Niche Trusts

Revocable Living, Irrevocable Life Insurance, Charitable Lead, and Grantor Retained Annuity - these are trust descriptors that are familiar to estate planning professionals. However, there are many less well-known types of trusts that clients may ask about or benefit from having. Some of those other types of trusts will fill an estate planning need like no other arrangement can. Some arrangements called "trusts" do not fit the traditional trust definition. Still other things called "trusts" are outright shams.

As professionals, we need to know about the lesser-known trusts, when to use them, when to avoid them, and when to warn our clients to get out of them.

In this issue of The Wealth Counselor, we review some trust basics and then provide an introduction to a number of these lesser-known trusts and things called "trusts."

What Is a Trust?
Almost always, when someone says "trust," they mean what is called an "express trust" - a tri-party relationship intentionally established by a grantor (who is the owner of property), a trustee (who receives and agrees to hold and manage the property), and a beneficiary or beneficiaries (for whose benefit and enjoyment the property is to be held). In this discussion, "trust" means "express trust" unless the contrary is stated.

A trust is a fiduciary relationship between the trustee and the beneficiary and between the trustee and the grantor. It involves two distinct elements of ownership of an asset: 1) legal (transferred by the grantor to the trustee) and 2) beneficial (vested in the beneficiaries to the extent specified in the trust agreement).

Although a trust is a relationship, for IRS purposes, it is treated as an entity. Under the Treasury Regulations, the key distinguishing factor of a trust is that it exists to protect and conserve property for the benefit of beneficiaries "who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit."

Planning Tip: An entity that is not classified as a trust under Treas. Reg. 301.7701-4 is a business entity.

Private Trusts
Most trusts are private trusts. In addition to those commonly encountered, there are many that have very special purposes. Some of them are:

Health and Education Exclusions Trust (HEET): The HEET is a multi-generational or "dynasty" trust. Through a HEET, a wealthy grantor can confer even more benefit on grandchildren and generations beyond than the amount that is exempt from the Generation Skipping Transfer (GST) Tax. The HEET does this by limiting distributions for the benefit of "skip persons" to direct payments of their medical and higher education tuition expenses. A skip person is someone two or more generations younger than the grantor. A HEET also prohibits direct payments to skip persons or for purposes that are not exempted from gift, estate, and GST tax. The HEET must have a least one beneficiary with a substantial present economic interest who is a non-skip-person. Typically, the non-skip beneficiary chosen is a charity so that the HEET can continue in existence for as long as the charity exists.

Planning Tip: A HEET is frequently created by a taxpayer who has already used their GST exemption, has charitable goals and wishes to create an education and health care safety net for future generations.

Delaware Incomplete-gift Non-Grantor (DING) Trust: A DING is a non-grantor self-settled irrevocable trust that gives the grantor creditor protection and avoids state income tax on undistributed ordinary income and capital gains. Delaware was the first state to allow self-settled asset protection trusts. Now, however, DINGs are not limited to Delaware. States where domestic asset protection trusts can be established now include Alaska, Nevada, New Hampshire, Rhode Island, South Dakota, Tennessee, Utah and Wyoming.

Assets placed in a DING get a step up in basis on the grantor's death and are included in the grantor's estate for estate tax purposes. A DING must require the consent of an adverse party for any trust distribution (typically a committee composed of two beneficiaries of the trust other than the grantor).

Rabbi Trust: The first Rabbi Trust was set up for a rabbi; hence, the name. They are used with various nonqualified deferred compensation arrangements for highly compensated executives who wish to defer the receipt of some of their compensation in order to minimize current income taxes. The Rabbi Trust can be revocable or irrevocable and funded or unfunded. A funded Rabbi Trust provides the executive more security; however it must be carefully structured to prevent the employee from being taxed now. The trustee must be an independent third party and the assets must be held separate from the employer's other funds.

Planning Tip: Assets held in a Rabbi Trust are subject to the claims of the employer's general creditors, so it is important to use this technique only with a financially solid company. The fact that the executive will be an unsecured creditor of the company should the company become insolvent is not especially reassuring, but is necessary in order to prevent the executive from being taxed currently on the deferred compensation.

Oral Trust: Although trusts are usually written documents, that is not always required. The Uniform Trust Code (UTC) does acknowledge that under certain circumstances a trust may be created orally. However, oral trusts of real property are not permitted in some states. The biggest problems with an oral trust, of course, are interpretation and enforcement. Disputes about the terms or even the very existence of an oral trust are common.

Alimony and Maintenance Trust: These are also called "Section 682" trusts. They are an exception to the general grantor trust rules in that the income paid from these trusts to an ex-spouse under a dissolution or separation decree/agreement will be taxed to the payee (the ex-spouse) and not to the grantor. Typically the trust's income is paid to the former spouse for a specified term or amount or until the spouse dies. After the former spouse's interest has ended, the trust can continue for the benefit of the grantor's designated successor beneficiaries, typically the children.

