CPAs and Consultants
Estate planning for unmarried
couples


Brian Whitlock, Partner, CPA, JD, LLM


M 27, 2009
 ay
Overview


    • W im
       hy portant to your practice


    • Non-tax Issues

    • Incom Gift, and Estate Tax Issues
 ...
IRS Circular 230

    This written advice is not intended or written to be used,
     and cannot be used by any taxpayer, ...
Part 1: Importance of Unmarried
    Couples in Your Practice




5
Dem  ographics: Increasing % of
    the Population




6
Part 2: Non-tax problems particular
    to unmarried couples




7
Problems particular to unmarried
    couples

    • No automatic recognition of legal rights (as enjoyed by
      married ...
Federal Statutes


      Defense of M   arriage Act - Sam sex couples ineligible
                                      e
 ...
Non-recognition of Spousal Rights
     in M States for Unm
         ost               arried
     Couples
     •




     ...
Lack of Spousal Rights:
     Docum  entation and
     record keeping needed
       Personal Issues
         – Health Care ...
Death Considerations


     •Will
        – A public docum ent
        –“ Speaks at death” Probate
                       ...
Death Considerations

     •Revocable Trust
        – A private document
        – No Probate Court appointm or supervisio...
Asset Protection Strategies

     •Lim Gift and Estate Tax Exposure
         it
     •Protect assets from Business Credito...
Part 3: Tax problems particular to
     unmarried couples




15
Tax Considerations involving
 unequal wealth of unm arried couples


     •Starting a Relationship - Gift Tax

     •Opera...
Starting a Relationship

     •Question: Have you made a taxable gift
      when..?
        – Acquire Assets together
    ...
Gift Tax Problems for
     Unmarried Couples

     • Planning required to avoid unintended taxable gifts
         IRS does...
Incom Tax Problem for
       e             s
  Unm arried Couples

 •Joint Returns not available under Federal law
     – ...
The invisible elephant in
     the house: unequal
     shared living expenses
     • Issue: disproportionate sharing of li...
On Title and Paying Expense
     - Options

     Inc o me Tax Tre atme nt
     • Interest Expenses and Real Estate Taxes
 ...
Not on Title and Paying
     Expense - Options

     Tre atme nt as a Re ntal Arrang e me nts - Inc o me

     • Could be ...
Not on Title and Paying
     Expense - Options

     Treatm as a Rental Arrangem
           ent                  ents -
  ...
Not on Title and Not Paying
      Expense - Options

     Taking Care of Hom or Kids
                       e
     • Title...
Som Incom Tax Potential
     e     e
  Benefits

 •Double the Section 179 im ediate expense
                           m
 ...
Incom Tax Planning
          e


     Reduce disparity by sharing or shifting income
     • Gift/Transfer incom producing ...
Strategies to Minim the Gift Tax
                        ize

     •Annual exclusion $12,000 per year per donee
     •Educ...
Strategies to M inimize
     the Gift Tax (continued)

     •Joint Bank Account
       – Gift is com  plete when other par...
Dealing w the Gift Tax
               ith
     Limitations

     • Replace Cash Gifts w Secured Loans
                    ...
Incom Tax
      e
 Considerations

     Eligibility for the Dependency Exemption
        – M be Citizen, resident alien, o...
Practical Considerations for
     em ployee benefits

      •Medical Insurance
         – Dom estic Partners not always co...
Planning Opportunities for
 Em ployee Benefits

     • General Partner or Managing m ber
                                 ...
Beginnings and Endings

     In Illinois, “
                  Cohabitation”  can term inate of maintenance
        paym   ...
Part 4: Asset transfer techniques
     for unmarried couples




34
Estate Tax Considerations


     • Credit Shelter –$2M in 2008 ($3.5M in 2009)
                          M              M
...
Estate Tax - Exclusions


     • Incom Interests that expire at death
            e
         – Life Estate in Real Estate ...
Estate Tax – Inclusion Traps


     • Retained Interests
        –   Section 2035 [certain transfer w ithin 3 years of dea...
Terminable Interest
     Property Trusts

     • Beneficiary of Trust has a right to enjoy the incom e
       and principa...
Life Insurance
     • Protect surviving partner and young children
        – Replace incom stream
                        ...
Life Insurance Issues –
     2 Year Contestability

     • Insurable Interest
        –M  arriage presum an insurable inte...
Viatical Settlements

     • Purpose to help terminally and/or chronically ill
        – Section 101(g) adopted in 1996
  ...
Irrevocable Life Insurance Trusts

