Women Managing the Farm
Conference-KansasBreakout Session 2
TRUSTS (Advanced)
Tim J. Larson, J.D., P.A.
7570 W. 21st St. N.
Building 1026, Suite C
Wichita, KS 67205
316-729-0100
Estate Planning for Farm Families - Business Succession Estate Planning – The Basics Everyone
Should Know
What is Estate Planning?
How does property pass after a death?
Will you be incapacitated or need assistance or long term care?
Will estate tax or some form of income tax affect your family?
What are the most common mistakes, goals and concerns clients face in Estate Planning? What solutions are available?
Estate Planning: The Basics There are 4 ways to pass property upon a
deathProperty owned in your own name Court Order (Probate)
Joint Tenancy with RightOf Survivorship Surviving Joint
Tenant(s)
Beneficiary Designations(POD/TOD) Pursuant to designation
Revocable Living TrustPursuant to Trust document
Beware of the 2nd
Death Trap
In order to understand the
present-
Let’s take a look at the past few years of
changing estate tax law, and the Tax Planning
Techniques and Strategies of the last 25
Years.
5
Federal Estate Tax Planning
Under The
Economic Growth and Tax Relief
Reconciliation Act of 2001
6
Sunset Provision (This would
become a big part of the “Fiscal
Cliff” in 2012SEC. 901. SUNSET OF
PROVISIONS OF ACT.
(a) IN GENERAL- All provisions of, and amendments made by, this Act shall not apply—
(1) to taxable, plan, or limitation years beginning after December 31, 2010, or
(2) in the case of title V, to estates of decedents dying, gifts made, or
generation skipping transfers, after December 31, 2010.
7
Federal Estate and Gift Tax
in 2002
A top tax.
An everything tax.
Estate tax exemption based on year of
death.
Annual gift tax exclusion of $11,000 (in
2002) per recipient per calendar year.
Rates range from 37% to 50% in 2002.
8
What Is Included in an Estate?
Real Estate
Personal Property
Stocks, Bonds, Mutual Funds
Bank Accounts
Retirement Accounts
Businesses
Life Insurance
Hint: Everything!
9
How Much Tax Will Be Owed?
Add up the value of all of your assets.
Subtract the exemption amount.
Multiply the excess.
Pay the tax within 9 months of death
Ž $ 1,100,000
Ž - 1,000,000 (in 2002)
100,000
x .37
Ž $ 37,000
10
Al & Betty’s Plan: No Tax Plan
($1,100,000 Estate)
1. Al dies
2. Betty receives the
entire estate
3. No federal estate tax
is imposed due to the
unlimited marital
deduction
4. Betty dies
5. The estate is now
subject to federal
estate tax because
she has more than the
exempt amount:
$1,100,000
- 1,000,000
100,000 x .37 = $37,000
Wow
!
11
Al & Betty’s New A-B Plan
1. Al dies
2. $1,000,000 is funded to the survivor’s (A) trust for Betty
3. $100,000 is funded to the family (B) trust; Betty receives income and HEMS from the principal of this trust
4. Betty dies
5. The marital trust goes to the children without federal estate tax
6. The family trust goes to the children without federal estate tax
NO TAX DUE!
(A savings of $37,000)
12
Al & Betty’s New A-B Plan
$1,100,000 Estate
Family Trust
$100,000
Surviving Spouse
Survivor’s Trust
$1,000,000
All income
HEMS
-Irrevocable
-File 706
-Tax number
Children receive the
benefit of the entire
$1,100,000
13
Federal Estate Tax ExclusionOutside Grantor’s
Estate
Inside
Grantor’s
Estate
2009:
$3,500,000
2006:
$2,000,000
2004:
$1,500,000
2002:
$1,000,000
2001: $
675,000
Value
exceeds
exclusion
14
Beyond the Exclusion
Exclusion
Outside
Grantor’s
Estate
Inside
Grantor’s
Estate
Beyond the exclusion,
every $1 in growth is
subject to both income
tax and estate tax!