Planning Tip: An alimony trust may be useful if a business owner cannot or does not want to sell an interest in the family business to make payments to his former spouse or if the business lacks the liquidity to redeem the stock of the former spouse. It can protect the payee in the event the payor should die or become financially insolvent before all payments have been made. Also, the trustee can be a neutral third-party who can act as an intermediary between the former spouses. One downside is that the trust can become under- or over-funded, so care should be taken when drafting the document and funding the trust.

Commercial Trusts
Also known as a business trust, the commercial trust is an unincorporated business organization. It is created by a written agreement under which assets are managed by a trustee for the benefit and profit of its beneficial owners. It is typically funded in a bargained-for exchange and shares of beneficial ownership are issued to the participants. The trustee can make risky investments for entrepreneurial gain and share that risk of loss with the beneficial owners. This arrangement is different from the traditional grantor/trustee/beneficiary relationship and the trustee does not have the same kinds of fiduciary duties and protections as in a conventional trust arrangement. It is not clear that these trusts would have as much asset protection as a conventional corporation or an LLC, or how they would be recognized in bankruptcy. Specific commercial/business trusts include:

Investment Trust: This trust is used by multiple individuals to pool funds for common investments. One common type of Investment Trust is the Real Estate Investment Trust (REIT). The trust may provide that beneficial interests in the trust may be bought and sold.

Environmental Remediation Trust: These are established to collect and disburse funds for environmental remediation of an existing waste site when the ultimate cost of remediation is uncertain. They are used in sales of contaminated real property.

Statutory Land Trust: These private non-charitable trusts are used to hold title to real property while keeping the identity of the beneficiary confidential, and are used to maintain privacy in the transfer of real estate (acquisition or sale). They can avoid probate, but do not provide asset protection.

Liquidating Trust: These relate primarily to income tax and bankruptcy. In bankruptcy, they are used to liquidate assets under Chapter 11. Outside bankruptcy, they are used to facilitate a sale.

Voting Trust: These allow voting rights in a business entity to be transferred to a trustee, usually for a specified period of time or for a specific event. They are useful in resolving conflicts of interest, in securing continuity, for corporate reorganization, and in divorce when it is necessary to divide an LLC or corporation owned by a divorcing couple.

Specific Purpose Trusts
There are some trusts created for specific purposes rather than for the benefit of individual beneficiaries. Non-charitable purposes include pets, artwork, aircraft; charitable purposes include private foundations organized as trusts and charitable land banks. Specific examples include:

Funeral and Cemetery Trust: A funeral trust is an arrangement between the grantor and funeral home or cemetery involving prepayment of funeral expenses. An endowment cemetery trust is a pooled income fund held in the name of the cemetery for ongoing maintenance of cemetery grounds. A service and merchandise cemetery trust, similar to a funeral trust, is for merchandise like a gravesite marker or mausoleum and for burial service.

Pet Trust: Many pet owners want to provide for the continuing care of their pets after their own deaths. As a result, many states have adopted some form of pet trust legislation. It is important to specifically identify the animal the trust is to benefit, especially if the pet is valuable or a large sum of money is involved. Special considerations include: how long the trust will need to last, what kind of care is needed and who will provide it, whether to name a separate trustee to manage funds in addition to a caretaker, successor fiduciaries and caretakers, a sanctuary or shelter of last resort if the pet outlives the caretakers or those named cannot serve, liability insurance for potential damage caused by the pet, a trust protector, and reimbursement of taxes if the payee is subject to additional income taxes. Also consider how much money will be required to fund the trust and what will happen to any funds that remain after the pet has died.

Gun Trust: Federal, state and local firearms laws strictly regulate possession and transfer of certain weapons and bar certain persons from owning or having access to firearms. When an estate has firearms, the executor must be careful to avoid violating these laws. Transferring a weapon to an heir to fulfill a bequest could subject the executor and/or the heir to criminal penalties. Just having a weapon appraised could result in its seizure.

A trust designed specifically for the ownership, transfer and possession of a firearm (known as a gun trust or firearm trust) can avoid some of the rules that regulate such transfers. The trust, which must be carefully drafted to account for the different types of firearms held and comply with firearms laws, establishes a trustee as the owner of the firearms. The trust can name several trustees, each of whom may lawfully possess the weapon without triggering transfer requirements. Once a weapon becomes a trust asset, any beneficiary (including a minor child) may use it.

Marketing Tip: There are four million members of the National Rifle Association (NRA) and an estimated 240 million firearms in this country. That means millions of American own guns. Many families also have guns as heirlooms. Providing guns trusts (and pet trusts, for that matter) is an excellent way to reach out to potential clients for estate planning.

Other Trusts
Blind Trust: These are used by higher net worth clients who are involved in public companies or politics and who need to strictly limit their knowledge of how their assets are being managed in order to avoid any conflict of interest or even the appearance of one. Investments are transferred to an independent trustee who is permitted to sell or dispose of any assets transferred to the trust, and then reinvest in assets that are unknown to the grantor.