     • Trust is funded w gifts
                        ith
         – Annual Premium Do...
Transfer Scenario
             Joe (age
                                              Jan (age 30)
             59) create...
Gift or Transfer at Death
             Joe (age
                                                  Jan (age 30)
           ...
Life Insurance (The “Private ” Gift)
             Joe (age
                                                Jan (age 30)
  ...
Utilizing leveraged
     techniques to
     m axim gifts
             ize
      – Gifts to Dynasty Trusts
      – Grantor ...
Utilizing leverage
     techniques to
     m axim gifts
             ize
     (continued)
     Estate freeze Rules of Chap...
Chapter 14 – Definition of
     “Applicable Family Members”
     excludes domestic partners
                              ...
Grantor Retained Incom Trust
                           e
             Joe (age
                                          ...
Grantor Retained Incom Trust
                           e
             Joe (age
                                          ...
Grantor Retained Annuity Trust
              Joe (age 59)
                                                          Jan (a...
Grantor Retained Annuity Trust

             Joe (age 59)                                  Jan (age 30)
             creat...
Charitable Lead Annuity Trust
             Joe (age
                                                      Jan (age 30)
   ...
Charitable Lead Annuity Trust
             Joe (age
                                                        Jan (age 30)
 ...
Structuring Co-ownership

     • Types
         –   Tenancy in Com onm
         –   Joint Tenancy w Rights of Survivorship...
Structuring Split Interests

     • Split Interest Purchase
         – Avoid retained interest by having each party com to...
Discount vehicles


     • Best assets m be the assets w the highest rates of
                       ay           ith
    ...
Gifts to Irrevocable Trusts
     • Section 2503(b) –“Present Interest”
     • Clifford Crum ey v. Com issioner
           ...
Situation #2 - Before Tax Planning



 Joe’ estate w
     s        ithout Joe’
                        s   Jon’ estate w
 ...
Situation #2 –Step A: Shrink the
     Value
                       Exchange old stock
                        for NewCom o...
Situation #2 –Step B Gift Com on
                                   m
      Keep Preferred



                          Co...
Situation #2 –“
                   Preferred Stock
     Recap” Stock Freeze
             –

                         Joe’ ...
Situation #3 Before Tax Planning

 Joe’ estate w
     s        ithout      Jon’ estate
                              s
  J...
Situation #3 - Sale to an IDIOT
     The Seed M  oney
              Joe creates
              trust and        Granto r Tr...
Situation #3 Sale to IDIOT –IDIOT
     should be w orth 10% of Purchase
                 Transfer      De fe c tive
      ...
Situation #3 –Im ediately After
                     m
     Note Exchange
                           De fe c tive
        ...
Situation #3 –at Date of Joe’
                                 s
     Death
                                   De fe c tiv...
Alternatives to Sale to a
     Defective Grantor Trust

     • Self-Canceling Installm Note –(SCIN)
                      ...
Conclusion

     • Personal Issues and Objectives of client
     •M  inim value
             ize
     • Transfer Value Kee...
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Income and Estate Tax Planning for Unmarried Couples and Same Sex Partners

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Tax Planning For Unmarried Couples

