Martin “Marty” Shenkman, Esq., CPA, MBA is an estate planning attorney and Certified Public Accountant who authors a number of publications each month, including his monthly e-mail newsletter, “Practical Planner“. Below is the second installment from Marty’s March/April 2012 newsletter. To be added to Marty’s monthly e-mail distribution list, e-mail firstname.lastname@example.org.
Summary: Unless you’re hiding under a rock, you’ve been bombarded with email newsletters, mailings and more from your CPA, investment adviser, the 100s of people who want to be your investment adviser and more, cajoling you to make gifts before the end of 2012. Well this article is one more of ‘em. And you should pay heed. While the main drift of this message is clear: “make gifts before the law changes in 2013.” There are a number of important nuances to the message that the media blitz has not addressed: Lot’s of people, not just the ultra-high net worth folks, should be doing this. So if you’ve tuned out these messages because you’re not a zillionaire, tune back in! So, “I’ll bet you think this song is about you. Don’t you? Don’t you?” Well Carly, it is! No one should just make a gift, the gifts should be in trust (your lawyer won’t make any money on the deal if it’s just a simple gift!). These trusts raise a host of issues, many of which have special implication to 2012 planning. So, we’re going to try to convey these key points in a really succinct amount of space, but hopefully enough can be conveyed to motivate you to act now, and act prudently.
- Point 1: Uncertainty shouldn’t be an excuse for inaction. If the weatherman says 20% chance of a horrible storm, you’d carry an umbrella. Uncertainty may also mean opportunity. If you don’t act now 2013 is scheduled to bring a $1 million exemption and 55% rate. President Obama has continued to propose estate and gift tax changes that will undermine much of the planning arsenal, making his proposed 45% rate and $3.5 million exemption far more costly than most imagine. Consider that the left end of the tax continuum. True, the future is uncertain. Perhaps the Republicans will sweep the election and repeal the estate tax. Consider that the right end of the tax continuum. If you don’t act now and the left end materializes you (not only your heirs) may lose out big time. If the right happens worst case you’ve wasted the cost of the planning, but have you? The trust planning that will serve your estate planning needs will also provide asset protection benefits, including divorce protection for heirs, and better control and management of your assets. So the planning in the best tax case scenario won’t be for naught, you’ll just have one less benefit. And by the way, even if the estate tax is repealed (and ya shouldn’t hold your breath hoping for that one) the gift tax may remain intact with a $1 million exemption even under Republican control. Most folks forget that the gift tax is an integral backstop for the income tax, not only for the estate tax. Look at what happened in 2010 with the gift tax.
- Point 2: Planning is not only for Richie Rich. If you have a non-married partner a $1 million gift exemption in 2013 may make it costly to shuffle ownership of assets between you and your partner. Everyone, not just surgeons, should be concerned about asset protection. Nothing anyone in Washington does will change the litigious nature of our society. About a score of states have decoupled from the federal estate tax system so that lower amounts of wealth may trigger state death tax. A simple gift today might be all it takes in many situations to reduce or eliminate state estate tax. Use the current favorable tax environment to shift assets into protective structures before the party ends. A $1 million gift exemption will render much of this planning costly, impractical, or impossible. Remember at midnight 12/31/12 the carriage turns back into a pumpkin and the ride is over.
- Point 3: Start with a Financial Plan. While your estate planner might think he or she holds the keys to the planning kingdom, this kinda planning should have at its foundation a well thought out financial plan. Does this suggest your wealth manager should be driving the bus? Nah, but they should be a co-pilot. How much can you afford to give away and be really assured that you won’t be asking the kids for a loan? Which assets can or should you give away? Do you need additional life insurance for coverage in light of components of the plan? Do you need access to the money you give away and if so how much? This analysis is meant to insure that you’re left with more than adequate assets to maintain your lifestyle after the transfers. This can deflect an IRS challenge that you had also an implied understanding with the trustees (or managers of an LLC) to get money back because you left yourself with insufficient resources. It can make it harder for a creditor to prove later that your transfers constituted a fraudulent conveyance.
- Point 4: Make Gifts in Trust. Whatever amount you determine to give away, give it to one or more trusts, not outright to an heir. Trusts provide asset protection, divorce protection, preserve generation skipping transfer tax benefits (in English they can keep the assets out of the transfer tax system forever). Trusts can be structured as “grantor trusts” so you can sell assets to them without triggering capital gains tax and you can pay the tax on trust income and gains thereby growing the value of the assets inside the trust faster while shrinking the assets left in your name, thus reducing assets reachable by creditors or subject to estate tax. Both of these bennies are on President Obama’s hit list, so get ‘em while you can. Perhaps the biggest vig of gifting to a trust is you can retain the ability to benefit from the assets in trust. Say you set up a trust for your spouse/partner and all future descendants. So long as your spouse/partner is a beneficiary you can indirectly benefit. Alternatively, you can set up a Domestic Asset Protection Trust (DAPT) and be a beneficiary of your own trust. Even if you’re mega rich, but much of your wealth is concentrated in a business, be very cautious about cutting off your access to trust assets. Don’t forget the harsh economic lessons of 2008-10+.