15
Estate Tax Planning TechniquesInside
Grantor’s
Estate
Outside
Grantor’s EstateReduce
• Reduce
growth
• Reduce value
Maintain
control
and….
Increase
growth and
increase value
(on the other
side of the
fence)
Exclusion
16
The plan used to be-Remove
Value and Reduce GrowthInside Grantor’s
Estate
Outside
Grantor’s Estate
Irrevocable
Trust
Irrevocable trusts allow the
Grantor to reduce growth
and value in Grantor’s
taxable estate.
Control comes through the
design of the Instruction
Manual.
Instruction Manual
(Trust Agreement)
The planning focus is no longer
on estate taxes for estates that are
less than $5,430,000 for an
individual
or
$10,680,000 for a married couple
This is because only 1% of the population is
affected by such a threshold.
What happened to all of the
estate TAX planning?
What happened at the top and the
bottom of the fiscal cliff at the end
of 2012? Was there a big “splat!”
What is the “rest of the
story?”
OR
As the end of 2012 approached, the fear was that
the Federal Gift and Estate tax exemption threshold
of $5,120,000 was going to go back (sunset) to a
$1,000,000 threshold at midnight, December 31st, 2012
as a result of the sunset provision in the federal law.
This was perceived by many as a one-time “use it or
lose it” opportunity to make gifts. People pondered
whether or not there would even be a “claw back” from
the estate tax at death if a person attempted to use the
gift tax exemption in 2012.
There was much discussion and in the end there was
much gifting.
Fiscal Cliff
The Estate Planning World Has Changed
Where are we now as a result of changes in
both Kansas and Federal law?
State of Kansas-What has happened?
Inheritance Tax was repealed in 1997
Replaced with a Kansas Estate Tax for Estates in
Excess of $1 Million, this tax was phased out at the
end of 2009 and there has been no proposal in
Topeka to reinstate an “inheritance” or state level
“estate tax.”
Presently there is no “death” tax in Kansas.
Threshold
1987-1997 Taxable Estate $ 600,000
1998-2012 Taxable Estate (SUNSET) $1,000,000
Effective Estate Tax Rate
50%! (as much as 55%)
Unless a client wanted to plan to die in 2010
(the year there was no Federal Estate Tax)
we all focused on the 2010 sunset amount for planning:
$1,000,000 as the planning threshold for estate
and gift taxes and a 50% estate tax rate.
Estate Planning HAS BEEN
Focused on Federal Estate Tax Avoidance
BUT, remember-
The Estate Planning World Has Changed
2013 ATRA: No SunsetTax Law is Permanent
(until it is changed again).
Unified Estate and Gift Tax
Applicable Credit =
$5,000,000 2011
$5,120,000 2012
$5,250,000 2013
$5,340,000 2014
$5,430,000 2015
$10,860,000 married couple 2015
The applicable lifetime credit
(a/k/a exemption or threshold amount
before any tax is imposed)
is indexed for inflation and will
continue to increase annually. Living longer
is good estate tax planning!
Now, in 2015-Federal Estate Tax
Planning is only Necessary for 1%
of all Americans!
Individual Threshold $ 5,430,000
Marital Threshold $10,860,000
It is fair to say that the focus of those with
taxable estates from 1986 until the end of 2012
was on estate and gift taxes and avoiding those
taxes.
Where should we focus now, after ATRA?
After ATRA there will need to be more focus
on income tax issues in the planning because
of the fact that the primary concern for most
people will no longer be the estate tax.
Where has the focus been?
Estate Planning Focus on Estate Tax
What are the issues facing those that do not have estates
that will be subject to federal estate tax?
The non-tax issues have not changed.
• People are still going to focus on planning for retirement.
• People are still going to be faced with the possibility of
becoming incapacitated and/or having diminished
capacity.
• People will be concerned how to leave property for
spouses and descendants.
• People are still going to be faced with the inevitability
of death and what to do with their $’s and other stuff.
After ATRA-Estate Planning Focus on Income Tax
Again, what hasn’t changed on the estate planning side?
