand your networking opportunities, become more aware of the services and resources available in your community, and generate new business. But most importantly, it will feel good to help your clients and charities in a way that is beneficial to both.

Income Tax Planning Concepts in Estate Planning

Estate planning sometimes has income tax effects. All advisors, therefore, should be at least aware of some basics of income tax planning to best serve their clients.

In this issue of The Wealth Counselor, we will examine some of the basics of income tax planning and some of the techniques used in estate tax planning that have income tax impacts.

The Goals of Income Tax Planning
The taxpayer's goal is generally to pay the least amount of income taxes they are legally obligated to pay at the latest possible date. Income tax planning is done to help the client get as close to those goals as the law allows.

Typically, the amount of tax due is reduced by having the income be in a class that has favorable treatment. Favorable rate treatment is granted to long-term capital gains and qualified corporate dividends. Some income is excluded from taxation altogether, such as interest paid by state and local governments, certain gain realized on the sale of the taxpayer's residence, and certain income earned while not living in the United States. The last two are subject to limiting rules and so not always available.

Income tax liability usually arises when an asset changes hands other than by gift or inheritance. However, the tax liability can sometimes be postponed. Examples are certain like-kind exchange transactions and certain installment sales. Sometimes, the fact of an asset changing hands is ignored for income tax purposes because the tax laws treat the transferring party and the transferee as the same taxpayer.

Basic Estate Planning Has No Income Tax Impact
Neither a Will nor a revocable living trust changes a client's income taxes. A Will only takes effect when the client dies and a revocable living trust is classified by the IRS as a grantor trust. Grantor trusts are disregarded for income tax purposes.

Advanced Estate Planning Can and Often Does Have Income Tax Implications
Advanced estate planning, on the other hand, often involves income tax considerations. Advanced planning involves creation of trusts and/or entities.

Sometimes, advanced estate planning is used to reduce income taxes by shifting income from a taxpayer in a high bracket to a taxpayer in a lower bracket. Irrevocable trusts are often used for this purpose when the "kiddie tax" does not apply. The "kiddie tax," when applicable, imposes the parent's tax rate to the income of the taxpayer's child who is under age 24.

For this donor to donee income tax liability shift to occur, the trust cannot be a grantor trust with respect to the donor. On the other hand, if the trust is a grantor trust, the donor's paying the income tax on the trust's income is not an additional gift. Thus not shifting the tax responsibility can be used to transfer additional wealth to children and grandchildren without using the donor's gift tax exemption.

When an asset is sold, the tax is determined by the amount of gain realized. Gain is generally the difference between the net proceeds of the sale and the taxpayer's basis in the asset. If the taxpayer receives the asset as a gift, the taxpayer's basis is the previous owner's basis plus any subsequent investment by the taxpayer. If the taxpayer received the gift as an inheritance, the basis is the asset's value at the death of the prior owner plus any subsequent investment by the taxpayer. Advanced estate planning, therefore, weighs the estate and gift tax avoided against the increased capital gain that would be due on the recipient's sale of a gifted asset as opposed to an inherited asset.

Some advanced estate planning involves charities. Trusts with charity and non-charity beneficiaries all have income tax effects. Such trusts are characterized as charitable lead trusts (CLTs) if the charity beneficiaries take before the non-charity beneficiaries and charitable remainder trusts (CRTs) if the charity beneficiaries get what is left over after payment to the non-charity beneficiaries. Both CLTs and CRTs can be grantor trusts or non-grantor trusts, depending on what the client is trying to achieve.

Advanced planning with income tax aspects also includes:

  • Investing in assets that produce tax-free income;
  • Converting ordinary income into capital gain income;
  • Defering income for the maximum period of time;
  • Accelerating deductions to the earliest possible year;
  • Taking maximum advantage of depreciation rules;
  • Taking maximum advantage of income exclusion rules;
  • Avoiding tax-inefficient business structures;
  • Structuring transactions to include some or all of the above.
Deciding which of these techniques should be used in a particular case requires advanced estate planning experience and probably accounting analysis. It is, however, important for every advisor to be at least aware that they exist so that the appropriate team member can be called on when needed.

Planning Tip: Remember, there is nothing illegal or improper about rearranging our clients' business affairs to take maximum advantage of all lawful strategies to reduce taxes.