Coogan Trust: This is a statutory trust account required in some states to protect a part of the earnings of child actors. It is named after the child actor, Jackie Coogan, who learned on becoming an adult that his parents had saved very little of his earnings.

Totten Trust: This is a pay-on-death account that, until the death of the depositor, is treated as an informal revocable living trust. While living, the depositor may be the grantor, trustee and beneficiary. Upon the depositor's death, the proceeds in the account will be paid to the beneficiary previously designated on a signature card by the depositor (who can change the designation any time before his/her death).

Sham Trusts
These are so-called trusts marketed by hucksters that violate public policy and are not recognized by state or federal income tax authorities or the courts. The document may claim to create a trust and promise tax benefits, but makes no actual change in ownership or control of the grantor's property or beneficial interests. They may be complex, involving multiple foreign and domestic trusts, and entities holding interests in other trusts. Funds may flow from one trust to another by various agreements, fees and distributions; often there are no named beneficiaries. They may claim that paying taxes is entirely voluntary. Names include Constitutional Trusts, Pure Trusts, Pure Equity Trusts, Contract Trusts, and Freedom Trusts.

Planning Tip: If your client has one of these sham trusts, the risk of an IRS audit with accompanying penalties - civil and criminal - is high. They thus provide the advisor an opportunity to un-do a great harm, providing the client is willing.

Constructive Trusts
A constructive trust is not a trust, but it resembles one. It is an equitable remedy imposed by a court to transfer the benefit of property to the rightful party when someone else has unjustly received it. A court may impose a constructive trust to remedy fraud, misrepresentation, bad faith, overreaching, undue influence, duress and mistake. Courts may also use the constructive trust doctrine creatively when a wrong has been committed but no legal remedy is available.

Conclusion
There are many kinds of trusts and trust-like arrangements that estate planners may not routinely use in their practices. It's good to be aware of them, and to understand when one might be useful for a client and when one might be dangerous, or possibly even criminal. Each represents an opportunity for the professional to enhance their role as trusted advisor.

Estate Planning You Can... and Should... Do In 2010

With the current economy and uncertainty about the federal estate tax, many people are finding themselves sitting on the fence, wondering if they should do any estate planning now, or if they should wait. You may be surprised to know that there are many non-tax reasons to plan your estate that have nothing to do with the economy or estate taxes. And if your estate may be subject to estate taxes in the future, this year can be a perfect time for many people to plan, specifically because of historically low interest rates and changes that have been proposed by the IRS and Congress.

Let's look first at planning needs that are not related to the economy or to the estate tax.

Disability Planning
It's a fact that most of us will need some kind of assistance with our daily living activities for at least some time before we die. This kind of care can be provided in your home, in an assisted living facility, or in a nursing home. All can become very expensive.

Home health care can easily run over $20,000 per year. That's at $16 per hour, for just 25 hours a week.

Depending on the skill required, number of hours needed and where you live, it can cost considerably more. Assisted living facilities can cost more than $25,000 per year; the more services you need, the higher the cost. Nursing home facilities, with round-the-clock care, are easily $50,000 or more a year.

Take a look at these statistics for Americans age 65 and older:

• 43% will need nursing home care;
• 25% will spend more than a year in a nursing home;
• 9% will spend more than five years in a nursing home; and
• the average stay in a nursing home is more than 2.5 years.

Planning Tip: Most insurance plans and Medicare do not currently cover long-term care. That means the cost will need to be paid from your assets. Consider purchasing a long-term care insurance policy to protect your assets.

Besides the cost of long-term care, you may also be concerned about who will provide the care you need and where you will receive it. You may prefer to stay in your home for as long as possible, or you may enjoy the companionship and social aspects of an assisted living facility. However, incapacity can deprive you of the ability to make your desires known and implemented.

Planning Tip: Your trust can include disability provisions that will make sure your desires are clearly expressed and carried out. It's best to take care of this now, while you are able to communicate your wishes.

Special Needs Planning
Here are some more eye-opening statistics. These are from the U.S. Census Bureau report in 2000. (It will be interesting to compare these when the latest Census reports are available.)

• 51.2 million Americans reported having a disability;
• 13-16% of U.S. families had a child with special needs;
• 15 out of every 1,000 children born in the U.S. had an Autism disorder;
• Between 1 and 1.5 million American had an Autism disorder.

Thanks to medical care advances in recent years, many with special needs now outlive their parents and/or caregivers. Planning that does not include specific provisions for the special needs person can have disastrous consequences, including the loss of valuable government benefits.

Planning Tip: A Special Needs Trust is a critical component of planning for families with a special needs person. This trust can provide the ongoing support the special needs person requires without jeopardizing government benefits.

Planning Tip: Insurance on the life of a parent, grandparent or other relative can provide the trust funds necessary to pay for care and extras that are not provided by government benefits.

Inheritance Protection Planning
Protecting an inheritance from predators, creditors, divorce and irresponsible spending is a major concern for many parents and grandparents today. Many feel that their children and grandchildren lack strong financial skills, and difficult economic times can make inheritances more vulnerable to creditor claims and/or maintaining a lifestyle beyond the beneficiary's means.

