2012 Advanced Sales Forum Presented by: Julius H. Giarmarco, J.D., LL.M. Giarmarco, Mullins & Horton, P.C. 101 W. Big Beaver Road, 10 th Floor Troy, Michigan

2012 Advanced Sales Forum

Presented by:

Julius H. Giarmarco, J.D., LL.M.Giarmarco, Mullins & Horton, P.C.

101 W. Big Beaver Road, 10th FloorTroy, Michigan 48084

(248) [email protected]

Sponsored by:

1

mailto:[email protected]

http://www.disinherit-irs.com/

Estate, Gift, and GST Taxes

YearEstate Tax Exemption Basis Method

GST Tax Exemption

Top Estate/GST Tax Rate

Gift Tax Exemption

Top Gift Tax Rate

2009 $3,500,000 Step-up in basis $3,500,000 45% $1,000,000 45%

20101

- 0 - Modified carryover basis

- 0 - 0%

$1,000,000 35%$5,000,000 Step-up in basis $5,000,000 35%

20112$5,000,000

$5,120,000

Step-up in basis

Step-up in basis

$5,000,000

$5,120,000

35%

35%

$5,000,000

$5,120,000

35%

35%20123

2013 $1,000,000 Step-up in basis $1,000,0004 55% $1,000,000 55%

1 The Tax Relief Act of 2010:• For individuals who died in 2010:

Tax the decedent’s assets at 35%, after estate tax exemption of $5 million and receive a “stepped up” income tax basis equal to fair market value at death.

Alternatively, elect out of the estate tax regime, no estate tax is assessed and modified carryover basis rules apply in determining recipients’ income tax basis in the assets.

2 For 2011 and 2012, portability of the estate tax exemption between married couples (Note: Not applicable to GST tax exemption).3 Estate, GST, and gift tax exemptions are indexed for inflation in 2012.4 Indexed for inflation ($1.4M estimate).

2

Transfer of wealthexcluded from

any gift tax

Transfer of wealththrough GST, estate,

and gift tax exemptions

Transfer of wealthutilizing discount

strategies

Transfer of wealthutilizing freeze strategies(appreciation-only gifts)

Transfer of wealththrough

taxable gifts

AnnuallyOver Lifetime

• $13,000 per individual ($26,000 gift splitting with spouse) per donee

• Direct payments to educational institutions and health care providers1

• Irrevocable life insurance trusts (ILIT)2

Wealth Transfer Strategies

• Gift tax exemption of up to $5M per individual

• GST and estate tax exemptions of $5M per individual3

• Generation-skipping transfer trust (GST)

• Family limited partnership (FLP)

• Family limited liability company (FLLC)

• Non-voting shares in family corporation (C or S corporation)

• Grantor retained annuity trust (GRAT)

• Intentionally defective grantor trust (IDGT)

• Qualified personal residence trust (QPRT)

• Intra-family loan

• Statutory freeze partnership (FLP or FLLC)4

• Pay gift tax now rather than paying estate tax later

• Converting traditional IRA to Roth IRA5

Charitable planning:

1 To qualify for exclusion, gifts of tuition and medical expenses must be made directly to the provider.2 Often can be structured to use annual exclusion gifting.3 In 2012, an estate is taxed at a top rate of 35% with a $5.12 million estate tax exemption and a $5.12 million GST tax exemption.4 Can serve to both utilize discount and transfer wealth utilizing freeze strategies.5 Paying the income tax in converting a traditional IRA to a Roth IRA is essentially a tax-free gift.

CRTs and CLTs.

3

4

2012: A Perfect Storm for Gifting

Low property values. Historically low AFRs and Section 7520

rates. $5.12M gift/GST tax exemptions are

expiring. President Obama’s proposals are looming.

President Obama’s 2013 Budget Proposal

Reduce the estate and GST exemptions to $3.5 million and the gift tax exemption to $1 million and provide a top rate of 45% for those taxes.