The need to plan for the possibility of aging, retirement,
incapacity, need for assistance, long-term care - both with
finances and documents, powers of attorney, living wills, and
other written plans and directions.
People will continue to have a need for growth of assets and
income.
People will continue to want to plan for children and
grandchildren no matter what the size of their estate is.
Clients want to Leave a Legacy. This has not changed.
They want to say “I love you.” Yet, they often want to assert some
Control. Incentive Planning can be negative or positive.
One option:
Negative Incentives for Beneficiaries who are not doing
what they should be doing:
•Refusing to work when they are able to do so
•Substance Abuse or other addictions
Reduce or stop distributions for certain situations on an attempt to
provide an incentive that is negative:
“I may not be able to make you do what I want you
to do, but I can make you wish you had.”
W.E. (Wally) Larson
Clients want to leave a Legacy. This has not changed.
Positive incentives for Beneficiaries
Increase distributions provide for bonus in certain events:
• Provide funds for education, maybe require being full
time student, maintain a certain grade point average,
to pursue a specific type of training or degree.
• Distribution of lump sum upon graduation or at age 30
(incentive to get education)
• Dollar for dollar earned income match up to a certain
income level.
(incentive to be a productive person)
• Family Bank concept (make loans for various
purposes to beneficiaries and increase availability
of funds for successes)
• Incentives for Charitable Giving by matching charitable
giving up to a certain level.
• Provide for opportunities. Incentive-Trustee directed to take into
consideration how previous distributions have been dealt with by
beneficiary.
Step-Up in Basis to fair market value at death
did not change!
General Rule:
Basis of property in the hands of person acquiring
property from decedent … is the fair market value at
the date of decedent’s death.
(Although referred to as the “step-up” rule, there
can also be a step-down in basis.)
What income tax matters did not change with ATRA?
Results of ATRA:
Prior to ATRA most planners would have agreed that
it made sense to obtain valuation adjustments and make
lifetime gifts for those with potentially
taxable estates, because passing basis and having imbedded
capital gain in property transferred during life without a
step-up in basis was considered better than paying estate tax
but getting a step-up in basis.
Now, with the greater exemption (applicable credit) amount
locked in and indexed to inflation, and with the threshold for
an estate tax liability Increasing significantly before the
possibility of tax being owed at 40% continues to grow
annually, holding assets until death to get a step-up in basis
may be the better tax avoidance plan.
Now, there is an even greater need to look at the
nature of the assets in a client’s estate to determine
income tax issues, such as those relating to basis.
Assets that have a low basis and that are likely
to be sold by the next generation are the most
significant for which to contemplate ways to
get a step-up in basis.
Prior to ATRA it was considered good planning to move
assets to a younger generation and have growth occur
in the estate of the younger generation.
Now, if capital gains tax rates go up and an individual is
faced with a significant state income tax, these types of
gifts come with a lot of risk.
One option may be to transfer assets to a trust that
includes provisions allowing the Trustee to force estate
tax inclusion (thus obtaining a step-up in basis) but at the
same time protecting assets from creditors and predators.
Irrevocable Life Insurance Trusts are still attractive to
provide an offset for possible taxes (income tax or estate
tax) particularly with the use of the annual exclusion for
funding.
Traditional Planning prior to ATRA
For a married couple:
A/B Trust Planning was primarily done by creating a
Separate trust for each spouse. (Although it can be
done with a joint trust.)
There are many variations, but the significant intent
of planning in the manner was to make sure that
exemption (applicable credit) for estate taxes was not
wasted at the death of the first spouse to die.
Typically, the result was to create a trust to hold assets
outside of the estate of the surviving spouse but for the
benefit of the surviving spouse.
Common names:
Credit Shelter Trust, Bypass Trust, Family Trust, A/B
Traditional Planning prior to ATRA
Example-Farm Family with Land
It was not unusual to have half the value of the farm
ground in the Credit Shelter or Family Trust.
What has happened in the last ten years with land
values in Kansas? Values have increased significantly.