Difficult economic times also increase the likelihood of divorce, which is already at a 50% rate. Most people do not want to see their hard-earned money ending up in the hands of a former daughter- or son-in-law.

Planning Tip: Your trust can include provisions to protect inheritances from divorce, creditors and from the beneficiaries themselves.

Blended Family Planning
More divorce leads to more marriages and blended families - his, hers and, sometimes, theirs. Each parent needs to make sure his/her children are protected, especially if you will also leave a surviving spouse. Not doing so can cause your children to be unintentionally disinherited or, at the very least, create a messy probate battle.

Planning Tip: Your trust can include provisions that will allow you to provide for your surviving spouse and make sure your children (and grandchildren) receive the inheritance you want them to have.

Planning for Estate Taxes
Yes, you do need to plan for estate taxes now, even though we currently do not have a federal estate tax in 2010. Here's why:

Reason One. Most states now have their own inheritance/death tax, so even though your estate may not have to pay a federal tax, it may have to pay a state tax. This is true whether you die in 2010 (when there currently is no federal estate tax), or if your estate is small enough that it will be exempt from the federal tax. Depending on where you live, an estate as small as $388,000 could be subject to a state death tax.

Planning Tip: Don't assume your estate will not have to pay estate taxes. Now is a good time to find out about your state's death/inheritance tax and plan for it.

Reason Two. Chances for permanent repeal of the federal estate tax are essentially zero. With all its spending programs, Congress is going to want/need every tax dollar it can get its hands on. The only questions are when will Congress act and what will it do. The more time that passes this year, the less likely it is that Congress will change anything for 2010. That's because both parties will probably make the estate tax an issue for the mid-term elections in November. If Congress does nothing this year, the estate tax will return in 2011 with a $1 Million exemption and a 55% tax rate. Compare this to the 2009 estate tax that had a $3.5 Million exemption and a 45% tax rate. There is no question that more people will be paying more in estate taxes.

Planning Tip: Don't wait until 2011 to plan. You could become physically or mentally incapacitated before then due to an illness, injury or accident. Plan now while you are able to do so.

Reason Three. Congress will almost certainly eliminate several wealth transfer techniques that will affect your ability to transfer assets to your beneficiaries at discounted values. Combine this with interest rates that are at an all-time low and depressed property and investment values, and you have an exceptional planning opportunity that can save substantial amounts in estate taxes and provide more for your loved ones.

For example, let's say you wanted to use a Family Limited Partnership (FLP) or a Family Limited Liability Company (FLLC) to, among other things, transfer a family business, farm, real estate or stocks to your children. In exchange for transferring the asset to the FLP or FLLC, you will receive ownership interests. You will have a fiduciary interest to other owners, but you can keep control as the general partner (FLP) or manager (FLLC). You can also give ownership interests to your children, which removes value from your taxable estate. And since these interests cannot be easily sold or transferred their value is often discounted. In other words, since most people would not pay full price for an asset they could not sell or transfer, it's value is worth less than the value of the underlying assets. This lets you transfer the underlying assets to your children at reduced value without losing control.

Other Planning Options
There are other planning options that let you transfer assets at discounted values and benefit from historically low interest rates. Here are two:

• Grantor Retained Annuity Trust (GRAT): Lets you transfer an income-producing asset (stock, real estate, business) to a trust for a set number of years, removing it from your estate, while you receive the income it produces. When the trust term ends, the asset will go the beneficiaries of the trust. Because they will not receive it until then, the value of the gift is reduced (discounted). If you die before the trust term ends, some or all of the asset may be included in your estate for estate tax purposes.


• Charitable Lead Trust (CLT): This charitable trust lets you transfer an asset into a trust for a set number of years or until you die. During this time, the charity or charities you select will receive the first or "lead" right to receive a stream of equal payments from the trust. At the end of the trust term, whatever is left in the trust (the remainder) will go to the beneficiaries of the trust, typically your children or grandchildren. Because the gift to the beneficiaries is delayed, the value is substantially reduced, resulting in little or no estate tax on the asset. CLTs are particularly suited for hard-to-value assets (such as real estate or family limited liability company interests) and assets which are expected to grow rapidly in value.

Planning Tip: While strategies like these have been used effectively for years to reduce estate taxes, it is no secret that the IRS is not fond of having to accept discounted values. With Congress looking for every possible way to increase revenue, many of these strategies could soon be eliminated. For example, a current proposal in Congress would eliminate GRATs with a term of less than 10 years, making it more likely that the GRAT assets would end up back in your estate. 2010 is an exceptional year to make good use of these strategies, while we still have them.

Planning Tip: Making gifts now can save estate taxes later.

Currently, each year you can give up to $13,000 tax-free to as many individuals as you like; you can double that amount if your spouse joins you. For example, if you have three children and six grandchildren, you can give them a total of $117,000 ($234,000 if your spouse joins you) each year. If you give more than this, it will be applied to your $1 Million lifetime gift tax exclusion ($2 Million if your spouse joins you). After that has been exhausted, you will pay a gift tax, but it is currently 35%. That's a lot less than estate taxes, which have historically been 45-55%.