Portability of a deceased spouse’s unused estate and gift tax exemption would continue.

5


Eliminate a trust’s GST exemption on the trust’s 90th anniversary.

Eliminate valuation discounts on family-controlled entities.

Require a minimum 10-year term for GRATs.

6


Modify the treatment of “grantor trusts” so that: Trust assets would be subject to estate tax. Distributions to a beneficiary during the

grantor’s lifetime would be subject to a gift tax. Trust assets would be subject to gift tax if the

trust ceases to be a grantor trust during the grantor’s lifetime.

7


Caution: Most ILITs are grantor trusts! The power to use trust income to benefit the

grantor’s spouse (IRC 677(a)(1)); The power to use income to pay premiums on

policies insuring the grantor (IRC 677(a)(3)); or The grantor’s non-fiduciary power to substitute

trust assets for assets of an equivalent value (IRC 675(4)(C) and Rev. Rul. 2011-28).

8

Advantages of Lifetime Gifting

Removes appreciation and income from the donor’s estate.

Gifts to an intentionally-defective grantor trust (“IDGT”) remove the taxes on trust income from the grantor’s estate.

9


Shifts income to lower tax brackets of donees (except where Kiddie Tax applies), unless IDGT is used.

Leverages GST exemption. For example, ILITs.

10


Removes the gift tax from the donor’s estate. Gift tax is exclusive; estate tax is inclusive. IRC Sec. 2035(b) adds back to the estate any

gift taxes paid within three (3) years of death.

Possible phase out of valuation discounts. Possible return to lower gift tax exemption

and higher tax rate in 2013.

11

Disadvantages of Lifetime Gifting

Loss of control, but this can be mitigated by: Using an FLP or FLLC with the grantor acting

as the general partner or manager. Voting and non-voting shares. Ability to remove and replace trustees (with

someone not related or subordinate to the grantor).

12

Disadvantages of Lifetime Gifting

Loss of stepped-up basis. Loss of income. Possible Clawback.

13

14

Is Clawback Really a Problem?

Arguments Against Clawback1. Congress did not intend clawback, and this intent

should override any contrary statutory interpretations.

2. The sunset provisions of EGTRRA treat the $5 million unified credit amount as having never existed, once 2013 rolls around.

15


Arguments Against Clawback3. Clawback is inconsistent with the entire unified

gift and estate tax regime – to tax prior gifts at death that were exempt from tax at the time of the gift.

4. Code §2001(B)(2) provides that the use of tax rates in effect at the decedent’s death applies to the constructive gift tax computation – thus, unified credit amounts at death should likewise apply.

16


But even if clawback becomes reality, the potential to pass appreciation on the transferred assets tax free is a powerful impetus for gifting now.

Simple Gifts

Forgive loans. Pay off children’s mortgages. Equalize custodial gifts and Section 529

plans. Pay off split-dollar and premium financing

arrangements. Outright gifts of non-voting interests in family

business.

17

Sophisticated Gifts

ILITs. Dynasty Trusts. Formula Gifts – Wandry. Spousal Lifetime Access Trusts. Intentionally-Defective Grantor Trusts. Grantor Retained Annuity Trusts Beneficiary-Defective Inheritor’s Trusts. Qualified Personal Residence Trusts. Private Split-Dollar - Loan Regime.

18

Irrevocable Life Insurance Trusts

GRAT

19

20

ILITs

Grantor/Insured

Dynasty/ILIT

Insurance Company

Children and More

Remote Descendants

Crummey Gifts Premium Payments

Allocate GST Exemption Death Benefit

Net Proceeds

21

Switching ILITs

Sale of policy from old ILIT to new ILIT for cash or promissory note. If purchase price is at fair market value, then

three-year rule of IRC Sec. 2503 does not apply. No transfer-for-value if new ILIT is grantor trust.