Taxation of Corporations, Limited Liability Companies, Partnerships, and Non-Grantor Trusts
Most corporations, limited liability companies (LLCs), and all partnerships, and non-grantor trusts are taxed differently than individuals. An exception is the LLC owned by an individual or the partnership or LLC owned 100% by a married couple. They will be disregarded for income tax purposes unless the taxpayer owner(s) elect otherwise.

Partnerships, for example, are not taxed at all. They report income and deductions, but the taxes are paid by the partners individually.

Some corporations and LLCs are eligible to elect to be taxed under Subchapter S of the Internal Revenue Code's Chapter 1. They are called S-corporations, and they are treated for income tax purposes very much like partnerships - as pass-through entities. Corporations that do not elect or are not eligible for Subchapter S treatment are taxed as separate taxpayers under Subchapter C. They are called C-corporations.

LLCs can elect to be taxed as corporations, otherwise they are taxed as partnerships or are disregarded. Some are eligible to be taxed as Subchapter S corporations.

Partnerships and LLCs that are taxed as partnerships, have special allocation rules. S-corporation taxation is available only if a number of qualification conditions are met. Some trusts, for example, are not qualified to be Subchapter S owners. Entities in which they own interests, therefore, are ineligible for Subchapter S tax treatment. And with corporations that are not Subchapter S corporations, there are adverse taxation, liquidation and distribution of property issues.

Some Specific Income Tax Planning Techniques
Home Sale Exclusion
Many clients will be able to take advantage of the limited exclusion of gain on the sale of a personal residence. It allows a taxpayer to exclude from income up to $250,000 ($500,000 if filing jointly) of gain, providing the property sold has been the owner's primary residence for two out of the five years preceding the date of sale. This exclusion is also available for residences owned in revocable living trusts and certain irrevocable trusts, including defective grantor trusts.

Planning Tip: Many clients have more than one residence. With planning and a responsive market, a client can use this exclusion every two years to sell multiple properties. For example, sell the principal residence first. Then move into the vacation home, make it the principal residence for two years, then sell it.

Converting Income Taxable Assets into Non-Taxable Assets
IRAs have built-in income taxes. Plus, they are includible in the owner's estate as income in respect of a decedent (IRD). Distributions from an inherited IRA are also taxed when received by the beneficiary (although the beneficiary receives an itemized deduction for estate taxes paid on that income). In taxable estates, the net result is that a $1 million IRA is often only worth about $250,000 net to the beneficiary. There are several solutions to this dilemma. Some are:

Solution #1: Stretch out the inherited IRA as long as possible to offset the double tax. The longer tax-deferred growth will allow it to earn back some of the amount paid in estate taxes. Naming a young beneficiary will provide the maximum stretch out, allowing for more growth over a longer period of time. To make sure this happens, consider a special-purpose trust designed to receive and stretch inherited retirement plan benefits.

Solution #2: Convert the IRA to a Roth IRA. It may make sense to convert and pay the tax now if the IRA assets are expected to increase substantially over the next few years. As with a regular IRA, naming a young beneficiary will provide the maximum stretch out, allowing for more tax-free growth over a longer period of time.

Solution #3: Liquidate the IRA now and pay income tax at the current rates. Then gift the net proceeds to an irrevocable life insurance trust (ILIT) where the trustee can use the money to purchase life insurance. This will work well in 2011 and 2012 when the gift tax exemption is $5 million. Using this approach, a $1 million taxable IRA could be converted to over $1 million in tax-free assets for multiple generations.

A C-corporation is taxed at a maximum rate of 35%, but, unlike individuals, it has no preferential capital gains rate. Thus, while capital gain income to an individual is taxed at a maximum of 15%, capital gains realized by a C-corporation are taxed at up to 35%. Then, when a C-corporation distributes a dividend to its shareholders, the dividend is taxed at up to 15% on the shareholder's return - thus creating double taxation on the same income. Even worse, if a C-corporation distributes appreciated assets to its shareholders, a deemed sale will have occurred at the corporate level, regardless of whether the corporation has any cash to pay the tax.

An S-corporation is a pass-through entity so there is only one level of tax. Grantor trusts, including revocable living trusts, can be S-corporation shareholders. An irrevocable trust can also be designed so that it is eligible to be an S-corporation shareholder.

Getting Out of the C-Corporation Trap
Many clients form corporations and elect C-corporation taxation unaware of the problems it can cause in the future because a C-corporation is tax-inefficient. Often the issue only surfaces when there is a real need to get out of the election. Liquidating the C-corporation and re-forming as an LLC (taxed as a partnership) will trigger capital gain on appreciated assets owned by the C-corporation, and shareholders will recognize gain on the receipt of corporate assets. This is not a viable solution unless assets are not appreciated and shareholders have unused capital losses.