- Point 5: Sell Assets to Trusts. While gifts can take advantage of the current law, sales of assets to trusts can also provide a huge benefit now, that may also disappear when the ball drops in Times Square. If you sell 45% of your interest in a family business valued with a 40% non-marketability and lack of control discount, that’s huge leverage. Discounts may head the way of the Dodo bird. Since few trusts will have sufficient cash to pay for the purchase these sales are structured as note sales. Interest rates remain at historic lows. So transfers well beyond the $5.12 million are “can do.” For many folks the better approach is a technique described in prior newsletters called a Beneficiary Defective Irrevocable Trust (BDIT) that will depend on this sale technique. Sell ‘em while you can!
- Point 6: Design the Trusts Right. The trust or trusts you’ll use should not be off the rack. This is the time to step up to the custom tailored suit. Navigating Scylla and Charybdis is child’s play by comparison. Some of the issues to consider include:
- Should you be a beneficiary or not? If yes, there are precautions to take and only certain states in which the trust can be established.
- Is there any reason the trust should not be a grantor trust? Unlikely, but ask. If it is a grantor trust what happens if there is a big capital gain? Example – you transfer your family business to the trust and 5 years from now sell out to a public company for big bucks. You have to pay the gain but the bucks are in the trust. Some practitioners use a tax reimbursement clause but caution is in order. These clauses have to be handled correctly and the trust must be in a state with appropriate laws. Also, worrisome is that if the trustee just so happens to reimburse you, the IRS might argue that you had an implied agreement with the trustee to reimburse you for the capital gains tax on a big sale. There may be better approaches.
- If you and your spouse/partner both set up trusts, the trusts need to be sufficiently different to avoid the IRS arguing what is called the “reciprocal trust doctrine” — that they are so identical that they should be “uncrossed” so that the trusts are taxable in each of your estates. That would entirely negate the planning. Differentiate the trusts using different powers, different distribution standards, set them up in different states, sign them on different dates, use different assets, print them on different color paper (just kidding on that one), etc.
- If you own all the assets to be given can you set up a trust and gift $10.24 million and have your spouse treat the gift as if it is ½ his thereby using up his exemption? While spouses can gift split, if your spouse is a beneficiary of the trust which is the recipient of the gift, that is a no-no.
- What if you gift $5.12 million to your spouse, and he then gifts it to his trust to avoid the gift splitting issue? Nice try but maybe no cigar. The IRS could attack using the “step transaction doctrine.” If the IRS wins they might treat your gift to your spouse, and his gift to the trust, as an indirect gift by you to his trust. Thus, you’d be treated as making two $5.12 million gifts and owe about $1.8 million in gift tax. Ouch!
- There has never been a time in history when so many taxpayers may feel so compelled to make so many large transfers in such a short time period. Big brother will be watching so more caution and planning then ever before should be exercised.
- You want to fund a FLP or LLC with appreciating assets, make gifts and secure discounts. If the assets are not inside the entity long enough the IRS will argue that the gifts were of the underlying assets – no discount.
- Point 7: Operate the Plan and Trusts Right. Administer the plan and trust properly, and monitor it by meeting not less than annually with all your advisers to make sure all formalities are adhered to. Be sure the CPA is in the loop to monitor the gift and income tax returns so they all properly reflect the reality of the transfers. Revise asset allocations to coordinate asset location decisions.
Bottom Line: Just Do It! Time is fleeting. Everyone should review planning options for themselves and their family/loved ones to ascertain what might be beneficial and how to expedite the process so planning is completed in advance of year end, preferably before the election.
To download the complete newsletter and prior newsletters, click here.
ABOUT THE AUTHOR: Martin “Marty” Shenkman, Esq., CPA, MBA is an estate planning attorney and Certified Public Accountant from Paramus, New Jersey. He received his Bachelor of Science degree from Wharton School, University of Pennsylvania 1977 with a concentration in accounting and economics. He received a Masters degree in Business Administration from the University of Michigan 1981, with a concentration in tax and finance.
Mr. Shenkman is a widely quoted expert on tax matters and is a regular source for numerous financial and business publications, including The Wall Street Journal, Fortune, Money, The New York Times, and others. He has appeared as a tax expert on numerous television and cable television shows including The Today Show, CNN, NBC Evening News, CNBC, MSNBC, CNN-FN and others. He is a frequent guest on radio talk shows throughout the country and has a regular weekly radio show on Money Matters Financial Network.
Mr. Shenkman is a prolific author, having published thirty-four books and more than seven hundred articles. Mr. Shenkman has served as contributing editor to a host of publications, including: New Jersey Lawyer, The Journal of Real Estate Finance, Real Estate Insight, Commercial Leasing Law & Strategy, The Journal of Accountancy, Real Estate Accounting and Taxation, Shopping Centers Today, and others.
Mr Shenkman is active in numerous charitable organizations, sitting on many boards and planned giving committees and lectures regularly for these and other organizations.