Result:
We now have Credit Shelter or Family Trusts that have
land with low basis compared to fair market value that
will not step-up in basis at the death of the second
spouse to die.
Deceased Spouse Unused
Exemption otherwise known as
DSUENo longer a primary planning
objective to make sure that estate tax
exemption is fully used at the first
death for a married couple!
Portability
for
Present Estate Tax Law For deaths in 2014 the Estate Tax Exemption was
$5,340,000
For 2015, the current estate tax exemption is $5,430,000.
Presently the exemption amount is indexed for inflation.
Top tax rate is 40% on the excess.
It is estimated that in 2013 when the law was made
permanent in its present form, only 3800 estates would
need to file returns at present levels, or less than 1% of all
decedent’s estates in the United States.
Estate and Gift Taxes no longer a
Common Problem
99 % of all Americans will not
have an estate or gift tax concern
after ATRA’s enactment!
Deceased Spouse Unused
Exemption
TRA ’12 permanently enacted from TRA ’10 the
provisions that provide a surviving spouse will be
able to use the unused exemption of a
predeceased spouse who died after December 31,
2010 for both gift and estate tax purposes. This is
commonly referred to as “portability.”
Using Portability to obtain
“Step-Up” in Basis “The use of a predeceased spouse’s unused exemption is
not a planning technique. It would normally only be
employed by a surviving spouse due to desirable planning
not being utilized in the predeceased spouse’s estate. This
would include funding a Family Trust for the benefit of the
surviving spouse with the predeceased spouse’s unused
exemption amount.”
This statement was published and presented a little over
one year ago in a program outlining the current status of
the law. It is typical of the belief all planners have had for
over 25 years that a primary goal of good planning was to
make sure that exemption (applicable credit) was not
wasted at the death of the first spouse to die.
Times have changed.
Using Portability to obtain
“Step-Up” in Basis
It has been hard to accept that planning to utilize DSUE
does affect planning and should be a part of many new
plans because it is an option to make sure the ability to
obtain a step-up in basis is not lost!
It has very much become an “estate planning technique!”
Portability and the DSUE
The “All-American Estate Plan for decades has
been the following: “Leave it all to the surviving
spouse.”
With a lower estate tax threshold, the “leave it all
to the surviving spouse” plan was seen as a
“waste” of exemption that was undesirable for any
couple with a marital estate in excess of $600,000
or $1,000,000.
The tax bill would be due within nine months of
the second death!
Portability and the DSUE
Under this type of plan, the unlimited marital deduction
was perceived as a trap for the unwary individual and it
resulted in a trap for imposing estate tax when the
surviving spouse died and the “wasting” of the exemption
could not be undone.
(Remember a tax of 50% was imposed on the first dollar in
excess of $1,000,000!)
Portability and DSUE
Congress, as often seems to be the case, took action to
protect those who found themselves the victim of this tax
trap about 15 years too late because under current law far
fewer estates feel the estate tax impact.
Congress’ Solution: the 2010 Tax Act. (2-year patch)
Provided for Portability of Unused Exemption beginning
in 2011.
Portability and DSUE What are the Requirement for the DSUE
Married Couples or widowed
Singles are not impacted
Mechanics of DSUE
Must be married at time of death
Both spouses are US citizens
Death after Jan 1, 2011
DSUE allocation is made to surviving Spouse
Timely filed election is made on the estate tax return
Portability and DSUE
Proceed with caution if there are multiple deceased
spouses – the last deceased spouse’s DSUE eliminates any
DSUE from a prior deceased spouse.
However, for fun, contemplate the “black widow” estate
plan through the use of gifting by the wealthy “black
widow”: Spouse “dies” and “black widow” obtains
DSUE, uses gift exemption to the fullest, then surviving
spouse remarries next non-propertied spouse down the hall
at the nursing home, repeat as many times as possible.
Portability and DSUE EXAMPLE
Married Couple. Estate is $7,000,000. 1st Spouse
(Husband) dies leaving all to surviving spouse (wife).
Assume death of husband occurs in 2015 and wife also
dies in 2015 and there are no lifetime gifts.
