Linda Hayes, JD, LL.M.

Wealth Transfer Planning

What We Will Cover

Overview of Federal Transfer Tax System Significance of forms of Title Gifting Grantor Retained Interest Trust Strategies

GRATs & QPRTs

Non Trust Strategies SCINs and Private Annuities

Advanced Trust Strategies ILITs and Sales to IDGTs

Overview of United States Transfer Tax System

Three Types of Transfer Taxes Gift Tax Estate Tax Generation Skipping Transfer Tax

The type and amount of tax imposed depends on: Relationship of transferor to the US Time of the transfer

(lifetime or testamentary) Type of property Fair market value of property Identity of transferee/recipient

(e.g. charity, spouse or other related or unrelated person)

Transfer Tax Exclusions & Deductions

Gift Tax Exclusions

Lifetime Gifting Exclusion Annual Exclusion Tuition and Medical Expenses Gift Splitting

Deductions Marital Deduction Charitable Deduction

Transfer Tax Exclusions & Deductions

Estate Tax Exclusions

Estate Exemption Qualified Conservation Easement

Deductions Marital Deduction

Direct to spouse In trust for spouse

QTIP/GPA/Estate Trust/QDOT Charitable Deduction Administrative Expenses

Tax Rates and Exemption Amounts

Estate &

GST Rate

Estate &

GST Exclusion/ Exemption Gift Tax Rate

Gift Tax Exemption

2004 48% $1,500,000 48% $1,000,000

2005 47 1,500,000 47 1,000,000

2006 46 2,000,000 46 1,000,000

2007 45 2,000,000 45 1,000,000

2008 45 2,000,000 45 1,000,000

2009 45 3,500,000 45 1,000,000

2010 0 Repealed 35 1,000,000

2011 55 1,000,000 55 1,000,000

Using the Unified Credit Amount Effectively

W ithout C red it T rust W ith C red it T rust

D ecedent'sA ssets $2M M

S urvivor'sA ssets$2M M

S urvivor's N etW orth a t D eath

$4M M

N et to H eir's :$3,080,000

S urvivor'sA ssets$2M M

D ecedent'sA ssets $2M M

S urvivor's N etW orth a t D eath

$2M M

N et to H eir's :$4M M

C red it T rust$2M M

N otTaxed

N otTaxed

N otTaxed

Taxed$920,000

Gifting

Forms of Title

Asset Selection

Traditional Gifting Strategies

Forms of Title

Joint Tenancy with Rights of Survivorship Community Property Community Property with Rights of Survivorship Funded Revocable Trust Custodial Accounts

Asset Selection for Gifting

Assets to Give High growth assets High income yield assets High basis assets

Assets Not to Give Assets with FMV < Basis Income from an asset without the principal

Traditional Gifting Strategies

Outright Gifts Custodial Accounts – UTMAs and UGMAs 529 Plans Gifts in Trust

2503(c) Trusts Crummey Trusts GST Trusts

Outright Gifts

Description Property transferred to donee’s own name

Advantages Simple Generally qualifies for annual exclusion

Disadvantages Intended donee may be a minor Subject to claims of donee’s creditors

Custodial Accounts

Description Minor is legal owner but transactions conducted by a

custodian Advantages

Simple Generally qualifies for the annual exclusion

Disadvantages Minor receives complete control over the assets at a

certain age (18, 21 or 25 depending on state law) Subject to claims of donee’s creditors Assets includible in donor’s estate if donor is custodian and

dies before minor reaches age of majority

529 Accounts

Description Income tax deferred account set up for a beneficiary to pay for the costs

of higher education

Advantages Control over assets Qualifies for the annual exclusion Can prefund up to five years Income tax avoidance if funds used for education Flexibility – can change beneficiary Asset protection

Disadvantages Limited investment options

Gifts in Trust

Description Donor transfers property to a trustee to hold for the benefit

of a another person Advantages

Flexibility - can be drafted to meet donor’s goals and reinforce values

Assets do not have to be distributed at a certain age Disadvantages

In general, gifts in trust do not qualify for the annual exclusion

Irrevocable Additional costs to administer

2503(c) Trusts

Description Discretionary income and principal distributions until beneficiary

reaches age 21 Trust terminates when beneficiary turns 21 unless extended by

the beneficiary Qualifies for the annual exclusion

Advantages Statutory Qualifies for annual exclusion

Disadvantages Not as flexible as other trusts Irrevocable

Crummey Trusts

Description

General rule is gifts in trust do not qualify for the annual exclusion because they are not gifts of a “present interest”