Rev. Rul. 2007-13. No gain on sale if old ILIT is a grantor trust (or if

no gain in policy).

Dynasty Trusts

GRAT

22

Dynasty Trust – Overview of Technique

Dynasty Trust

Discretionary Distributionsto Children for Life

Discretionary Distributions to Grandchildren for Life

Discretionary Distributionsto Great-Grandchildren

for Life

Future Generations

Grantor

Advantages•Creditor protection•Divorce protection•Estate tax protection•Dispositive plan protection•Spendthrift protection•Consolidation of capital

Gift should take advantage of any remaining lifetime gift exclusion and lifetime GST exclusion

No transfer tax paid.




23

Dynasty Trust vs.35% Estate Tax Every 30 Years

$1 MillionAfter-Tax Growth

Value of Dynasty Trust After 120

Years

Value of Property if No Trust

3.00% $34,710,987 $6,196,128

4.00% $110,662,561 $19,753,959

5.00% $348,911,561 $62,282,970

6.00% $1,088,187,748 $194,248,314

7.00% $3,357,788,383 $599,386,213

8.00% $10,252,992,943 $1,830,223,321

9.00% $30,987,015,749 $5,531,375,980

10.00% $92,709,068,818 $16,549,148,21624

Formula Gifts

GRAT

25

Wandry v Comm’r, TC Memo 2012-88

Say this: I hereby transfer a fixed dollar amount of my FLP interests worth $5.12 million.

Not this: I hereby transfer 25% of my FLP interests.

26


The Tax Court in Wandry took note that other federal courts validated formula clauses, citing Christiansen (180 T.C. 1, aff’d 586 F. 3d 1061); Petter (T.C. Memo 2009-280, aff’d 653 F. 3d 1012; and McCord (461 F. 3d 614).

27


In those three cases, and in Hendrix (T.C. Memo 2011-133), the formula clauses reallocated any “excess” transfers to charities (thereby qualifying for a charitable gift tax deduction) – not back to the donor.

The Courts were comforted by the fact that, presumably, the charities would assure the values used represented FMV.

28


The Tax Court stated that it is inconsequential that the adjustment clause reallocated membership units among petitioners and the donees, rather than to a charitable organization.

The Tax Court explicitly stated that the lack of charitable component in formula value clauses does not result in a “severe and immediate” public policy concern.

29


Possible drawback with formula clauses: How to allocate income and losses during

“open” period? If the transferee is a grantor trust, all income

and losses are includible on the grantor’s income tax return during the open years.

As such, no amended tax returns will be necessary.

30

Spousal Lifetime Access Trusts

GRAT

31

SLATs

32

Grantor SLATAssets

Spouse and children

Spouse is trustee; and spouse and children have access to income and principal; spouse is primary beneficiary

Remainder to children and more remote

descendants

At spouse’s death

Reciprocal SLATs

If Husband and Wife set up trusts for each other that are similar, then the two trusts may be “uncrossed” and treated for estate tax purposes as if each spouse had created a trust for himself / herself. United States v Grace, 395 US 316 1969.

Gift splitting is generally unavailable with SLATs.

33

Avoiding the Reciprocal Trust Doctrine

Use different distribution standards (i.e., an ascertainable standard in one SLAT, and a fully-discretionary trust in the other SLAT).

Use different trustees. For example, wife can be sole trustee and beneficiary of one trust; and husband can be a co-trustee (with an independent third party) and beneficiary of other trust.

34


Give one spouse a 5% / $5,000 power, but not the other.

Give one spouse a limited power of appointment, but not the other.

Give one spouse the broadest possible limited power of appointment, and the other spouse a power of appointment limited to the grantor’s descendants.

35


Give one spouse a limited power of appointment – both during lifetime and at death; and give the other spouse only a testamentary limited power of appointment.

In an ILIT, include a marital deduction savings clause in one trust; but not the other.

36


Fund one trust with liquid assets and the other with illiquid assets (i.e., closely-held business interests).

