ROLE OF LLCS IN TRUST AND ESTATE PLANNING (60 minutes) · 2018-03-13 · of probate, business and taxation related issues. His practice integrates the personal and estate tax planning

ROLE OF LLCS IN TRUST AND ESTATE PLANNING

First Run Broadcast: March 14, 2018

1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes)

LLCs can be effective vehicles for achieving client goals in trust and estate planning. They are

helpful particularly helpful in the context of transferring family-held businesses, from obtaining

valuation discounts to succession planning and transfer of control. As income tax planning

becomes more important in traditional trust and estate planning, LLCs also offer substantial

opportunities for tax reduction. There are also substantial uses of LLCs in holding and

transferring real estate, which often forms the most valuable asset in an estate. This program will

provide you with a real world guide to using LLCs in your trust and estate planning practice.

• Use of LLCs for business succession planning purposes

• Family LLCs and LPs – practical uses and risks of IRS challenge

• Rising importance of income tax planning opportunities

• Issues involved in holding real estate

• Impact of new tax law

• Valuation discount planning when using LLCs – and spotting red flags for IRS challenge

Speakers:

William Kalish is a partner in the Tampa office of Johnson Pope Bokor Ruppel & Burns, LLP.

His practice focuses on advising individual clients and their families on their estate and trust

plans, including wills, revocable trusts, irrevocable trusts, charitable trusts, private foundations,

and limited partnerships. He also practices in probate administration, asset preservation, business

succession planning for family-owned entities, and the division of business interests in the

context of divorce. He is a Fellow of the American College of Tax Counsel, formerly served as

chair of Administrative Practice Committee of the ABA Tax Section, and has served as an

Adjunct Professor of Law at Stetson Law School teaching estate planning. Mr. Kalish received

his B.A. from the University of Pittsburg and his J.D. with honors from George Washington

University Law School.

Jeffrey M. Gad is a partner in the Tampa, Florida office of Johnson Pope Bokor Ruppel &

Burns, LLP, where his practice emphasizes representing individuals emphasizing a broad range

of probate, business and taxation related issues. His practice integrates the personal and estate tax

planning concerns of individuals with tax and business planning for their closely-held

businesses. He has extensive experience in all aspects of probate and trust administration,

including the preparation of estate tax returns. Mr. Gad earned his B.S.B.A. from the University

of Florida, his J.D., magna cum laude, from Nova Southeastern University, Shepard Broad Law

Center, and his LLM from New York University School of Law.

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Role of LLCs in Trust & Estate Planning Teleseminar

March 14, 2018 1:00PM – 2:00PM

1.0 MCLE GENERAL CREDITS

PAYMENT METHOD:

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CERTIFICATE OF ATTENDANCE

Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: March 14, 2018 Seminar Title: Role of LLCs in Trust & Estate Planning Location: Teleseminar - LIVE Credits: 1.0 MCLE General Credit Program Minutes: 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

© 2018 Wiggin and Dana

Family Business Succession Planning, the New Tax Act, and Asset Protection

Daniel L. Daniels

[email protected]

203-363-7665

3840755

mailto:[email protected]

© 2008 Wiggin and Dana © 2018 Wiggin and Dana 2

Introduction • General Challenges

– Estate tax uncertainty

– Planning must be done on short time frame

– Business is valuable, but often illiquid, asset

– Business owners can be challenging clients

• Creating a Succession Plan Which:

– Passes the business to intended owners

– Doesn’t adversely affect the business

– Doesn’t treat anyone unfairly


Same Family Business Succession

Statistics - 90% of U.S. businesses are family firms

- Represent 64% of Gross Domestic Product

- Only one-third make the successful transition to the second generation

- Only 15% make it to the third generation

- Recent studies indicate 25% will transfer control over the next 5 years (40% over 10 years)

- 71% have not completed business succession plans

- 93% have little income diversification outside the business

- 80% want business to stay in family


Family Dynamics

- Family dynamics issues more important than proper estate tax planning to future success of business.

