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Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
Capital Gains Tax Planning
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Capital Gains Tax Planning

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Everyone knows about Section 1031 tax deferred exchanges. But what else is there that you can do? What is the role of the tax professional? How has our advice chnaged in light of the change in the …

Everyone knows about Section 1031 tax deferred exchanges. But what else is there that you can do? What is the role of the tax professional? How has our advice chnaged in light of the change in the tax rates? What is the difference between a situation where the taxpayer is under time pressure versus where the taxpayer has no pending transaction? Death is a capital gains tax loophole. What is wrong with installment sales? How do you fix an installment sale? What is the restriction on related party installment sales? Does a deferred sales trust "work"? What is the $5,000,000 per seller limit on the benefit of installment sales? How does the assignment of income doctrine impact this planning? Does a charitable lead annuity trust have a place in this planning?

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  • 1. Sophisticated Capital Gains Tax Strategies: Risks and Rewards Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 1
  • 2. Capital Gains Tax Strategies Table Of Contents 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. Capital Gains Tax Rates Our Traditional Advice What Has Changed? Role Of The Tax Professional Role Of Professional Fees – Review Engagement Role Of Professional Fees – Implementation Engagement The Engagement – Before The Meeting The Engagement Meeting – Under No Time Pressure The Engagement Meeting – Those Under Pressure Describing Strategies Death Is A Capital Gains Tax Loophole What’s Wrong With Installment Sales? How To Fix An Installment Sale IRC Section 453(e) – Restriction On Related Party Installment Sales The Statute Diagrams Economics Disadvantages Exit Strategy Unrelated Party Installment Sales – Friend Unrelated Party Installment Sales – Deferred Sales Trusts Section 1031 Exchanges In 2013 Nevada Non-Grantor Trust IRC Section 453A – The $5,000,000 Restriction Assignment Of Income Doctrine – Ferguson. Charitable Lead Annuity Trusts Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 2
  • 3. Capital Gains Tax Strategies Capital Gains Tax Rates The income tax began in 1913. The capital gains tax was introduced in 1916 at 15%. It reached its maximum – 77% - in 1918 and its lowest – 12.5% - in 1922. In the modern era, the maximum tax on long-term capital gains was 25% from 1954 to 1967. Starting in 1968 it climbed slowly reaching a peak of almost 40% in 1978. It dipped to 28% for 3 years and then stayed at 20% from 1982 to 1986. It stayed in the 28% range for a decade. From 1998 to 2003 it remained in the 21% range and then dropped to the 15% - 16% range from 2004 – 2009. Then it was 15% to the end of 2012. Now it is 23.8% (24.988% given the 1.188% adjustment for itemized deductions per Bob Keebler). That is a large percentage increase (almost 60%) from what it was in 2012. However, from an historic perspective, it is not high. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 3
  • 4. Capital Gains Tax Strategies Our “Traditional” Advice For the past 15 years we have suggested that clients “pay the capital gains tax, avoid any complications that come from planning, and pocket what’s left. It’s the best rate available under our system.” When the capital gains tax was 15%, and especially for taxpayers in states like Nevada, that is advice that taxpayers readily accepted. When IRC Section 7701(o), the economic substance doctrine, was added in 2010, that confirmed that we want to be very careful before engaging in any tax planning. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 4
  • 5. Capital Gains Tax Strategies What Has Changed? In 2013, in California, the capital gains tax is 20% federal + 3.8% federal + 13.3% (income above $1,000,000) state = 37.1%! So, at that, it is arguably only 11% or so below the maximum individual rate (39.6% + a deductible 13.3% is about 48%). When taxpayers are shown that result, more of them now, than in the past, are interested in understanding if there are palatable alternatives to simply “paying the tax and pocketing the difference.” In Nevada, the capital gains tax is now 23.8%. That is still 15.8% less that the maximum individual rate on ordinary income.* However, human nature is that when the transaction is large enough, some people will be curious just to be certain whether there is anything they are overlooking before they write the check to Uncle Sam. So, if it is a $1,000,000 capital gain, the taxpayer may simply write the check. But if it is $10,000,000, the magnitude of the check motivates some people to buy a few hours from a tax lawyer to explore alternatives. *Bob Keebler: 44.588% top rate on investment income – 24.988% on capital gains = 19.6%. 41.688% top rate on salary – 24.988% on capital gains = 16.7% Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 5