Create the trusts at different times.

37


If the richer spouse transfers assets to the poorer spouse so that the poorer spouse can establish a SLAT, this might trigger the step-transaction doctrine.

In Holman, 130 T.C. No. 12 and Gross, T.C. Memo 2008-21 2008, gifts of partnership interests 6 days and 11 days, respectively, after the formation of the partnership were ruled not to be step transactions.

38

Grantor Retained Annuity Trusts

GRAT

39

GRATs

Grantor(Age 70)

GRAT

______________________End of Year 1

______________________End of Year 2

______________________GRAT Remainder

$137,915

Beneficiaries

$1 million of Securities

$510,517 of Securities



Actual Asset Transfer $1,000,000Annuity Payments (Projected) $1,021,033Remainder (Projected) $137,915Taxable Gift $0.08Assumed 10% growth with a 1.4% §7520**January 2011 §7520 Rate

40

Intentionally-Defective Grantor Trusts

GRAT

41

42

IDGT Authorities

Sale to a grantor trust is disregarded for income tax purposes. Rev. Rul. 85-13.

Grantor’s payment of trust’s income taxes is not a gift. Rev. Rul. 2004-64.

Power of substitution does not result in adverse estate tax consequences. IRC Sec. 675(4)(c) and Rev. Rul. 2008-22.

Power of substitution over life insurance not an incident of ownership. Rev. Rul. 2011-28.

Installment Sale to IDIT

Grantor/Insured

IDGTLife Insurance

Company

1. Gifts $1M

2. Loans $9M

5. Excess Cash Flow/Premiums

6. Death Proceeds (Income and Estate Tax Free/Leverages GST Exemption)3. $9M Note to Grantor

Balloon Payment in 9 Years

4. $105,300 annual interest (Interest Rate 1.17%)

Advantages:

Value of loan proceeds frozen at 1.17% for nine years (assumed mid-term AFR).

Grantor’s estate further reduced by the income taxes paid on behalf of the trust.

The trust property escapes estate taxation for as long as permitted under state law.

Possible valuation discounts for promissory note in Grantor’s estate. 43

Grantor Trust vs. Non-Grantor Trust

NON-GRANTOR TRUST GRANTOR TRUST

YearBeginning Balance

Taxable Income

7%

Less: Taxes at

40%Ending Balance Year

Beginning Balance

Taxable Income

7%

Less: Taxes at

40%Ending Balance

1 $10,000,000 $700,000 $(280,000) $10,420,000 1 $10,000,000 $700,000 $ - $10,700,000

2 10,420,000 729,400 (291,760) 10,857,640 2 10,700,000 749,000 - 11,449,000

3 10,857,640 760,035 (304,014) 11,313,661 3 11,449,000 801,430 - 12,250,430

4 11,313,661 791,956 (316,783) 11,788,835 4 12,250,430 857,530 - 13,107,960

5 11,788,835 825,218 (330,087) 12,283,966 5 13,107,960 917,557 - 14,025,517

6 12,283,966 859,878 (343,951) 12,799,892 6 14,025,517 981,786 - 15,007,304

7 12,799,892 895,992 (358,397) 13,337,488 7 15,007,304 1,050,511 - 16,057,815

8 13,337,488 933,624 (373,450) 13,897,662 8 16,057,815 1,124,047 - 17,181,862

9 13,897,662 972,836 (389,135) 14,481,364 9 17,181,862 1,202,730 - 18,384,592

10 14,481,364 1,013,695 (405,478) 15,089,581 10 18,384,592 1,286,921 - 19,671,514

44

IDGT vs. GRAT

With IDGT: No mortality risk. Can allocate GST exemption to seed gift. Mid-term AFR is less than Section 7520 rate. Back-loading (i.e., interest only with balloon

payment vs. level annuity payment). Not a statutory technique. Possibility of unintended gift tax, which may be

mitigated by using a “defined value” clause.