- Choice of successor manager

- Active vs. inactive family members

- Separating management structures from ownership structures

- Intergenerational communications

- Providing equally for children

- Cash flow concerns of senior generation

- Conflict Management and Dispute Resolution

- Role of professional facilitators


Fact Pattern

• Family Information

– Client and Spouse, age 65

– Client has three children, A, B and C

– A active in business; B and C are not

– A is married, but not happily

– B and C are both married with children


Fact Pattern • Business Information

– Client is 90% owner of XYZ Inc., an S corporation

– A, B and C each own 3.33%

– XYZ’s primary business is commercial real estate

– Company book value is $20 million

– Company owns $2 million of insurance on Client’s life

– Company leases its headquarters building and premises from Client


Fact Pattern

• Other Assets

– Client owns headquarters building valued at $1

million

– Client and spouse jointly own principal residence

worth $3 million and vacation residence worth $1

million

– Client has IRA worth $2 million

– Client and spouse have joint brokerage account

worth $3 million

– Client owns life insurance policy of $2 million


Fact Pattern • Current Estate Planning Documents

– Client and spouse each have wills leaving entire estates to each other, then to the children

• Planning Objectives – Keep the non-active children (B and C) out of the

business

– Pass control of the business to A

– Treat A, B and C equally financially

– Pay as little estate taxes as possible

– Avoid forced sale of business at death

– Minimize probate

– Minimize liabilities


“Phase One” Planning


• Testamentary documents (will and revocable trust)

• “Defensive” tax planning

• Powers of attorney

• Health care proxies

• Life insurance (even if temporary) to deal with liquidity issues pending results of Phase Two planning

• Buy-sell agreement

Phase One Planning (Review)


PHASE TWO PLANNING • The new tax law

• Choice of entity

• Asset protection

• Advanced Lifetime Gift Planning

• Advanced Testamentary Planning

• Charitable Strategies


2017 Tax Act – Transfer Tax Provisions

• Increased estate, gift and generation skipping tax exemptions to $11.2 million, indexed for inflation

– Only in effect until January 1, 2026

• Retains 40 percent rate

• Retains unlimited marital deduction


2017 Tax Act – Selected Corporate Income Tax

Provisions – C Corporations

• Flat corporate income tax rate of 21 percent

• Corporate AMT repealed

• Does not sunset



Provisions – Pass-Through Entities

• Deduction equal to 20 percent of “qualified business income”

• BUT deduction limited to the greater of:

– 50 percent of taxpayer’s allocable share of W-2 wages for the entity OR

– 25 percent of taxpayer’s allocable share of W-2 wages plus 2.5 percent of depreciable property in service



Provisions – Pass-Through Entities (2)

• Qualified business income is income earned from a “trade or business”

• Income from most service businesses doesn’t count to the extent it exceeds certain thresholds

– $315,000 for married couples

– $157,500 for singles

• Service businesses include health, law, accounting, consulting, actuarial science, performing arts, athletics, financial services, brokerage services, reputation-based services and investment management

– Architecture and engineering service business income DOES count

• Pass through entity provisions expire January 1, 2026


• Choice of entity

– C corporation now receives highly advantageous income tax rate but is highly undesirable at death

– LLC or LP produces best basis step up flexibility

– “Synthetic basis step up” may be available for S corporation inside assets if corporation liquidated after death

• Consider dividing stock between spouses for Mellinger discount

• Consider voting-nonvoting recap to allow for transfer of value – but not control– to inactive children

• Consider moving real estate out of corporation into LLC for asset protection purposes

ENTITY-LEVEL PLANNING


ASSET PROTECTION

• Exemption Planning

• Asset Transfer Planning

• Family Partnership or LLC Planning

• On- and Off-shore Trusts


Overview: Sources of

Liability • Fiduciary positions

– Example: directors of public companies

• Contract

– Example: personal guarantee of business loan

• Tort

– Example: professional malpractice

• Family

– Example: divorce


Overview: Two Prongs of

Planning

• Two basic planning concepts:

– Limitation of Liability

– Asset Protection


Limitation of Liability

• “Inside-out” protection.