  • 6. Capital Gains Tax Strategies Role Of The Tax Professional We do not try to encourage our existing clients, or the taxpayers referred to us by other professionals for this type of advice, to engage in transactions that minimize or eliminate the capital gains tax. We view our role as educators. We want to be certain that the client is aware of the legal and ethical alternatives. We want the client to make an informed decision. We are afraid of this situation: (i) 6 months after meeting with us, the taxpayer hears someone at the Country Club mention that he or she had a big gain at the end of last year but, based upon advice of that person’s CPA and/or tax lawyer, set up a “CLAT” that ended up dramatically reducing the tax that the person would have otherwise paid; and (ii) the taxpayer did not hear from us a thorough explanation of the advantages and disadvantages of a CLAT. If that happens, the client will say or think, “Boy, Givner must not be that good. He never even mentioned that to me.” Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 6
  • 7. Capital Gains Tax Strategies Role Of Professional Fees – Review Engagement Once you understand that you are an educator, then you understand why you cannot meeting with taxpayers about this type of planning for free, or even at complimentary or dramatically reduced fees. That applies even to an initial meeting. You must charge fairly for your time. If you do not charge, or if you charge less than your normal fee, you will have an incentive to encourage the client to engage in planning that will generate a large fee. That is a very bad idea. You want to be absolutely comfortable, at the end of your time with the taxpayer, recommending – if that is your feeling – that the taxpayer simply pay the tax and pocket the difference (do no planning). Indeed, for the majority of the taxpayers you meet that will probably be the best advice. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 7
  • 8. Capital Gains Tax Strategies Role Of Professional Fees – Implementation Engagement If you are engaged to implement a structure, you must be careful to charge a fee that is enough to compensate you to thoroughly analyze the facts; be certain that the alternative selected makes sense for the clients; be certain that the client is aware of other alternatives; thoroughly explain the structure to the client (you cannot rely only on your transmittal letter); and thoroughly explain the downside risks. Unfortunately, although we are not paid to give financial advice, you probably have to address the fact that the economics can spoil the structure. Also, have the client on a plan for annual reviews to be certain the plan works in operation from year to year. Many structures are perfect when they leave the lawyer’s office. But they crash and burn due to the client’s misunderstanding or inattention in later years. Even if you have a strong transmittal letter and “operating guide,” the client will still be unhappy with you if things go wrong. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 8
  • 9. Capital Gains Tax Strategies The Engagement: Before The Meeting We try to get the prospective client to complete (and send to us before the meeting) our normal “Confidential Information Checklist” that we use for preparing family trusts, as that gathers a great deal of helpful information. (For existing clients we ask them to “freshen” the Checklist in our files.) We also ask them to send us a copy of a recent personal tax return, their existing estate planning documents and a personal financial statement (which need not be formal – it can be handwritten). We review this information before the meeting and pose any questions about these materials at the start of the meeting. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 9
  • 10. Capital Gains Tax Strategies The Engagement: Meeting – Those Under No Time Pressure Some few people come to us during the year under no time pressure: they do not have a transaction pending; they have not already incurred a capital gain; they are simply toying with the idea of selling something at some unspecified time in the future. For those people we follow a more elaborate procedure. The first meeting would be to review goals and objectives, talk generally about tax planning, assure the clients that we can help them meet their needs, and get an engagement to do a Design. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 10
  • 11. Capital Gains Tax Strategies The Engagement: Meeting – Those Under Pressure Most people come to us under some type of pressure: they do have a transaction pending; they have already incurred a capital gain; they want to sell. There is usually just time for one meeting. The meeting will begin with a confirmation of the information provided, and clarification of uncertainties. We confirm their goals, only one of which is to reduce taxes. They also are concerned with maintaining dictatorial control of their money forever; maintaining their standard of living; asset protection; perhaps estate tax planning; perhaps philanthropic planning; perhaps mentoring heirs. We then describe strategies not by names, which we will use in this seminar, but by what they accomplish. Important point: once you label something, the taxpayer will react to the label. So, instead, describe the results (discussion follows). Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 11