45

Beneficiary-Defective Inheritor’s Trusts

GRAT

46

Beneficiary-Defective Inheritor’s Trust

A grantor cannot establish a trust for his/her benefit and protect the trust assets from creditors or estate taxes (except in the “self-settled” states).

But, a third party (i.e., parent) can establish a trust for a child / grandchild’s benefit and protect the trust assets from the beneficiary’s creditors and estate taxes – provided the beneficiary does not make gifts to the trust.

47

1. Beneficiary has a Crummey withdrawal power which makes the beneficiary the owner of the Trust for income tax purposes. IRC Sec. 678(a).

2. Grantor can have no grantor trust powers.

3. Grantor allocates his/her GST exemption to the gift.

Parent/Grantor

BDIT fbo Child

Funds BDIT with $5,000

48

4. Beneficiary is co-trustee with a third party and has the right to remove and replace trustees with someone who is not related or subordinate. IRC Section 672(c).

5. Trustees can use trust income and principal for the beneficiary’s health, education, maintenance and support.

6. Beneficiary has a testamentary limited power of appointment (except over any life insurance on the beneficiary’s life) to “re-write” the trust.

Parent/Grantor

BDIT fbo Child


49

7. Beneficiary sells non-voting interests of a start-up business to BDIT. Beneficiary continues to control the business entity. Possible valuation discounts.

8. No gain on the sale. Rev. Rul. 85-13.

9. Beneficiary’s payment of BDIT’s income taxes is a tax-free gift to the BDIT. Rev. Rul. 2004-64.

Parent/Grantor

BDIT fbo Child


BeneficiaryIRSInstallment Sale

Interest Payments(at mid-term AFR) /Balloon (in 9 years)

Pays Income Taxes

50

10. Since beneficiary cannot make a gift to the Trust, a third party must guarantee 10% of the loan. Guarantee fee should be determined by an independent appraiser.

11. The guarantee is the “seed” money so that the sale is not treated as a disguised gift. IRC Secs. 2036 and 2702.

12. If beneficiary’s spouse is guarantor, fee is not taxable.

Parent/Grantor

BDIT fbo Child




Pays Income Taxes

Third Party

51

Guarantee Fee

Partial Guarantee

13. Trust funds in excess of the interest payment and guarantee fee can be used to fund the balloon payment.

14. Excess funds may also be used to purchase life insurance so as to “leverage” the GST exemption.

15. All incidents of ownership must rest with the independent co-trustee.

Parent/Grantor

BDIT fbo Child




Pays Income Taxes

Third Party

Life Insurance Company

Pays PremiumsDeath Benefit

52

Guarantee Fee

Partial Guarantee

16. BDITs are relatively untested and based upon PLRs 20084025, 200949012, 201039010 and 129745-11.

17. If the FMV of the assets sold to the Trust is undervalued, a portion of the asset’s value may be includible in the beneficiary’s estate.

18. Possible step-transaction challenge by the IRS.

Parent/Grantor

BDIT fbo Child




Pays Income Taxes

Third Party Guarantee Fee

Partial Guarantee

Life Insurance Company

Pays PremiumsDeath Benefit

53

Portability

GRAT

54

55

Reasons for portability:1. Eliminates the need for spouses to retitle

property and create credit shelter trusts.

2. Basis step-up at surviving spouse’s death.

3. Protection against erosion by IRD; preserve spousal rollover.

Portability

56

Reasons for portability:4. Supercharging first decedent’s exemption

amount by having surviving spouse gift that amount to a grantor trust for the descendants.

5. Protection in decline in value of the credit shelter trust.

6. Deferral of state death tax on the difference between federal and state exemption amounts.

Portability

57

Reasons for Credit Shelter Trusts:1. Property management.