• Attempt to trap liabilities within an

entity.

– Prototype is parent-subsidiary (or

owner-company) structure.


Limitation of Liability

Parent/Owner

Subsidiary/

Company


Asset Protection

• “Outside-in” protection

– Take advantage of exemptions

– Separate assets from source of liability

– Hold assets in a protected form

• No “silver bullet”

– Planning is generally a process of discounting

settlement of creditors’ claims


Exempt Assets

• Homestead?

• Life insurance?

• Primarily retirement assets

–401(k) plans

–Roth IRAs

–Traditional IRAs


Separating Assets

• Separating assets means client must

transfer assets.

• Transfer will be subject to scrutiny and

may be voided as fraudulent

conveyance.


Separating Assets: Examples • Gift to spouse

– Simple

– Often beneficial for general estate planning purposes

– No tax impact unless spouse is non-U.S. citizen

• Gift to children

– Can have estate planning benefits

– May generate gift tax

• Gift to trust for spouse and/or children

– Consider Spousal Estate Reduction Trust

• Gift to trust for self generally not effective

– Consider off-shore or special U.S. jurisdictions?


FLPs and Other “Protected” Assets

• Charging order entities.

• Other illiquid assets.

• Encumbered assets.


Charging Orders

• Creditors cannot force the sale of

certain types of entities (partnerships

and their LLC relatives).

• Step into the shoes of the debtor-

partner and wait until the management

of the partnership decides to make

distributions to the partners.


Charging Orders

• A “charging order” is a remedy created

by statute which essentially assigns the

debtor’s interest in a partnership or

limited liability company to the creditor.

As an assignee, the creditor is not

entitled to become a limited partner,

and has no ability to dissolve the entity.


On- and Off-shore Asset Protection Trusts

• Have your cake and eat it too?

• Transfers to self-settled trust allow transferor to divest

self of title, but still have beneficial interest.

– Self-settled trusts not recognized at common law.

• Statute of Elizabeth.

• Restatement (Second) of Trusts, § 156.

• Greenwich Trust Co. v. Tyson, 129 Conn. 211

(1942).

– Some jurisdictions have changed this by statute.


On-shore Asset Protection

Trusts • Several US states now permit self-settled trusts to

some degree:

– Alaska, Delaware, South Dakota.

– Untested problems with these protections.

– Full Faith and Credit Clause of Const.


APPLYING CREDITOR PROTECTION CONCEPTS

TO CHARLIE AND SALLY’S SITUATION

• Be sure to respect the form of the

entity

• Segregate separate parcels into

separate entities

– Consider “Master LLC” with subsidiary for

each parcel

– Consider spendthrift trust for Abby

© 2018 Wiggin and Dana 32

LIFETIME GIFTING

FUNDAMENTALS

• Gifts valued at time of gift – Avoid tax on future growth and income

– Defer tax on applicable exclusion amount

• Valuation opportunities – Property without clear value

– Discounted gift tax value

• Choice of property to gift – Should be likely to appreciate

• Avoid tax on gift tax

• Beware: loss of basis step-up at death


Lifetime Gift Strategies

• Outright Gifts

– To spouse to create discounts

– applicable exclusion amount

– Annual exclusion

– Taxable gifts

• Spousal Lifetime Access Trust

• Grantor Retained Annuity Trust

• Preferred/Common Recap Gifts

– Caveat: Recapitalization must comply with section 2701

• Opportunity Shifting


A Zeroed Out GRAT

• Grantor transfers $1 million to a GRAT when IRS assumed interest rate = 1.4%

• Grantor receives $119,000 annually for 9 years

• After 9 years, remaining GRAT funds pass to children

• Value of taxable gift is near $0


Savings Dependent On Investment

Performance

Average Return

for 9 years

Amount Passing Tax-Free

to Children After 9 Years

1.4% $0

4% $164,000

6% $322,000

8% $513,000


Property Suitable for a GRAT

• Growth stocks

• Commercial real

estate

• Closely held

business

• LLCs and LPs Gift tax risk of undervaluation can be minimized


GRAT Risks

• What if grantor dies before termination of

GRAT?