  • 12. Capital Gains Tax Strategies Describing Strategies You do not say “Let me describe a charitable lead annuity trust.” You will not get to the third syllable of the first word and the client will already say “no.” Just the first two syllables – “char – it” – is enough to give the client the impression that he or she is giving assets away, and what good could that possibly be? One approach is to pose a series of questions: would you be interested in a result where you can deduct $1,000,000? Client responds “yes.” Would you be interested if you could control the investment of the $1,000,000? Client responds “yes.” Would you be interest if, at the end of 12 years, you get back $4,000,000? Client responds “yes. What is that?” You respond: “We call it a chocolate chip cookie. Would you like a chocolate chip cookie?” There is plenty of time after the taxpayer understands the benefits to put a technical label on the structure. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 12
  • 13. Capital Gains Tax Strategies Death Is A Capital Gains Tax Loophole Setting aside how low the rate is, does it make any sense to try to defer or eliminate the capital gains tax? Many people are happy with the asset. It is just that they have received an offer for more money than they thought the asset was worth. However, perhaps they should now realize it is worth more than they thought and they should continue to hold on to it. If the income is good, why sell? If it does not require painful upkeep, why sell? If it is a good asset for the children, definitely do not sell as death is a great capital gains tax loophole. Bear in mind, it only takes the death of one spouse to get the basis step up. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 13
  • 14. Capital Gains Tax Strategies What’s Wrong With Installment Sales? As a matter of deferral, a sale for an installment note is a great way to defer the tax (but not depreciation recapture). And deferring the tax is a great idea if you think that (i) a tax deferred is a tax saved; and/or (ii) you can make a lot of money on the money that would have otherwise been paid in taxes. So it involves a lot of guesswork as to the future. However, as an economic matter, an installment note with a stranger is an awful idea. Some transaction lawyers will tell you that the failure to receive all cash at the closing is a failure of the negotiations. It truly does not matter who the buyer is, no matter how well secured the note is (you may not want to get the asset back) and no matter the fact that the deal is “as is.” If you do not get paid all of your money at the closing, you are asking for trouble. There is not a single company in the country that is incapable of going bankrupt. Remember that in the 1950s the expression was “What’s Good For GM Is Good For America.” Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 14
  • 15. Capital Gains Tax Strategies How To Fix An Installment Sale What if you could do an installment sale with someone whom you absolutely trust? You are confident that no matter what happens this party is going to pay you the cash at any time that you want to receive the cash. How do you do that? Establish an irrevocable trust for the benefit of your children. You pick the trustee that you trust to do whatever you want the trustee to do whenever you want them to do it without question. Same for the successor trustees. You have the right to remove the trustee and name a new one (subject to IRC Section 672(c)). The trust can have a protector who can change the allocation among the children and the manner of distribution to the children (and perhaps add you as a beneficiary). The trust can contribute all the assets to a single member LLC of which you can be the non-member manager. What’s not to like? Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 15
  • 16. Capital Gains Tax Strategies IRC Section 453(e) – Restriction On Related Party Installment Sales (e) Second dispositions by related persons. (1) In general. If— (A) any person disposes of property to a related person (hereinafter in this subsection referred to as the “first disposition”), and (B) before the person making the first disposition receives all payments with respect to such disposition, the related person disposes of the property (hereinafter in this subsection referred to as the “second disposition”), then, for purposes of this section, the amount realized with respect to such second disposition shall be treated as received at the time of the second disposition by the person making the first disposition. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 16