Plus, any appreciation on gifts you make now is also out of your estate. Say you transfer $1 Million to your children today. Assuming these assets grow at 10%, in ten years they will be worth $1,930,690. If you wait and give the $1 Million to your children when you die, and we assume the estate tax exemption is $1 Million, the $1,930,690 will be subject to federal estate tax of at least $418,810, leaving just $1,511,879 for your children.

Planning Tip: Using a Grantor Trust can provide even more for your children.

A Grantor Trust is a separate irrevocable trust that you can establish for estate planning purposes. The rules are different, which can be used to your advantage. For example, without getting too technical, the IRS defines a Grantor Trust one way for income taxes and another way for estate and gift taxes; in other words, the rules don't match. By using this long-standing "wrinkle," in the tax code, transfers of assets by gifts and sales to irrevocable trusts can be "supercharged," letting you transfer even more to your children estate tax free. For example, if you used a Grantor Trust and paid the income tax, the same $1 Million gift would grow to $2,592,742, which is $663,052 more than if the gift were made directly to your children and they paid the tax.

Conclusion
Take advantage of the rare planning opportunities that exist now, that can save substantial amounts in estate taxes and provide more for your loved ones. For more information about estate planning in 2010, please contact our office.

Highlights of the New Estate Tax Legislation

On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the "2010 Tax Act"). In a nutshell, it did five things: extended current unemployment benefits to 99 weeks, extended current income tax rates (the Bush tax cuts) for all taxpayers for two more years, made significant changes to the estate tax applicable to those dying in 2010, 2011, or 2012, modified the gift tax for 2011 and 2012, and modified the Generation Skipping Transfer Tax for 2010, 2011, and 2012.

In this issue of The Wealth Advisor, we will look at how these temporary changes can affect your estate planning.

Estate Tax Exemption and Tax Rate
Your estate will have to pay federal estate taxes if its net value when you die is more than the exempt amount in effect at that time. For 2010, 2011 and 2012, the individual exemption is now $5 million and the tax rate is 35%. So, if someone dies in 2010, 2011 or 2012 and their taxable estate is less than $5 million, no estate taxes will be due (assuming none of the exemption was used during life to make gifts). If the taxable estate is more than $5 million, the excess over $5 million will be taxed at 35%. Those who are married and have planned ahead can use both exemptions (more on this later).

Planning Tip: To determine your current taxable estate, add the value of all your assets, including your home, business interests, bank accounts, investments, IRAs, retirement plans and death benefits from your life insurance policies, and then subtract all of the debts you owe.

It's important to remember two things: These changes are only effective for the next two years. If Congress does not act again before the end of 2012, on January 1, 2013, the estate tax exemption will drop to $1 million (adjusted for inflation) with a top tax rate of 55%. Also, some states have their own death tax, so your estate could be exempt from federal estate tax but still have to pay a state death tax.

Optional Retroactive Planning for Estates of Those Who Died in 2010
As noted above, the new law retroactively reinstated the estate tax for all of 2010. However, the Executor for anyone who died in 2010 has the option of electing to use the law as it existed before the 2010 Tax Act and pay no estate tax, but have a "modified carryover basis" instead of adjusting the basis of all assets to the date of death value (including, in community property states, the surviving spouse's interest).

The "basis" of an asset is the value used to determine gain or loss for income tax purposes when the property is sold. If you give someone an asset while you are alive, it keeps your basis (what you paid for it) so the recipient gets what is called a "carryover" basis.

For 2010, under the pre-2010 Tax Act law, limits were placed on the amount of asset basis that could be stepped up in a decedent's estate: only $1.3 million in asset value increases were allowed, plus an additional $3 million of basis increases for assets passing to a surviving spouse. In effect, the law substituted paying capital gains taxes for paying estate taxes. Under the 2010 Tax Act, there is a choice for those who died in 2010.

Planning Tip: Executors have until September 17, 2011, to decide if the option is better for the estate, file an estate tax return, pay taxes and make any disclaimers. Electing the "no estate tax/modified basis option" would generally be good for those with large estates that would not be covered by the $5 million exemption. However, each case must be evaluated individually, considering, for example, the amount of estate tax that would be payable now versus income tax that would be due on the gain when the assets are sold at some point in the future; the expected sale date of the assets; and what the capital gains and ordinary income tax rates might be in the future.

Portability of Estate Tax Exemptions between Spouses
The estate tax law provides an unlimited deduction for assets left to a surviving U.S. citizen spouse. Therefore, the first spouse who dies can leave everything to the surviving U.S. citizen spouse and no estate taxes will be due upon the first death. Most married couples like this arrangement because it's easy to administer and all of the assets are available to the surviving spouse. For those who died before January 1, 2011, and for those whose surviving spouses live beyond December 31, 2012, however, a big problem can occur because the estate tax exemption that could have been used at the first death is not available to shield assets in the surviving spouse's estate.