– At worst, property is taxable in

grantor’s estate

– Nothing gained, but nothing lost

• What if trust investment performance is

less than IRS assumed rate of return?

– Again, nothing gained, but nothing lost


Sale to an Intentionally Defective

Irrevocable Trust (IDIT Sale)

• Grantor Sells Property to Irrevocable Grantor Trust

• Grantor Receives Promissory Note From Trust

• Note Terms

– Interest Only at Applicable Section 1274 Rate

– Balloon Payment of Principal at End of Note Term

• Grantor’s Interest in Property Frozen at Face Value of

Note Plus Annual Interest Payments

• Objective: Outperform Required Interest Rate On

Note Under Section 1274


IDIT Sale Example

• Grantor Sells Property Worth $1,000,000 to

“Seeded” Irrevocable Grantor Trust

• Grantor Receives 9-Year Promissory Note

From Trust

• Note Terms

– Interest Only at Applicable Section 1274

Rate (1.20% for this example)

– Balloon Payment of Principal at End of

Note Term


Amount to Children Depends on

Investment Performance

Average Return

for 9 years



1.2% $ 0

1.4% $ 19,000

4% $296,000

6% $552,000

8% $849,000


IDIT Sale Risks

• No Safe Harbor Under Code

• No Automatic Revaluation of Note Upon Audit – Will formula work to avoid Proctor?

• Possible Application of Sections 2036 and

2702

• Statute of Limitations

• Possible Gain Recognition At Grantor’s Death


Self-Canceling Installment Note

(SCIN) • By its terms note is extinguished on Client’s

death

• Note must take possibility of death into account in form of “risk premium” – Increased interest rate or increased

principal amount

– No safe harbor for valuation; IRS will look at client’s actual health status.

• Note is excluded from Client’s estate

• Client’s estate recognizes unrealized gain at death


SCIN Example

• Client sells $1,000,000 asset to A in return for self-canceling note

• Interest only for 9 years; balloon principal at end of year 9

• Note interest rate includes “risk premium” so that rate increases from 4.82% to 6.98%

– Or increase principal face amount to $1,181,000

• Client receives payments of $69,800 per year

• Balloon payment of $1,000,000 at end of year 9


SCIN: Amount to Children Depends on

Investment Performance

Average Return

for 10 years



6.98% $0

8% $138,000

10% $451,000

12% $831,000

14% $1,287,000


Private Annuity

• Client transfers stock to A in return for A’s agreement to pay an annuity for remainder of A’s lifetime

• Advantages to Client

– Estate freeze at value of annuity payments plus internal interest rate.

– No gift tax provided that annuity value equals value of transferred stock.

– Income stream “guaranteed” for life

• Advantages to A

– Cash flow

– Windfall in the event Client dies early


Private Annuity (Continued)

• Disadvantages

– Regulations on income tax treatment of the

annuity.

– If stock is undervalued, Client will be

treated as having made a taxable gift. A

price adjustment clause may not be

respected.

– A’s payments are indefinite and non-

deductible.


BOOTSTRAP REDEMPTION

• Client gifts small amount of stock to A

• Corporation redeems Client’s stock,

thereby increasing A’s ownership

percentage – Caveat: Since B and C, and key employees own

shares as well, their ownership percentages will

also be increased

•


Selected Charitable Options


The Typical Charitable Vehicles

• Private Foundations

• Charitable Lead Trusts

• Charitable Remainder Trusts


Private Family Foundation

• Default Status - Greatest Donor Control

• 3 Typical Characteristics:

– single source of funding

– make grants rather than operate programs

– grants and administrative expenses paid from endowment

• Subject to Chapter 42 Excise Tax Rules

– unavoidable: tax on net investment income

– avoidable: self-dealing, failure to distribute income, excess business holdings, jeopardy investments and taxable expenditure