  • 17. Capital Gains Tax Strategies IRC Section 453(e) – Restriction On Related Party Installment Sales (2) 2-year cutoff for property other than marketable securities. (A) In general. Except in the case of marketable securities, paragraph (1) shall apply only if the date of the second disposition is not more than 2 years after the date of the first disposition. (B) Substantial diminishing of risk of ownership. The running of the 2-year period set forth in subparagraph (A) shall be suspended as to any property for any period during which the related person's risk of loss as to the property is substantially diminished by— (i) the holding of a put as to the property (or similar property), (ii) another person’s holding of a right to acquire the property, or (iii) a short sale or any other transaction. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 17
  • 18. Capital Gains Tax Strategies IRC Section 453(e) – Restriction On Related Party Installment Sales The statute restricts related party installment sales if the related party who paid on an installment basis sells the asset in two years. However, the statute is black and white: if the sale by the related party takes place in 2 years and a day, the transaction “works” and the related party can use the related party’s purchase price as the basis for the sale to the outsider. Unfortunately, these fact situations do not come up often. Most people do not plan that far in advance. However, when you can identify these situations they are terrific. This is why it is so important to have a network of CPAs who will refer clients to you because they have annual meetings with their clients and can easily ask “do you have plans to sell your business/investment real estate sometime in the next few years?” Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 18
  • 19. Capital Gains Tax Strategies IRC Section 453(e) – Restriction On Related Party Installment Sales In the first diagram that follows the parents sell the high value, low basis asset to a non-grantor children’s trust for an interest-only installment note. In the second diagram that follows the children’s trust, after a wait of at least two years, sells the asset for more than the face value of the note, to an outside buyer for cash. In the third diagram, the children’s trust continues to hold the cash proceeds of the sale and continues to make the interest only payments on the note to the parents. In the fourth diagram, after four years, the trustee of the children’s trust drops the assets into a single member LLC and the parents can be the nonmember managers. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 19
  • 20. Capital Gains Tax Strategies IRC Section 453(e) – Restriction On Related Party Installment Sales Sell Asset Parents Installment note Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 20
  • 21. Capital Gains Tax Strategies IRC Section 453(e) – Restriction On Related Party Installment Sales Cash Buyer Sell Asset Pay Cash Parents Installment note Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 21
  • 22. Capital Gains Tax Strategies IRC Section 453(e) – Restriction On Related Party Installment Sales Parents Installment note Cash Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 22
  • 23. Capital Gains Tax Strategies IRC Section 453(e) – Restriction On Related Party Installment Sales Parents Installment note Nonmember managers Single Member LLC (cash) Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 23
  • 24. Capital Gains Tax Strategies IRC Section 453(e) – Restriction On Related Party Installment Sales Do the economics make sense? The property being sold must generate enough income so that the non-grantor children’s trust will have enough revenue to both pay the tax and the interest due to the parents. Assume the applicable mid-term (more than 3, no more than 9 years) federal rate is 2% (it is currently 1.73%). Assume the asset is an apartment building worth $2.0, subject to $1.0 of debt, in which the parents have a $1,0 basis and on which the free cash flow is $50,000 per year. The children’s trust will have to pay tax on the $50,000 less a deduction for the $20,000 per year of interest due the parents. Before the transaction the parents were taxed on $50,000. After the transaction the trust is taxable on $50,000 AND the parents are taxable on $20,000 of interest. So there may be some additional cost. However, if the family can make money for the next several decades on $238,000 to $371,000 that would have otherwise gone in taxes, that is a trade-off that many people will be glad to make. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 24
  • 25. Capital Gains Tax Strategies IRC Section 453(e) – Restriction On Related Party Installment Sales Are there disadvantages? 1. The parents no longer own the asset so it will not have the opportunity to step up in basis on the first parent’s death. 2. The note will be included in the parents’ estates. 3. If the note causes an estate tax, there must be another source for the payment of the estate tax. 4. The note is an item of income in respect of a decedent. 5. This is just a deferral: the tax must be paid when the principal on the note is paid. 6. If you pick an initial 9 year term to get a low interest rate, you must renegotiate in the future when the rates might be higher. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 25