A better solution is to liquidate the C-corporation, re-form as an LLC, and make the election to be taxed as an S-corporation. This will eventually eliminate the double taxation. However, a 10-year rule applies, so it is best to get the process started as soon as the problem is detected because any disposition of corporate assets within this 10-year period will result in some double taxation.

Deferring Income Recognition
Any time a client can defer taxes, it is wise to do so unless the tax rate increases. The longer a client can defer the payment of tax the better, because he or she can use and invest that money. Here are some of the opportunities the IRS gives us to defer the tax on income:

Exchange of Insurance Policies (Code Section 1035)
Allows the exchange of a current policy for one with better underwriting or a better product. Often the gain in the current policy is used to partially fund the new policy.

Like-Kind Exchange of Tangible Property (Code Section 1031)
Relinquished tangible property must be of a "like kind" to the replacement property (for example, a herd of cattle cannot be exchanged for a commercial building), and the exchange must occur within certain timing requirements (45 days for identifying and 180 days for acquiring the replacement property). No constructive receipt of cash is allowed in a non-simultaneous exchange, so a qualified intermediary is often used. To completely defer gain recognition, the value of the replacement property must be greater than or equal to the value of the relinquished property, and the taxpayer's equity in the replacement property must be greater than or equal to the taxpayer's equity in the relinquished property. If either is not true, there will be a taxable "boot" that is recognized in the year of the exchange. Tangible property not eligible for a 1031 exchange includes stock in trade or other property held primarily for sale. Intangible property, such as stocks, bonds, notes, other securities or evidences of indebtedness or interest, partnership interests, and certificates of trust or beneficial interests are not eligible for section 1031 exchange deferral.

Certain Corporate Reorganizations (Code Section 368)
Certain corporate reorganizations permit corporations to merge and acquire each other on a tax-free basis, which allows the client to rearrange corporate structure without an immediate income tax.

Installment Sale (Code Section 453)
Generally, if property is sold at a gain and at least one payment is received after the close of the tax year of sale, installment reporting is required unless the taxpayer elects out. There are many specific rules that apply to installment sales.

Charitable Trusts
In the right circumstances, charitable trusts can also provide tax deferral.

Charitable Remainder Trust (CRT)
The grantor retains an annual income stream and the remainder, if any, at the end goes to charity. The annual income stream can be an annuity or a "unitrust": i.e., an amount that is a fixed percentage of the balance of the trust at the beginning of the year. The net present value of the remainder interest when the trust is created must be at least 10% of the value of the initial contribution. The annual distributions can be payable for a term of years, a single life, joint lives or multiple lives.

Tax Deferral with a CRT
A CRT is exempt from income tax because the ultimate beneficiary of the trust is a charity. There will be no capital gain tax when appreciated property is placed in the trust or when it is sold by the trust. Capital gain is eventually taxed as annual payments are made to the grantor, but only after ordinary income has been taxed. Distributions that exceed ordinary income and accumulated capital gains are tax-free. The client also gets a charitable deduction in year one for the present value of the remainder interest.

Charitable Lead Trust (CLT)
With a CLT, a charity is the beneficiary that gets a stream of annual payments and the remainder, if any, goes to the grantor or whoever the grantor chooses. A CLT is funded with income-producing assets that are ultimately earmarked for heirs. At termination of the CLT, the trust assets pass on to the heirs free of any transfer tax on appreciation realized after the date the trust was created, as long as the rate of return on the assets exceeds the AFR in effect when the CLT is established. The taxable gift to the heirs is calculated in the year the CLT is created if the stream of payments is an annuity, or at termination if the CLT is a unitrust. When the grantor gets a charitable deduction depends on whether the CLT is a grantor trust.

Tax Deferral with a CLT
A CLT is not exempt from income tax because the ultimate beneficiary of the trust is not a charity. If it is a non-grantor CLT, there is an income tax deduction for the amount paid to the charity each year. If it is a grantor CLT, the charitable income tax deduction can be accelerated and taken on the grantor's income tax return in the year the trust is created. This can be very beneficial for a client who has a substantial amount of income in one year. All taxable income earned by the trust in future years will then be taxed to the grantor.