• 5% Mandatory Annual Distributions


Charitable Remainder Trust

• Irrevocable trust

• Income stream payable to one or more

noncharitable beneficiaries

–For life or for a fixed term

• Remainder interest payable to charity


Charitable Remainder Trust

• Trust pays no income tax

• Tax-free diversification vehicle

• Grantor gets estate, gift and income tax

deductions

• Increased cash flow

• Income deferral (NIMCRUT)

• Closely held business assets (FLIPCRUT)


Charitable Lead Trust

• Charitable remainder trust “in reverse”

• Lead Interest - annuity or unitrust to charity

• Term

• Remainder interest to grantor or family

• Income tax deductibility limited to grantor trusts only

• Income taxation of trust depends on structure

– Non-grantor trusts taxed as complex trust with 642(c) deduction for payments to charity

– Grantor trust taxed under traditional rules


Overview of Tax Issues

• Private Foundation Excise Taxes

– Self-dealing and excess business holdings are primary concern

• Unrelated Business Income Tax (“UBIT”)

• Prearranged Sale

• Ascertainability

• Other Tax Issues


Entities Subject to Excise Taxes

• Private Foundations

– Subject to all taxes • Charitable Lead Trusts

– Subject to taxes on self-dealing, excess business holdings, jeopardy investments and taxable expenditures

– CLTs are subject to taxes on excess business holdings or jeopardy investments if value of the charitable interest exceeds 60%

– CLTs are not subject to the minimum distribution tax or the net investment income tax

• Charitable Remainder Trusts

– Subject only taxes on self-dealing and taxable expenditures


Self Dealing

• Most transactions between a private foundation and a disqualified person are strictly prohibited regardless of whether the transaction is beneficial to the foundation – Example: Use of foundation to satisfy charitable

pledge

• Tax rates

– 10% initial tax

– 200% tax if act not corrected within prescribed period

• Indirect self dealing

• The general redemption exception


Excess Business Holdings

• Excess business holdings occur when holdings of foundation plus disqualified persons exceed 20%

– Increased to 35% if effective control of the business is held by non-disqualified persons

– Does not apply to business receiving 95% or more of income from passive sources

– 2% de minimis rule

• Foundation has five years to dispose of excess business holdings

• Up to additional five years with permission of IRS

• Tax rate:

– 10% of value of holdings

– Rate increased to 200% if not corrected in timely manner


Unrelated Business Taxable Income

• General Rule: Charities Exempt from Federal Income Tax

• Exception: Charities Taxable on Unrelated Business Taxable Income (“UBTI”)

• UBTI Defined:

– Income from an Active Trade or Business

– Excludes Passive Investments (unless Debt-financed)

– Example of Debt-financed Passive Income

• Mortgaged real estate

• Tax only imposed on debt-financed portion of income and gain

• Prior to 1/1/2007, A CRT lost its tax exempt status in any year that it had UBTI

• Post 1/1/2007, no loss of exempt status but rather 100% excise tax on any UBTI


The Prearranged Sale Problem

• If Foundation or CRT enters into informal agreement to sell property prior to contribution, then IRS may recharacterize transaction as a sale by grantor personally

• Causes grantor to be taxed personally on sale

• Cases and rulings favorable to taxpayer

– Palmer v. Commissioner

– Rev. Rul. 78-197

– Rauenhorst v. Commissioner

• Cases favorable to IRS

– Blake v. Commissioner

– Ferguson v. Commissioner


The Ascertainability Problem

• To qualify for charitable deduction value of bequest must be presently ascertainable as of date of death

• The Marine case

– Decedent’s will left residuary estate to charity

– Will gave executor discretion to make preresiduary gifts to various individuals of up to 1% of the estate per individual

– Estate tax charitable deduction denied because executor’s discretion made value of residuary estate unascertainable

• Note, a beneficiary’s power to choose between two different charitable lead trusts did not fail the Marine test