1st spouse’s trustee/executor elects DSUE. $5,340,000
unused exemption from husband is portable to wife.
At 2nd spouse’s death, her taxable estate is still $7,000,000.
At 2nd spouse’s death, she has her $5.43M exemption for
her death in 2015. In addition with a timely elected DSUE
from husband, she has an additional $5.43M exemption.
Thus $7M is distributed free from estate tax. Without
DSUE, wife’s estate pays over $600,000 in Estate tax.
Portability and DSUE• Filing the 706 timely to Elect DSUE
• For Non-taxable Estates:• Property qualified for marital deduction of charitable deduction
is subject to special valuation rules – For a good laugh, See Next Slide for language from Form 706 for special valuation rules.
• Property should still be listed on appropriate schedules.
• Only in limited types of items is a valuation needed
• For the vast majority of assets, a good faith estimate is made.
• Essentially value is made by good faith estimate and then rounded to the nearest $250,000 to determine DSUE.
Portability and DSUE
This is the language on each schedule of the
706 return. If the value of the gross estate, together with the amount of
adjusted taxable gifts, is less than the basic exclusion
amount and the Form 706 is being filed solely to elect
portability of the DSUE amount, consideration should be
given as to whether you are required to report the value of
assets eligible for the marital or charitable deduction on
this schedule. See the instructions and Reg. section
20.2010-2T (a)(7)(ii) for more information. If you are not
required to report the value of an asset, identify the
property but make no entries in the last four columns.
Portability and DSUE As a side note, when was the last time the IRS specifically
instructed a taxpayer to use their best judgment and that
there is no need to provide values for entries on the return?
And then the IRS makes a specific instruction to the
taxpayer that after they have used their best judgment and
skill in determining values that the IRS doesn’t need to
know about, the taxpayer is then to round those values to
the nearest $250,000 to determine remaining credit for a
return?!?
(see pages 16-17 of Instructions for Form 706 for more “best
guesstimate” language and the $250,000 rounding table)
Portability and DSUE
Back to a more serious note, when and
where should we utilize Portability and the
DSUE?
DSUE is not always a perfect solution.
Bypass Planning should still be used in many
cases
Creditor Protection
Predator Protection
Future appreciation of assets concerns
DSUE is not indexed and doesn’t apply to GST
exemption
Portability and DSUE
Considerations of when to elect portability?
What is the liability for failure to elect? Advisor/Executor may have exposure if tax occurs at
survivors death when it might not have otherwise done
so with timely election.
Cost considerations on non-taxable estates.
What if Congress reduces the exemption amount and
advisor/executor failed to timely elect?
Decision to use Bypass planning which results in no
step-up in basis at second death v. no Bypass planning
but 2nd death step-up.
Start with the end in mind-or-Where are you going?
What are your goals?
What are your concerns?
What do you want the picture to look like?
Who should be involved in the decision making?
Family Business Succession What is Estate Planning in the realm of
Family Business Succession?
Think of the family business (farm) as a team bus going down the road.
Where is the bus going?
What is the plan? You have to know where you are going in order to properly plan how to get there. What direction are you going and is it the right direction? Ultimately, there is more than one route that can be taken to get to the same destination. Who decides which route? What does the destination look like? Are there people on the bus that think the bus is going to a different destination?
Family Business Succession Who is driving the bus?
Should the current driver really be behind the wheel? Who decides where the bus is going? Who is at the helm making decisions? Why are we doing this plan? Who are those affected? Who is most affected? Does somebody else really want to be driving? Do you know when it is a good time to not drive and be a passenger?
Family Business Succession
Who is on the bus?
Why is this group together on the bus? Is there a sense of unity? Does anyone need to be included who has not been included? Is there anyone on the bus who doesn’t want to make the trip or would like a different destination? Are there people on the bus that don’t or won’t talk to each other?
Family Business Succession Client Goals and Concerns
Each family member is likely to have different Concerns and Goals.
Typically, it is good to have appropriate leadership in place prior to the passing of the Patriarch or Matriarch. One of the biggest mistakes in planning for business succession is simply waiting until there is a death to make a change.