Income tax planning should be an integral part of the estate planning process. We hope that this review will be useful for issue spotting and serve as a reminder that we need to work together as a team in order to provide the best possible service for our mutual clients.

Top Income Tax Planning Ideas for 2011 and 2012

With the recent discussions about closing tax loopholes and increasing taxes for the "wealthy" incident to increasing the national debt limit, clients are beginning to fear that the taxes on their wealth will increase. Even without higher tax rates, wealthier Americans will pay more in taxes if allowable deductions (possibly charitable) and exemptions (probably estate tax) are lowered.

We need to be prepared to help our clients as they begin to draw down retirement savings and look for more tax-efficient investments for their stocks, bonds, real estate and savings.

In this issue of The Wealth Counselor, we will examine some of the top income tax planning ideas to implement in 2011 and 2012.

Income Tax Overview
Anything can happen between now and January 1, 2013, but, based on current law, that will be the date the top income tax rate increases from 36% to 39.6%, qualified dividends become subject to ordinary income tax rates, the tax on long-term capital gains jumps from 15% to 20%, and the 3.8% Medicare surtax kicks in (unless the Florida Federal District Court decision striking down the health care reform act is upheld). Let's look more closely at how these taxes can impact your clients, and what you can do to help them.

Qualified Dividends
Under current law, in tax years beginning on or after January 1, 2013, qualified dividends will be subject to ordinary income tax rates. Therefore, C Corporations with accumulated earnings and profits and the cash to do so should consider making larger dividends in 2011 and 2012.

Example, Distribution of C Corp Dividends: Should the sole shareholder of a C Corp make a $1 million dividend to himself in one lump payment in 2012 or in $200,000 increments over five years (2012-2016)? Assuming he is in the highest marginal income tax bracket, 15% capital gains tax rate on dividends in 2012, and 39.6% + 3.8% = 43.4% ordinary income tax rate on dividends for 2013 and beyond, he would pay $150,000 in taxes on the lump sum distribution in 2012 and $377,200 on the incremental distributions paid over five years. He would save $ 227,200 by taking the lump sum in 2012.

Long-Term Capital Gains
Under current law, in tax years beginning on or after January 1, 2013, long-term capital gains will be taxed at a top rate of 20%. Taxpayers should consider selling (or otherwise disposing of) appreciated property and recognizing the taxable gain in 2011 and/or 2012. Taxpayers who have realized capital gains deferred on an installment note may want to consider accelerating the unrecognized gain in 2011 and/or 2012.

Example, Acceleration of Gains: In 2012, Judy sold her business for $1 million in exchange for a nine-year installment note. At the time of the sale, she realized a $900,000 gain. By electing out of the installment treatment, she would pay $135,000 in capital gains tax on the lump sum in 2012 vs. $175,500 on the installments in 2012-2021, and would save $40,500 in taxes (900,000 x .15 = 135,000 versus 900,000 x .1 x .15 = 13,500 plus 900,000 x .9 x .2 = 162,000).

Ordinary Income
Under current law, in tax years beginning on or after January 1, 2013, ordinary income tax rates will increase to their pre-2001 levels. Taxpayers should consider accelerating certain types of ordinary income (bond interest, annuity income, traditional IRA income, compensation income) into 2011 and 2012 if they expect to be in the same tax bracket or higher in future tax years. This is especially true for top bracket taxpayers who may pay the 3.8% Medicare surtax on their "net investment income."

Example, Accelerating Bond Interest: Mike has $100,000 of accrued bond interest that will be paid on January 3, 2013. Mike is in the 35% tax bracket for 2012 and 39.6% + 3.8% for 2013. If he sells his bonds (at par) before the end of 2012 and recognizes the accrued interest income, he will pay $35,000 in taxes vs. $43,400 if he waits and collects the interest in 2013, and will save $8,400 in taxes.

Example, Sale/Repurchase of Bond: James purchased $1 million of corporate bonds in 1993 at par value; they mature December 31, 2011. On December 31, 2012, he sold them for $1,050,000. On January 3, 2013, he repurchased the same bonds for $1,050,000. Under tax law, this $50,000 premium can be used to offset his interest income over the remaining life of the bond (one year). By selling the bonds in 2012 and repurchasing them in 2013, he realizes a net income tax savings of $14,200 ($21,700 in income tax savings on the bond premium, less $7,500 in capital gains tax on the sale of the bonds = $14,200).