– PLR 9631021


Testamentary Charitable

Planning • Simple Bequest of the Business to a Private

Foundation

• Bequest to Private Foundation Followed by a Redemption

• Bequest to Private Foundation Coupled with an Option

• Bequest to a Charitable Lead Trust Coupled


Simple Bequest to Private Foundation

• Perceived Benefits

– Eliminates estate tax on the business at death

– Preserves owner’s control

– Preserves family control as Trustees of Foundation

• Tax Issues Typically Make the Simple Bequest Untenable

– Excess business holdings

– Self-dealing

– Indirect self-dealing

– UBIT

– S corporation concerns

• Solution: Get the Business Out of the Foundation

– How


The General Redemption

Exception • Simple sale of business to family member causes self-dealing problem

• Redemption must be:

– At fair market value

– All cash

– Offered to all owners of same class of stock

• Structuring the Estate Plan with the Exception in Mind:

– Prior to death, recapitalize business into separate classes of stock

– Class A held or bequeathed to family members

– Class B bequeathed to Foundation

– Corporation redeems Class B stock from Foundation

– Beware charitable deduction valuation whipsaw


Bequest to Foundation Coupled with an

Option

• Alternative to General Redemption Technique

• Decedent bequeaths business to Foundation subject to option in family to purchase from the estate for fair value

• Sale will not constitute self-dealing if requirements of Treas. Regs. sec. 53.4941(d)-1(c) are met

– Sale for fair market value

– Court approval

– Completed during reasonable period of estate administration


Benefits and Risks of Option/Note

Technique

• Benefits

– Avoids problems presented by simple bequest

– Unlike general redemption exception, IRS has approved use of a disqualified person’s note to fund the purchase price

• Concerns/Risks

– Terms of note must be fair

– Court approval required

– Payments under note must be timely made

• Refinancing of note probably constitutes self-dealing

– All payments on the note inure to benefit of Foundation


Bequest to CLAT Coupled with an Option

• Alternative to Foundation/Note Technique

• Similar Benefits and Risks

• Additional Benefit: Decedent’s Family Receives CLAT Remainder

• Additional Concerns

– CLAT payments should be set to correspond to cash flow from business

– Ascertainability issues if CLAT design set by formula or if multiple CLATs are used

– Possible generation-skipping tax if CLAT rather than CLUT is used


Bequest to CLAT Coupled with an Option:

Example

• C owns commercial real estate business with NAV of $100 million

• Business produces annual cash flow of $8 million

• Assume 30% valuation discount

• C bequeaths business to CLAT subject to option in children to purchase from estate for fair market value using promissory note

• Assume section 7520 rate of 5.4%



Example (Continued)

• $70 million CLAT with lead payment of roughly $7.6

million zeroes out with a 13 year term

• Note structured with interest rate of 5.4% amortizes at

annual payment of approximately $7.6 million in 13

years

• At end of CLAT term

– Note is fully paid

– CLAT has minimal remainder interest

– Children receive business free and clear of note



Issues to Consider • Payout rate

– What if cash flow from business is less than anticipated or Trustee is concerned that planned-for valuation discounts may not materialize?

– Consider giving Trustee power to choose among CLATs with varying payout rates

• Term

– Draft trust to last for a sufficient term to produce an estate tax charitable deduction equal to the value of the assets passing to the trust

• Promissory note

– Set note term equal to term of CLAT

– Set interest rate at or above section 7520 rate

– Provide for security



Issues to Consider

• CLAT remainder beneficiaries

– Ensure remainder beneficiaries are identical to payors on the promissory note

– Consider guarantees/personal liability if necessary to support valuation of note

– Consider trust structure to defer application of generation-skipping transfer tax and provide management and creditor protection


Contact Information

Daniel L. Daniels, Esq.

Wiggin and Dana LLP

30 Milbank Avenue

Greenwich, CT 06830

203.363.7665

[email protected]

www.wiggin.com

mailto:[email protected]

http://www.wiggin.com/