Transfers considered a “present interest” if the beneficiary has the right to withdraw the contribution (the Crummey withdrawal power)

Advantages Qualifies for the annual exclusion Flexibility in trust terms

Disadvantages Irrevocable Administrative requirements – Crummey Letters must be sent

Generation Skipping Trusts

Description Trust created for the benefit of grandchildren, designed to use

GST exemption

Advantages Prevents application of estate tax at one generation below donor Creditor protection Can be drafted as a Crummey Trust to use annual exclusions

Disadvantages Irrevocable Flexibility requires careful drafting because of the length of the

trust (e.g., use of trust protector)

Benefits and Role of Trusts

Revocable Living Trusts - Purposes Manage & protect assets Provide continuity in management at death Avoid delays and costs of probate Control how and when assets distributed Ensure privacy and confidentiality

Irrevocable Trusts - Purposes Protect assets through generations Control how & when assets are distributed Ensure privacy and confidentiality Reduce estate and gift taxes through annual and lifetime

exemptions Transferring appreciation

Basic Estate Plan

Will

Durable Power of Attorney (Financial Matters)

Health Care Power of Attorney (Health Care Proxy)

Living Will (Optional)

Revocable Living Trust (Depending on Assets and Residency)

Grantor Trusts

Definition Grantor retained rights or powers over trust sufficient enough to be taxed

on the trust income FOR INCOME TAX PURPOSES ONLY Examples: Living Trust, GRAT, IDGT

Income Taxation Grantor subject to tax on all income; receives benefit of all deductions No separate tax return required

Powers Causing Grantor Status Power of Substitution Power to borrow without security Power of trustee to distribute to grantor’s spouse Power to Revoke

Income Tax Benefit of Grantor Trusts

  Non Grantor Grantor

  Trust Trust

Trust Assets at End of Year 1 $1,000,000 $1,000,000

Basis of Assets $0 $0

Capital Gains Realized $1,000,000 $1,000,000

Ordinary Income Earned $50,000 $50,000

Capital Gains Taxed to Trust (15%) ($150,000) -

Ordinary Income Taxed to Trust (35%) ($17,500) -

Capital Gains Taxed to Grantor (15%) - ($150,000)

Ordinary Income Taxed to Grantor (35%) - ($17,500)

Trust Assets at End of Year 2 $882,500 $1,050,000

Additional Assets to Heirs $167,500

Estate Tax Savings (46%) $77,050

Grantor Retained Annuity Trusts

(GRATs)

Grantor Retained Annuity Trust (GRAT)

Description Irrevocable trust Grantor transfers property and retains right to receive a

fixed payment based on initial FMV of property transferred to trust

Value of remainder interest is a current gift Can do a “Walton GRAT” making the gift zero

Purpose Reduce estate and gift tax Transfer appreciation over 7520 rate (set each month by

IRS)

Grantor Retained Annuity Trust (GRAT)

Advantages “Zeroed out” GRAT results in no gift Simple to explain, understand, and execute

Disadvantages Irrevocable Grantor trust – income taxed to Grantor GRAT assets must outperform the Section 7520 Rate Grandchildren cannot be beneficiaries Timing and amount of annuity payments inflexible

Investment Choices Highly appreciating assets are best Concentrated assets – distributions can be “in kind” Hard to value assets can be used but need appraisal upon contribution and

distribution

Qualified Personal Residence Trusts

(QPRTs)

Qualified Personal Residence Trust (QPRT)

Description Irrevocable trust Grantor transfers a personal residence Grantor retains the right to use the property for the term At end of term, title passes to remainder beneficiary Value of remainder interest is a current gift Grantor must maintain property

Purpose Reduce estate and gift tax Transfer appreciation Asset protection

Qualified Personal Residence Trust (QPRT)

Advantages Effective way to keep trophy house in the family May have some asset protection benefits Reduction of estate and gift tax