Additional Income Tax Planning Ideas
Oil and Gas Investments
Intangible drilling costs (IDCs) provide a large immediate income tax deduction (up to 85% of the initial investment). Losses, if any, created as a result of IDCs will be ordinary and will lower the taxpayer's Adjusted Gross Income. Depletion and other depreciation provide for additional deductions during the term of the investment. Additional tax credits may be available for certain oil and gas ventures.

Planning Tip: Be careful with oil and gas investment where the client may be subject to the alternative minimum tax (AMT). The AMT may limit the amount of deductions allowed.

Gold Investments
Generally, gold held as coins or bullion is treated as "collectibles," for which the long-term capital gain rate is 28%. All short-term capital gains are treated as ordinary income. Therefore, a taxpayer in a lower tax bracket would be better off triggering short-term rather than long-term capital gain on gold coins or bullion. On the plus side, the "wash sale rule" (explained below) does not apply to "collectible" losses.

Planning Tip: The "collectibles" tax rate does not generally apply to gold held in mutual funds or to non-exchange-traded options on gold. Gold futures must be "marked to market" and the unrealized gain/loss must be recognized each tax year. Moreover, gold futures gains are subject to special tax treatment (60% long-term capital gain or 40% short-term capital gain).

Foreign Currency Transactions
Gains and losses in foreign exchange transactions are ordinary income/loss rather than capital gain/loss. Generally, taxpayers will want to recognize ordinary income in 2011 and 2012 and push ordinary losses to 2013 and later years.

Index Options
These have special gains treatment on certain broad-based listed options (60% long-term and 40% short-term). For taxpayers in the highest marginal income tax bracket in 2013, this would result in a blended capital gains tax rate of 29.36% ((.6 x .2) + (.4 x .434)).

Loss Harvesting
Loss harvesting can apply to individuals, trusts/estates, and charitable lead and remainder trusts. Considerations include:

Wash Sale Rule: Capital losses are denied to the extent that a taxpayer has acquired (or has entered into a contract or option to acquire) a "substantially identical" stock or security within a period beginning 30 days before the sale and ending 30 days after the sale of a stock that was sold at a loss ("loss stock"). The disallowed loss on the loss stock is added to the cost basis of the new stock, and the holding period of the loss stock is carried over to the new stock. This rule also applies to ETFs, index funds, IRAs and taxable investment accounts. It does not apply to "collectibles."

Diminishing Real Value of Capital Losses: Because of the cost of capital, the sooner a capital loss is used the better.

Efficiency of Capital Loss Offsetting: In general, capital losses are more tax effective if they can be used to offset income taxed at higher tax rates (short-term capital gains and ordinary income). Long-term losses used against short-term gains are tax-efficient. Short-term losses used against long-term capital gains are tax inefficient.

Income Shifting to Junior Generations
Income taxes can be saved by shifting income-producing assets from parents or grandparents who are in a high income tax bracket to their children and grandchildren who are in lower tax brackets. Planning considerations include asset protection (accomplished through the use of trusts) and the "kiddie tax" for beneficiaries under age 24.

What makes this most attractive in 2011 and 2012 is the $5 million per person gift tax exemption: a married couple can gift up to $10 million and no gift tax will be incurred on the gift. The gift can be made in trust and then used to invest and/or purchase life insurance on the donors.

Example: Husband and wife, who are taxed at the current top (35%) rate, own $16,000,000 in S Corporation stock. They gift $10 million of it to their four adult children (15 5/8% of the S Corporation stock to each child). The S Corporation income is $2 million per year. After the gift, 37.5% is attributed to the parents and taxed at their rate and 62.5% is attributed to the children and taxed at their lower rates (assume 25%). Annual income tax savings: $10,000,000 x 10% = $100,000.

Planning Tip: Income can also be shifted upwards. For example, a high-earning professional can make the gift to his/her elderly parents who are in a lower tax bracket. The additional income can be used to help pay for medical and/or assisted living expenses. After the parents die, the assets can go to the original donor's children (if the "kiddie tax" does not apply) for additional income shifting.

Roth IRA Conversions
Benefits of converting include a lowering overall of taxable income long-term; tax-free compounding; no required minimum distributions (RMDs) during the owner's life; tax-free withdrawals for beneficiaries; and more effective funding of the bypass trust. For most people, converting to a Roth IRA is highly beneficial over the long term.

Planning Tip: When exploring a Roth IRA conversion, consider the tax rate in the year of conversion vs. the tax rate in years of withdrawals; the owner's ability to use outside assets to pay the income tax on the conversion; and the need for the IRA to meet annual living expenses.