For those couples in which both spouses die between January 1, 2011, and December 31, 2012, the Congress tried to fix this problem with something called "portability." Under the 2010 Tax Act, if one spouse dies in 2011 or 2012, the Executor of the deceased spouse's estate may transfer any unused federal estate tax exemption to the surviving spouse by so electing on a timely filed estate tax return. But, the transferred exemption must be used before December 31, 2012, or it is lost. Also, only the most recent deceased spouse's unused exemption may be used by the surviving spouse, which could impact the surviving spouse's decision to remarry.

For example, let's say that after Jack dies, Jill marries Bill. If Bill dies before Jill does, Jack's unused exemption would no longer be available to Jill. And Bill may have little or no unused exemption to transfer to Jill.

Even with temporary portability, relying on the unlimited marital deduction can cause other problems. For example, by leaving everything to Jill, Jack has no control over how his share of their estate is managed or distributed. Jill can do whatever she wants with the assets, including disinheriting any children Jack may have from a previous marriage. Also, any growth on the assets will be included in Jill's estate when she dies and will be taxed at the rate in effect at that time. (Remember, the estate tax exemption will be just $1 million with a 55% maximum tax rate in 2013 unless the Congress acts.)

If Jack and Jill plan ahead, they can make sure they use both of their exemptions. Their wills or living trusts could include a provision that splits their $10 million estate into two trusts of $5 million each. When Jack dies, his trust uses his $5 million exemption and when Jill dies, her trust uses her $5 million exemption. This reduces their taxable estate to $0, letting them leave the full amount to their beneficiaries. (This tax-planning provision is often called an A-B trust or credit shelter trust.)

There are other benefits to this planning. For example, Jack can keep control over how his share of their estate is managed. He can choose his own beneficiaries, which may or may not be the same as Jill's. The assets in his trust are valued and taxed only when he dies, so any growth on these assets will not be included in Jill's estate when she dies. And even though the assets remain in Jack's trust, they still can be available to provide for anything Jill needs.

Planning Tip: The portability provision may work fine for some couples. But you may still prefer the benefits of the A-B (credit shelter) trust, especially if you have a "blended" family. Also, if you use a living trust and properly fund it (transfer your assets to it), you will avoid probate which, depending on where you live, could save your family thousands more.

Gifting in 2011 and 2012
For 2011 and 2012, the gift tax exemption is $5 million per person ($10 million for a married couple), with the tax rate above the exemption at 35%. This exemption is unified with the estate tax exemption, so any unused amount can be transferred to the surviving spouse under the portability provision.

You can still make annual tax-free gifts of $13,000 ($26,000 if married) to as many individuals as you wish each year. (This amount is tied to inflation and is adjusted from time to time.) If you give more than this, the excess is considered a taxable gift and goes against your lifetime gift/estate tax exemption. ($5 million through 2012, $1 million thereafter.)

Generation Skipping Transfers in 2011 and 2012
A generation skipping transfer occurs when some or all of your estate goes directly to a grandchild or a non-relative who is more than 37.5 years younger than you. This can happen intentionally: for example, if you skip the living parent (your child) and leave an inheritance directly to your grandchild, that is a generation skipping transfer. It can also happen unintentionally: for example, if an inheritance is in a trust for your child, he or she dies after you but before receiving the full amount and, under the terms of the trust, your grandchildren will receive their parent's remaining inheritance. That, too, is a generation skipping transfer.

Skipping a generation can cause the inheritance to be subject to the "generation skipping transfer" (GST) tax. The onerous GST tax is equal to the highest federal estate tax rate in effect at the time of the transfer and is in addition to the federal estate tax. This tax exists because Uncle Sam wants the estate tax to apply when assets are transferred at every generation. So, if you skip a generation, you don't skip the taxes that would have been paid.

For 2010, the GST tax exemption was $1 million with a 0% tax rate, because there was no estate tax. In 2011 and 2012, the GST tax exemption is $5 million ($10 million if you are married and you plan ahead) with a 35% tax rate.

Planning Tip: Remember, there is a possibility that Congress will not act before the end of 2012, and the GST tax exemption will decrease in 2013 to $1 million with a 55% tax rate. With this in mind, if you have a large estate, you may want to use a good portion (or all) of your $5 million GST tax exemption ($10 million, if married) in 2011 and 2012.

Planning Opportunities in 2011 and 2012
Being able to give up to $5 million ($10 million, if married) will allow many individuals to transfer as much as they would want to family members without having to worry about gift taxes. For those with larger estates, planning opportunities abound during this two-year period and, when combined with leveraging strategies, allow for huge amounts of wealth to be transferred. For example:

Grantor Trusts
Using a grantor trust will allow you to transfer substantial additional amounts out of your estate over time. After transferring assets to the grantor trust, you still have to pay the income tax on the trust income, which further reduces your estate. And, by not having to pay the income tax, the trust assets can grow faster. In effect, every extra dollar of income tax you pay is a dollar transferred to the grantor trust.