Disadvantages If Grantor dies during the term, included in Grantor’s estate Cannot be transferred to grandchildren After term, Grantor must pay fair market value rent

Investment Choices None - however, if residence sold during trust term, the QPRT

converts to a GRAT

Non-Traditional Strategies

Self-Canceling Installment Notes (SCINs)

Private Annuities

Self-Canceling Installment Notes

(SCINs)

Self-Canceling Installment Notes (SCINs)

Description Installment sale of an appreciated asset between family

members or unrelated parties Recognition of gain is spread out over a term of years Obligation under the installment note automatically ceases

upon the death of the seller Cancellation provision must be “bargained for”

Purpose Transfer appreciation in an asset Reduce estate and gift tax Provide income stream to seller for life

Self-Canceling Installment Notes (SCINs)

Advantages If seller dies before note is paid off, the unpaid balance is

not subject to estate or gift tax Seller keeps an income stream for life

Disadvantages IRS attack – part sale/part gift Cancellation provision must be bargained for resulting in

above market sales price or higher rate of interest Seller cannot keep control over property sold

Private Annuities(PAs)

Private Annuity

Description Sale of property from one family member to another or unrelated

third parties Consideration for sale is purchaser’s (obligor’s) unsecured

promise to payments to seller (annuitant) Must make specific, periodic payment to the seller (annuitant) for

the seller’s lifetime

Purpose Transfer of property from one generation to the next without

using lifetime gifting exemption in family context Getting income stream from non-income producing asset in third-

party unrelated context

Private Annuity

Advantages Does not use any of seller’s (annuitant’s) lifetime gifting exemption Provides income stream to annuitant; taxes prorated per payment Reduces annuitant’s potential estate tax liability Annuity can be “deferred” or back-loaded

Disadvantages Obligor may not have ability to make payments if annuitant lives long Must be unsecured If annuitant dies soon, obligor has negative income tax consequences On 10/17/06, IRS issued proposed regs that would require immediate recognition

of income! May be the death knell.

Investment Choices Real property Assets expected to appreciate in value Assets that can be discounted

Irrevocable Life Insurance Trusts(ILITs)

Irrevocable Life Insurance Trust (ILIT)

Description Irrevocable grantor or non grantor trust designed to

purchase and hold insurance on life of one or more persons

Purpose To exclude life insurance proceeds from insured’s estate

because insured has no “incidents of ownership” May be used as “wealth replacement” vehicle

Irrevocable Life Insurance Trusts (ILITs)

Advantages Excluded from insured’s estate Giving Crummey powers to numerous ILIT beneficiaries can absorb

large portion of gift tax

Disadvantages Insured cannot act as trustee Premium payments made directly by insured are a gift Payment of Gift Tax can be avoided

Investment Choices Trust owns life insurance policy or policies Policies generally invest in mutual funds

Common Misconceptions

Creation of Joint Tenancy Account will remove at least a portion of the account from the estate of individual who creates the account.

Once a Revocable Living Trust is created, your estate plan is complete.

If primary beneficiary of insurance policy dies, and no secondary beneficiary is named, proceeds will go directly to insured’s children or other family members.

Revocable Living Trusts cannot be named as beneficiary of employee benefit plans, IRAs or 401(k) plans.

Common Misconceptions

If two unmarried individuals make unequal contributions to purchase of real property, there are no gift tax consequences.

Assets held in joint tenancy form of title can never be divided.

If the combined estates of husband and wife are less than tax exempt amount (currently $4,000,000), joint tenancy is an appropriate method for holding title to assets.

Planning “Landmines” Charitable Planning

Always make sure property held long term (i.e., one year or more) Is the intended charity is a public charity or private foundation?

Private foundation – most donations limited to client’s basis in the gifted property

Is the real property being gifted is mortgaged, could have part gift/part sale

Gifts of Stock How, when was stock acquired (beware disqualifying dispositions)? If property bring gifted is < than FMV, sell the asset, give the cash

Family Dynamics Always understand the family dynamics. Some strategies are clearly

inappropriate for families with problematic dynamics (e.g., QPRT) Understand dynamics not only of client’s lineal descendants, but their

spouses as well.