  • 26. Capital Gains Tax Strategies IRC Section 453(e) – Restriction On Related Party Installment Sales What generally happens with these transactions? After two or three decades of deferral, the clients come back to us and say “Thanks. We enjoyed having the benefit of the taxes we should have paid back in 1982 (or 1992). We have made a lot of money with that. However, we now want to wind this transaction up. So let’s amortize the note and pay it down over the next 5 (or 10) years.” Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 26
  • 27. Capital Gains Tax Strategies Unrelated Party Installment Sales - Friend What if you don’t have two years? Can you sell the property to a party who is not technically related? For example your sister-in-law and your cousins are not “related” as defined in IRC Section 318(a) and 267(b) (see Section 453(f)(1)). However, will such a transaction have “economic substance”? If not, under Section 6662(b)(6) if the transaction is not disclosed the penalty is 40% (20% if disclosed). How would you give the transaction economic substance? Presumably the unrelated party would make a reasonable, e.g., 10% downpayment. So the seller must pay tax on that portion of the capital gain in year one. Does the unrelated party independently have the cash to make the downpayment? Is the seller happy to see the unrelated buyer make a big profit when the assets is sold to a true outsider in 2+ years? Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 27
  • 28. Capital Gains Tax Strategies Unrelated Party Installment Sales - Friend What if you don’t have two years? Can you sell the property to a party who is not technically related? For example your sister-in-law and your cousins are not “related” as defined in IRC Section 318(a) and 267(b) (see Section 453(f)(1)). However, will such a transaction have “economic substance”? If not, under Section 6662(b)(6) if the transaction is not disclosed the penalty is 40% (20% if disclosed). How would you give the transaction economic substance? Presumably the unrelated party would make a reasonable, e.g., 10% downpayment. So the seller must pay tax on that portion of the capital gain in year one. Does the unrelated party independently have the cash to make the downpayment? Is the seller happy to see the unrelated buyer make a big profit when the assets is sold to a true outsider in 2+ years? Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 28
  • 29. Capital Gains Tax Strategies Unrelated Party Installment Sales – Deferred Sales Trust Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 29
  • 30. Capital Gains Tax Strategies Unrelated Party Installment Sales – Deferred Sales Trust Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 30
  • 31. Capital Gains Tax Strategies Unrelated Party Installment Sales – Deferred Sales Trust Legal Issues: 1. Must read all the contracts between taxpayer and the DST company. Does the taxpayer understand the power that is being handed to the DST company? The answer is usually “no.” However, without that power, tax problems arise. 2. Are the DST company’s on-going fees appropriate, e.g., 1.25%? 3. Are the sales proceeds safe? 4. Does the taxpayer expect to have investment control over the proceeds? If so, does that vitiate the independence of the DST company for tax purposes? 5. Does the taxpayer expect to be able to borrow from the trust? Ditto. 6. Does the taxpayer expect to be able to “call” the loan? If the taxpayer cannot do so, what happens if the taxpayer unexpectedly runs into financial problems? 7. Is the installment note protected from creditors? Not if the seller holds onto it. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 31
  • 32. Capital Gains Tax Strategies Unrelated Party Installment Sales – Deferred Sales Trust Tax Issues: 1. Is the DST company the seller’s agent? That probably depends upon the terms of the contract between the taxpayer and the DST company. The stronger the contract (in terms of making sure that the DST company is not the taxpayer’s agent), the more uncomfortable the taxpayer is going to be in terms of the security of the sales proceeds. So it is a push-pull problem. 2. Is the transaction a sham? For this we must look not only to the terms of the contract, but to the reality of the custody and control of the funds. 3. Does the transaction have economic substance? Should it be disclosed (Form 8275)? 4. Does this seem too much like the PATs (private annuity trusts) that were heavily marketed 10 years ago, causing the IRS to change the regulations on October 18, 2006? We now know, if we did not know previously, that the IRS reads the internet and knows how to use Google. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 32