2. Spendthrift protection.

3. Creditor protection for surviving spouse.

4. Remarriage and blended families.

5. Transfer of post-death appreciation.

6. Protection against decreases in the inherited exemption amount.

Portability

58

Reasons for Credit Shelter Trusts:7. Possible loss of exemption if surviving spouse

remarries and survives a second spouse.

8. Use of state death tax exemption by deceased spouse.

9. Allocation of first decedent’s GST exemption.

10. Surviving spouse can lend money to the Credit Shelter Trust at the AFR to obtain a greater rate of return.

11. Portability set to expire in 2013.

Portability

59

Optional Credit Shelter Trust – Disclaimer Trust

Living Trust

Heirs

First Spouse’s Death

Surviving Spouse’s Death

Everything is left to surviving spouse outright, except what he/she disclaims.

Surviving spouse can receive income and principal for health, education, maintenance and support; plus a 5% annual withdrawal right.

After second death, all trust assets pass to the couple’s heirs.

60

Potential Problems with Disclaimer Trusts

No protection for children from a prior marriage.

Surviving spouse may not disclaim, remarry, and then leave assets to a new spouse.

Surviving spouse might not be in the right state of mind to protect the qualified disclaimer.

Qualified Personal Residence Trusts

GRAT

61

Grantor QPRT

Residence

Rent-Free Right of Use of Residence for 15 Years

Childrenor ILIT

After Expiration of Selected

Term of YearsGrantor’s Age 70FMV of Residence $1,000,000FMV in 15 years at 5% growth $2,079,000Term of QPRT 15 Years

Initial Gift $374,130FET Savings (35%) $569,679§7520 Rate (January 2012) 1.4%

QPRTs

ASSUMPTIONS:

RESULTS:Grantor

Pays

Rent

62

63

QPRT vs. IDGT Sale-Leaseback

Section 7520 rate and AFR: QPRTs are less tax efficient when Section 7520

rates are low, resulting in higher gift tax values. Conversely, IDGTs are more tax efficient in

times of lower interest rates.

Grantor’s age and health: There’s a mortality risk with QPRTs. In contrast, with an IDGT only the unpaid

balance of the note is included in the grantor’s estate.

64


Valuation issues: With a QPRT, an upward adjustment of value

(upon a gift tax audit) increases the value of the gift.

However, with an IDGT, it may be possible to avoid an unintended gift tax by using a formula clause. Wandry v Comm’r, T.C. Memo 2012-88.

65


Basic issues: With a QPRT, the remainder beneficiaries take

the grantor’s basis in the residence. And the grantor cannot reacquire the residence (to obtain a stepped-up basis).

In contrast, with an IDGT, the grantor can reacquire the residence by substituting other high-basis property of equivalent value. The power of substitution (IRC Section 675(4)) is the most commonly-used grantor trust trigger.

66


GST planning: Because of the so-called “ETIP” rules, GST

exemption cannot be allocated upon QPRT funding.

In contrast, with an IDGT, GST exemption can be allocated to the seed gift.

67


Other issues: QPRTs are statutory techniques; whereas,

IDGTs are based on case law and rulings. A single taxpayer may have two QPRTs; and a

married couple may have three QPRTs. But, with IDGTs, there is no limit on the number of sales and leasebacks.

An IDGT sale and leaseback could result in higher property taxes at the onset; whereas, with a QPRT, such increased taxes will not occur until the end of the term.

Private Split-Dollar – Loan Regime

GRAT

68

Private Split-Dollar - Loan Regime

69

Insured(s)ILIT Owns

Policy

Premium

ILIT for the Benefit of

Beneficiaries

Net Death Benefit

Interest Payment

Collateral Interest in Policy Equal to Premiums Paid

Gift Equal to Interest Payment

THE END

THANK YOU

Documents

2012 Advanced Sales Forum Presented by: Julius H. Giarmarco, J.D., LL.M. Giarmarco, Mullins & Horton, P.C. 101 W. Big Beaver Road, 10 th Floor Troy, Michigan