Net Unrealized Appreciation (NUA) Planning
If an employee has employer securities in his/her qualified retirement plan, he/she may be able to convert a portion of the total distribution from the plan from ordinary income into capital gain income. The distribution must be made as a lump-sum distribution due to the employee's death, attaining age 59 1/2, separation from service, or becoming disabled within the meaning of Code section 72(m)(7).

Taxation of Lump-Sum Distribution
Ordinary income is recognized on the cost basis of the employer securities distributed (a 10% early withdrawal penalty is due if the employee is under age 55 at the time of distribution). The difference between the fair market value at distribution and the cost basis is Net Unrealized Appreciation (NUA). NUA is not taxed at the time of distribution, but at a later time when the stock is sold, and is taxed then at long-term capital gain tax rates. (Ten-year averaging is available to those born before 1/2/1936; 20% capital gain applies to pre-1974 contributions only.)

Planning Tip: NUA does not receive a step-up in basis at death, although subsequent gain above the value at distribution should. Also, if an estate or trust contains NUA stock, a fractional funding clause must be used; otherwise, the NUA will be subject to immediate taxation.

Charitable Planning
If the capital gains tax rate increases to 20% and the 3.8% Medicare surtax applies, charitable remainder trusts (CRTs) could become very attractive again. That's because appreciated assets that are transferred to a CRT are not taxed, so the full value of these assets is available to provide income to the donor, generating much more income than if the donor had sold the asset, paid the capital gains tax, and re-invested the proceeds.

Planning Tip: With the current historically low 7520 rates, charitable lead trusts can be used now by charitably inclined clients to shift significant wealth while using only an insignificant amount of their estate/gift tax exemption.

Inherited IRAs
An IRA is treated as inherited if the individual for whose benefit the IRA is maintained acquired the IRA upon the death of the original owner. Under the tax law, the IRA assets can be distributed based upon the life expectancy of the beneficiary if the beneficiary is a living person or a trust that meets certain requirements, such as that it is irrevocable, all beneficiaries are natural persons, and the oldest possible beneficiary can be determined.

Spouse as Beneficiary
A surviving spouse named as beneficiary of the deceased spouse's IRA may roll it over into a new or existing IRA in the spouse's own name. The spouse is then treated as the owner and may delay taking required minimum distributions (RMDs) until he/she turns age 70 1/2 and then take distributions based on his/her life, often allowing for a greater stretch-out period.

Planning Tip: If the surviving spouse is under 59 1/2, rolling over can expose him/her to the early withdrawal penalty if the IRA funds are needed before the surviving spouse reaches 59 1/2. Safer strategy is to wait until then to roll over and use the inherited IRA withdrawal rules before then.

Non-Spouse as Beneficiary
Naming a non-spouse beneficiary avoids having the IRA assets being subject to estate tax in the surviving spouse's estate. Required minimum distributions (RMDs) occur over the life expectancy of the designated beneficiary.

Common Inherited IRA Mistakes to Avoid
For non-spouse beneficiaries, it is critical to keep the inherited IRA in the name of the deceased IRA owner. Correct wording for an individual: "John Smith, deceased, IRA for the benefit of James Smith." Correct wording for a trust: "John Smith, deceased, IRA for the benefit of James Smith as Trustee of the Smith Family Trust dated 1/1/2010."

Other mistakes include not taking required minimum distributions, not using disclaimers when appropriate, not analyzing contingent beneficiaries, and taking a lump-sum distribution at the death of the IRA owner.

Life Insurance Planning for Inherited IRA
If the IRA owner's taxable estate does not have sufficient other assets, it could be necessary to use a portion of the IRA to pay estate taxes. Because this use triggers additional income taxes, between 60-80% of the IRA could be lost to taxes.

A solution is to establish an Irrevocable Trust that holds a life insurance policy on the IRA owner's life. Upon his/her death, the death benefit proceeds can be used to provide liquidity to the IRA owner's estate and preserve the inherited IRA. 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. Another alternative is to annuitize the IRA and contribute the annuity payments to the Irrevocable Trust where they are used to pay premiums for life insurance on the IRA owner.

The current income tax laws and the tax increases that will happen in just 16 months (unless the Congress and President agree otherwise) provide some unique opportunities for estate planning professionals to work together as a team to help our mutual clients. Take advantage of this limited time to meet with your clients, ask the right questions, and make a positive difference for them and their families.