  • 33. Capital Gains Tax Strategies Unrelated Party Installment Sales – “C453 Transaction” Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 33
  • 34. Capital Gains Tax Strategies Section 1031 Exchanges In 2013 Section 1031 (in one form or another) has been in the Internal Revenue Code since 1921. With a 60% higher capital gains tax rate, it is more attractive than before. Since it can eliminate the 3.8% surtax on passive investment income, it is more attractive than before. Why does it seem that fewer Section 1031 exchanges are being consummated in 2013 than previously? There may be several reasons. First, people have been shaken by the real estate debacle that followed the Lehman Brothers crash. Those that are selling may not wish to remain invested in real property. Also (a more traditional objection to an exchange), many of those that are invested in real property do not wish to trade a property they already know for one that they do not know. Second, many people experienced bad results with Section 1031 exchanges in the past two decades. Due to the 45 and 180 day requirements, despite the availability of deferred exchanges, many people have been rushed into acquiring replacement properties with which they were later unhappy. Third, many people feel that the market has already been overpriced. So even though they get attractive offers for their own properties, they see nothing attractive to buy. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 34
  • 35. Capital Gains Tax Strategies NNGs A Nevada Non-Grantor Trust (sometimes called a Nevada incomplete gift non-grantor trust – NING) are touted for asset protection planning and for saving state income tax. Every state is, of course, different when it comes to the taxation of trusts. California taxes trusts based on the residence of the (i) trustees and (ii) beneficiaries. Rev. & Tax. Code Section 17742. However, in determining who is a “beneficiary,” California ignores a beneficiary whose interest is “contingent.” “A resident beneficiary whose interest in a trust is subject to the sole and absolute discretion of the trustee holds a contingent interest in the trust.” FTB TAX 2006-0002. How is this used? Mom and Dad, California residents, have stock in a publicly traded company with a fair market value of $1,000,000 with a basis of zero. They transfer the stock to a NNG with a Nevada trustee. There are three beneficiaries: the American Cancer Society; and Son and Daughter. The Trustee has complete discretion as to distributions of principal and income. Mom and Dad have the right to remove the trustee and name a new one subject to the limits of IRC Section 672(c). In years 1 – 5 the Trustee distributes $5,000 to the American Cancer Society and nothing to Son and Daughter. In year 6 the stock is sold and the trust owes no California tax. No California tax is owed until distributions are, in fact, paid to California beneficiaries. If, at the time of distribution, Son and Daughter are living in Florida, Texas, Nevada, etc., there will be no state tax. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 35
  • 36. Capital Gains Tax Strategies IRC Section 453A – The $5,000,000 Restriction (a) General rule. (a) In the case of an installment obligation to which this section applies— (1) interest shall be paid on the deferred tax liability with respect to such obligation in the manner provided under subsection (c)… (b) Installment obligations to which section applies. … (2) Special rule for interest payments. For purposes of subsection (a)(1), this section shall apply to an obligation described in paragraph (1) arising during a taxable year only if— (A) such obligation is outstanding as of the close of such taxable year, and (B) the face amount of all such obligations held by the taxpayer which arose during, and are outstanding as of the close of, such taxable year exceeds $5,000,000. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 36
  • 37. Capital Gains Tax Strategies IRC Section 453A – The $5,000,000 Restriction Does it make sense to exceed the $5,000,000 per person ($10,000,000 per couple) installment note when doing this type of transaction? Currently the interest rate on underpayments is 3%, so if H&W do a $20,000,000 note in California they will owe ($20,000,000 - $10,000,000 = $10,000,000 is the excess X 37.1% tax = $3,710,000 X 3% interest rate = ) $111,300 per year in interest. Do clients do this (exceed the Section 453A limit)? Some do because they feel that they can make more on the money that would otherwise be paid in tax than two times the interest (since it is non-deductible). Certainly many engage in transactions for double the Section 453A limit because they rationalize that at $10,000,000 per person the effective interest rate is only 1.5% on the tax. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 37