Family Business Succession
Plan ahead for an orderly process and
transition, or stop when a key person dies
and attempt to reorganize.
Changing drivers while going down the
road is not a good plan.
It is your choice.
Family Business Succession
Think of having to change drivers on the bus while going down the road. There is likely to be a messy accident. People will be hurt and injuries suffered that may not heal. The bus may be wrecked so bad that we can’t get it back on the road, or the time and expense involved will drastically affect what it looks like when it does.
Mistakes Failing to plan for the possibilities
Illness
Incapacity
Long Term Care
(not just for the Patriarch or Matriarch that has driven the bus for many years, but for all of the players)
Mistakes Not communicating and transferring values.
Has the vision of one generation been shared with the next generation?
Has the older generation asked the younger generation what their vision is?
Getting the Priorities Right Start with the end in mind.
Get all the right people on the bus in the right seats.
Determine who should be involved in a discussion of where the destination should be.
Plan for the trip and plan for all aspects, including contingencies.
Know where you are headed and how you are going to get there.
Getting the Priorities Right
Know and consider the possible travel detours and problems that might prevent you from getting to your destination.
Don’t even turn the key and start the engine without having the plan in place and the GPS programmed.
Now Back to Basics Goal #1 – Probate Avoidance
Avoid, Minimize, or Reduce the loss of control and waste of time and expense associated with Probate. Ensure the largest amount of assets possible goes to the beneficiaries instead of other parties.
Solutions
Proper Titling of Assets
Coordination of Beneficiary Designations
Use of Trust planning to handle the administration
Utilizing the Will as a “spare-tire” or “back-up” plan for administration
Estate Planning: The Basics Goal # 2 – Capital Gains and other Income
Tax Issues (unless you are in the 1% that has a federally taxable estate)
What capital gains issues are there?
How are you operating and what entities are involved?
There are issues for succession if you have an LLC, Corporation, or Limited Partnership, for example.
Estate Planning: The Basics
Goal #3 - Family Harmony Concerns
How to prevent beneficiaries from fighting among themselves and having large attorney’s fees as a result.
Using Trust Planning typically provides a more difficult avenue to litigation
Selecting the correct Executor(s) or Trustee(s)
Openly discussing family concerns with estate planning attorney
No-contest clauses in planning documents-what can be prevented?
Beneficiaries need to receive good advice from their advisors
Estate Planning: The Basics
Goal #4 - Reduce Creditor Concerns for the Grantor
Solutions –
A revocable trust does not provide any additional creditor protection to the Grantor (s)
Use of Entity Planning (FLP, LLC, Irrevocable Trusts)
Farm Families can benefit greatly from asset protection strategies
Asset protection needs to be done at a time when everything is seemingly fine.
Estate Planning: The Basics Goal#5 – Protect Beneficiaries from
Creditors or Predators
Solutions
Open and frank discussion with estate planning attorney about your concerns regarding your beneficiaries issues with:
Troubled Marriages/Divorces
Bankruptcy
Lawsuits & Judgments
Special Needs
Poor Money Management/Substance Abuse Problems
Spendthrift Clauses in Trust Documents provide tremendous asset protect to beneficiaries
Estate Planning: The Basics
Goal #6 – Preserve or create a Family Legacy
Problem: Ensuring assets are managed in accordance with your wishes and that your success preserves a legacy for heirs.
Solutions
Incentive Clauses to prevent “Trust-Funders”
IRA Trusts with RMD requirements
For farming families, plans to keep land in family
Plan for succession of privately owned, family business
Plan for those who will be involved and those who will not be involved
Business Succession Planning We believe that the greatest mistake in
planning for those with family businesses is to do little but be the boss and then die. It is estimated that over 80% of the businesses
in the U.S. are private or family dominated
70% don’t make it to the 2nd generation
85% don’t make it to the 3rd generation
Average business lasts 24 years
The difference is in having a good plan, which involves including the key people necessary to make the transition from one generation to the next.
Recommended