Leveraging Transfers through Discounts Quite often, the value of transferred assets can be discounted due to a lack of control and lack of marketability. For example, if you transfer assets to a family limited partnership or limited liability company that you control, an outside buyer would pay substantially less than asset value for shares that have no say in how the business is run and that cannot be sold without your approval. Discounting values through planning strategies like this can leverage your $5 million exemption and further increase its value.

Life Insurance
A very large amount of life insurance can be purchased with $5 or $10 million. If structured properly, the insurance proceeds can pass free of probate, income and estate taxes to younger generations.

Other Items of Interest
* Individual income tax rates will remain at current levels for two more years. If no action had been taken, the top income tax rate would have increased from 35% to 39.6%.

* Tax on long-term capital gains and qualified dividends remains at 15% for two more years. If no action had been taken, capital gains would have been taxed at 20% and dividends would have been subject to the individual ordinary tax rates.

Planning Tip: The danger of the Congress not extending those tax rates beyond 2012 is significant. Remember that the justification for not allowing income tax rates to increase at the end of 2010 was the state of the economy. If the economy is improved as the end of 2012 approaches, those reasons will not exist.

* The AMT (alternative minimum tax) exemption for a married couple was increased from $45,000 to $72,450.

Conclusion
Now is the perfect time to move forward with your estate, retirement and disability planning.

The 2010 Tax Act provides tremendous planning opportunities to transfer vast amounts of wealth for families with estates of all sizes, but it is a limited time opportunity that expires on December 31, 2012. At the same time, individuals with estates of less than $5 million and married couples with estates of less than $10 million can focus on planning that concentrates on family goals and objectives without, at least for the next two years, having to jump through hoops to avoid federal estate taxes. Of course, state death taxes and income taxes must still be considered.

We are ready to help you define your personal and financial goals and desires, and take advantage of these unique planning opportunities. Contact our office for a consultation.


Test Your Knowledge

1. Everyone has to pay estate taxes when they die. True or False

2. The estate tax exemption was set permanently at $5 million with a 35% tax rate. True or False

3. Basis is the value used to determine estate taxes. True or False

4. If an estate does not have to pay federal estate taxes, it will not have to pay any state death tax. True or False

5. If Congress does not act by the end of 2012, the current estate tax exemption and rate will stay in effect. True or False

6. For those who died in 2010, their estates did not have to pay any federal estate tax or capital gains tax, and all of the assets received a stepped-up basis. True or False

7. The new provision for portability of the estate tax exemption between spouses occurs automatically; nothing needs to be done. True or False

8. The unlimited marital deduction lets you leave everything to your spouse and no estate taxes will ever be due. True or False

9. I can leave my grandchildren an unlimited amount of assets when I die completely tax-free because the IRS considers grandchildren to be special. True or False

10. The top income tax rate and long-term capital gains tax rate increased to 39.5% for 2011. True or False



Answers: All of the above are false.

Don't Make the Same Mistakes You've Seen in the Headlines

Now is the time to update your existing estate plan, or proceed with implementing a comprehensive estate plan. Why? First, we now know with certainty that the federal estate tax is not going away, and thus we should establish a plan that avoids or at least minimizes this voluntary tax.

More importantly, if you don't, you just might end up like the host of celebrities who have made the headlines recently because they either had no estate planning or because the planning they did have was woefully out of date or otherwise inadequate.

As the recent celebrity examples demonstrate, estate planning is not just about planning to avoid estate tax. Instead, estate planning is about accomplishing what is important to you and your family, like: passing values to your children and grandchildren; passing property in a way that creates a lasting legacy; and protecting your privacy.

Pending Changes to Federal Estate Tax Law: Does It Really Matter?
As we approach year-end we continue to hear scuttlebutt from Capitol Hill that Congress will enact some estate tax legislation before January 1, 2010. As you may recall, this is "necessary" because under current law we are scheduled to have no federal estate tax for those who pass in 2010. Note, however, that in 2010 the estate tax would be replaced with a system that would tax a greater number of Americans when they sell appreciated assets (like stocks and real estate) - a system that Congress tried once before, but it failed miserably!

The consensus from Washington, D.C. is that we will see a "patch" that simply extends current law through the end of 2010. What will happen then, however, is anyone's guess. The cynics suggest that because 2010 is an election year, both Republicans and Democrats may be encouraged to do nothing. If that happens, the current law will expire, and beginning January 1, 2011 we would revert to a $1 Million federal estate tax exemption and maximum estate tax rate of 55%.

While we don't know the details, the fact that we will have an estate tax means that we should all take steps to minimize or avoid it. In addition, more and more states are enacting separate state estate taxes (usually with much lower thresholds) as a way to generate revenue, so state estate tax will ensnarl many who do not plan to avoid it.

Celebrity Examples of What Not to Do with Your Estate Planning
When it comes to estate planning, it seems that folks generally fall into one of three broad categories: (1) those who have done no planning; (2) those who have done some (often inadequate) planning; and (3) those who have done good planning, but who should have it reviewed and possibly updated. The recent spate of celebrity cases that have been in the news serves as a pretty telling primer on these various categories. As you consider the lives and stories of these famous people, how do you stack up? You may find that this winter is a good time to revisit your estate planning to make sure your plan is as it should be.