  • 38. Capital Gains Tax Strategies What Is The “Assignment Of Income Doctrine”? U.S. Supreme Court Justice Oliver Wendell Holmes in Lucas v. Earl, 281 U.S. 111 (1930): “The case presents the question whether the respondent, Earl, could be taxed for the whole of the salary and attorney’s fees earned by him…or should be taxed for only a half of them in view of a contract with his wife…. There is no doubt that the statute could tax salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skillfully devised to prevent the salary when paid from vesting even for a second in the man who earned it. That seems to us the import of the statute before us and we think that no distinction can be taken according to the motives leading to the arrangement by which the fruits are attributed to a different tree from that on which they grew.” Under the anticipatory assignment of income doctrine, once a right to receive income has “ripened” (into fruit) for tax purposes, the taxpayer who earned or otherwise created that right, will be taxed on any gain realized from it, despite the fact the taxpayer has transferred the right before actually receiving the income. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 38
  • 39. Capital Gains Tax Strategies Assignment Of Income Doctrine: The Scary Ferguson case, 174 F3d 997 (1999) Shareholders who donated stock to charities were taxable under the anticipatory assignment of income doctrine on gain realized on the later sale of that stock by the charities pursuant to a tender offer pending at the time of the gifts. The stock was converted from an interest in a viable corporation to a fixed right to receive cash before the date of the gifts. Although the merger agreement was not formally approved before the gifts were made, the right to merger proceeds matured on the date when more than 50% of the outstanding shares of stock had been tendered; that was all that was needed for the merger agreement to be approved. The taxpayers relinquished control of the stock and completed their charitable gifts when they later executed final letters of authorization for the transfer. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 39
  • 40. Capital Gains Tax Strategies Assignment Of Income Doctrine: The Scary Ferguson case, 174 F3d 997 (1999) “In the present case, the Tax Court determined that the realities and substance of the ongoing tender offer and the pending merger agreement indicated the AHC stock already had ripened from an interest in a viable corporation into a fixed right to receive cash, by 8/31/88 - the first date by which over 50% of the AHC shares had been tendered. To wit, the Tax Court determined that by 8-31-88, it was practically certain that the tender offer and merger would be completed successfully and that all AHC stock, even untendered stock, either already had been converted into cash (via the tender offer) or imminently would be (via the merger).” Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 40
  • 41. Capital Gains Tax Strategies Assignment Of Income Doctrine: The Scary Ferguson case, 174 F3d 997 (1999) “…the Fergusons note that the logic of the Tax Court’s decision implies that their AHC stock already might have ripened by some date even earlier than 8-31-88. In essence, they note that there is no clear line demarcating the first date upon which a taxpayer’s appreciated stock has ripened into a fixed right to receive cash pursuant to a pending merger. However, from the taxpayers' perspective, walking the line between tax evasion and tax avoidance seems to be a patently dangerous business. Any tax lawyer worth his fees would not have recommended that a donor make a gift of appreciated stock this close to an ongoing tender offer and a pending merger, especially when they were negotiated and planned by the donor. … Therefore, we will not go out of our way to make this dangerous business any easier for taxpayers who knowingly assume its risks. ” Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 41
  • 42. Capital Gains Tax Strategies Assignment Of Income Doctrine: Practical Ferguson is an extreme case. Rauenhorst, 119 T.C. 157 (2002) returned to Rev. Rul. 78-197 which provides that, in the case of a charitable contribution of stock, the IRS will treat sales proceeds as income to the donor only if at the time of the gift the donee is legally bound or can be compelled to sell the shares. Therefore, there are 3 ways in which your client may have gone "too far," is legally obligated to sell, and must thus recognize the gain on the sale: (1) signed a binding Letter of Intent ("LOI"); (2) has a written Agreement; and/or (3) has entered into a binding oral contract. Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 42
  • 43. Capital Gains Tax Strategies Charitable Lead Annuity Trust Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 43
  • 44. Capital Gains Tax Strategies Charitable Lead Annuity Trust Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 44
  • 45. Capital Gains Tax Strategies Charitable Lead Annuity Trust Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 45
  • 46. Capital Gains Tax Strategies Charitable Lead Annuity Trust Givner & Kaye,  A Professional Corporation Bruce@GivnerKaye.com 46

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