Leaving It to Chance with No Planning
Steve McNair seemed to have it together. A Super Bowl quarterback, 3-time Pro Bowl selection, and one of football's most prolific passers, McNair was killed at the age of 36. Surely thinking that his whole life was ahead of him, McNair did no estate planning at all, leaving his substantial wealth (nearly $20 Million) to be argued over - publicly - in the Tennessee probate courts. His children, assuming they are given substantial shares of his estate, will not enjoy the gift their father could have given by providing a framework in which they could grow into their inheritance.

When McNair's children turn 18 - the legal age of majority in Tennessee - they will receive their inheritance outright; they will be free to do what they please with the money. Can you imagine turning an 18-year-old child loose with several million dollars?

Even if you don't have millions, do you want your loved ones to be able to do with their inheritance as they please, knowing that you can provide them with predictability and guidance to help them protect and preserve what you leave behind?

Inadequate, or "Do-It-Yourself" Planning
Studies indicate that nearly 70% of all Americans have done no estate planning at all. But even of those roughly 30% of people who have done some estate planning, many have done a very poor job, designing an estate plan that inadequately represents their wishes or worse, causes confusion, delays, and unmet expectations.

Heath Ledger had a will. It was a simple, three-page document created before he made his mark in the film industry and made his millions with his Oscar-nominated performance in the movie Brokeback Mountain. When he died at age 28, his estate and his family had far outgrown his inadequate estate plan. His will provided that his estate should be divided equally among Ledger's parents and his siblings, and failed to provide anything for his infant daughter. Although she will surely ultimately be provided for, by relying on a will (and a very deficient one), Ledger assured his family a legacy of confusion, frustration, and public litigation.

The worst offenders feeding this category are those who sell "one size fits none" form estate planning documents, either online or in stores. These folks sell documents to well-intentioned individuals who are proactive and motivated enough to do something about their estate plan. But the key to this mistake is that it approaches estate planning as a document transaction. Sure you get a "will" or a "trust" and some other documents, but do they really represent your goals? Will they properly instruct your family when they need to? As in Heath Ledger's case we may have only one chance to get estate planning right. Printing and signing documents without thoughtful legal help is a disaster waiting to happen.

Imagine that your child is getting married and you need a new suit. Will you go to the corner discount retailer and pull something off the sale rack? After all, they advertise "always the low price." You'll have a jacket, pants, the whole ensemble. But is that really the right solution for you on this special occasion? Isn't it more appropriate to see an expert who can learn about your tastes, your needs, your best features, and deliver what you really need, something you can be proud of?

By the same measure, buying documents - from a retailer or from an attorney - is not estate planning. Although estate planning requires documents to make a plan legally effective, the art of effective estate planning comes through professional, comprehensive advice that only focused and dedicated estate planning professionals can provide.

Outgrown Estate Plans

Now some time has passed since you bought that new suit for the special occasion. One grandchild, maybe two are born and things have changed. Maybe you've lost a few pounds (or, heaven forbid, gained a few!). What has happened to that nice suit? Sure it's a little musty, but never the worse for wear. But no matter how hard you try, it just doesn't fit like it used to.

Just like a finely tailored suit, an estate plan can get outgrown, too. The estate plan that you spent time, effort, and money to get just right will not automatically evolve as your life changes. Even when you have a great estate plan in place you must remain vigilant. The current battle over Michael Crichton's estate illustrates this point precisely.

Crichton was the creator of movie hits like Jurassic Park and the television series ER. Understanding the importance of sound estate planning to preserve peace of mind for his family, Crichton apparently had a robust estate plan in place. And then life changed.

Michael Crichton had prepared carefully, incorporating a premarital agreement with his fifth (and surviving) wife to make sure that he fully provided for his child from a previous marriage. However, Crichton and his wife were expecting a new baby when Crichton died unexpectedly late last year. Though he had apparently gone to great lengths in earlier planning, the fact that he failed to provide for his unborn child has cast a cloud of uncertainty over Crichton's estate. It appears that despite his earlier efforts, Michael Crichton is bound to leave a legacy of distress, uncertainty, and litigation for his family.

Unlike Heath Ledger and Michael Crichton, you may be certain that you will not have children later in life. But do you know with certainty that your loved ones will not become a spendthrift, develop a creditor problem (50% of marriages end in divorce), or receive government benefits such that an outright inheritance would result in disqualification of those benefits?

Where Do YOU Stand?
Although none of us likes to embrace our mortality, as responsible adults we have to prepare ourselves and our families for the inevitable. Whether you're a millionaire or of more modest means, you want to leave a lasting legacy of family harmony, good memories, and caring protection for those you love. Estate planning can be challenging, and should never be done alone. Take the time to discuss your needs with a team of well-trained, attentive estate planning professionals now.