  1. 1. CPAs and Consultants
  2. 2. Estate planning for unmarried couples Brian Whitlock, Partner, CPA, JD, LLM M 27, 2009 ay
  3. 3. Overview • W im hy portant to your practice • Non-tax Issues • Incom Gift, and Estate Tax Issues e, • Asset transfer techniques 3
  4. 4. IRS Circular 230 This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code. 4
  5. 5. Part 1: Importance of Unmarried Couples in Your Practice 5
  6. 6. Dem ographics: Increasing % of the Population 6
  7. 7. Part 2: Non-tax problems particular to unmarried couples 7
  8. 8. Problems particular to unmarried couples • No automatic recognition of legal rights (as enjoyed by married couples). • Easier to exit relationship than a marriage (e.g. no divorce or legal separation) 8
  9. 9. Federal Statutes Defense of M arriage Act - Sam sex couples ineligible e for tax preferences and other rights enjoyed by m arried couples under Federal Law s • Internal Revenue Code (IRC) • Em ployee Retirem Incom Security Act (ERISA) ent e • Consolidated Om nibus Budget Reconciliation Act (COBRA) • Fam Mily edical Leave Act • Social Security Act (SSA) •M edicare Act 9
  10. 10. Non-recognition of Spousal Rights in M States for Unm ost arried Couples • Source: Hum Rights Cam an paign RELATIONSHIP RECOGNITION IN THE US, updated 01/11/2008 10
  11. 11. Lack of Spousal Rights: Docum entation and record keeping needed Personal Issues – Health Care Pow of Attorney for dealing w ers ith HIPAA – Directive for the Disposition of Remains – Custody of M inors •Property Issues (co-ownership and transfer) – Pre-Nuptial Agreem ents – Co-Habitation Agreem ents – Dom estic Partnership Agreements (Not Legally recognized in som states) e – Business Partnership Agreem ents – Trusts vs. W in creating a sustainable estate plan ills 11
  12. 12. Death Considerations •Will – A public docum ent –“ Speaks at death” Probate via – Nom inates Executor and/or Guardian over Minor kids – W override “ ills Lawof Intestate succession” • Spouse/children (adopted children sam as natural) e • Parents/Siblings • Grandparents/Cousins – If W is challenged in Probate default is state statute ill • Gay and Lesbian persons are often estranged from families • Incentive for Biological Fam to Challenge W ily ill • Adoption m be a stronger option than guardianship ay 12
  13. 13. Death Considerations •Revocable Trust – A private document – No Probate Court appointm or supervision required ent • Trustee is nam in docum not by court ed ent • Trustee is subject to fiduciary duty not routine supervision • Stronger than Guardian for M inor Child • Not subject to Probate (Johnson v. LaGrange State Bank) •Irrevocable Trust – A private docum ent – Generally not subject to Probate – Taxable w hen gift com pleted to Trust, if no retained interest 13
  14. 14. Asset Protection Strategies •Lim Gift and Estate Tax Exposure it •Protect assets from Business Creditors •Protect assets upon Term ination of Relationship – Pre-Nuptial and Partnership Agreem ents – Loans secured by a m ortgage – Term inable Interest Trusts – Flexible Irrevocable Trusts (Trust Protectors) – Split Interests (Chapter 14 Exem Transfers) pt – Lim ited Partnerships and Lim ited Liability Com panies 14
  15. 15. Part 3: Tax problems particular to unmarried couples 15
  16. 16. Tax Considerations involving unequal wealth of unm arried couples •Starting a Relationship - Gift Tax •Operation and Dissolution - Incom Tax e •Death - Estate Tax 16
  17. 17. Starting a Relationship •Question: Have you made a taxable gift when..? – Acquire Assets together – Share Living Expenses – Change the title on an asset •No Spousal exclusion or ability to split gifts 17
  18. 18. Gift Tax Problems for Unmarried Couples • Planning required to avoid unintended taxable gifts IRS does not need to prove donative intent (see 25.25 11-1(g)(1)) •A“ Gift” a transfer for less than full and adequate is consideration w ithout legal obligation to repay •“ Love” and “ affection” not consideration under IRC are Treasury Regulation Section 25.25 12-8 • Transfer could be exem if it fulfills a local legal pt obligation, such as providing for a child or an incapacitated adult [Hooke r, 10 TC 388 (1948) , aff‘d 37 AFTR 1530 (CA5, 1949); Re v. Rul. 54-343; Conv e rs e , 5 TC 1014 (1945) ]. Generally not so for a healthy adult. 18
  19. 19. Incom Tax Problem for e s Unm arried Couples •Joint Returns not available under Federal law – Tax Tables – Dependency and Exclusions •Gross Incom or Gift e – “ Incom from w All e hatever source derived” •Sharing or Allocating Tax Deductions – General Rule: He (or she) w pays m deduct ho ay •M ortgage Interest - payer m be on title and m ust ortgage (§163) • Real estate taxes –payer m be on title (§164) ust • Charitable Contributions (§170) 19
  20. 20. The invisible elephant in the house: unequal shared living expenses • Issue: disproportionate sharing of living expenses • Questions: Incom Deduction, Gift e, • The m luxurious the lifestyle, the m exaggerated ore ore the issue • View issue from tw perspectives o – On Title or Not on Title – Paying expenses or not paying share of expenses 20
  21. 21. On Title and Paying Expense - Options Inc o me Tax Tre atme nt • Interest Expenses and Real Estate Taxes – Deductions generally allow to title holder ed •Maintenance and other Expense – Household help not Incom Tax deductible e – Could be eligible for Child and dependent Care (limits) Gift Tax Tre atme nt • Absent as support obligation could be deem a gift ed • Suprem Court Dissent in Interest Free Loan Cases e 21
  22. 22. Not on Title and Paying Expense - Options Tre atme nt as a Re ntal Arrang e me nts - Inc o me • Could be Rental incom to Title Holder e – Definition of gross incom is expansive (IRC Section 6 e 1). • Reim bursem of expenses for som ent eone else has been ruled to be included in gross incom (For exam e ple, see Old Colony Trus t Co. v. CIR, 279 US 716 (1929)). 22
  23. 23. Not on Title and Paying Expense - Options Treatm as a Rental Arrangem ent ents - Deductions • Section 280A vacation hom rule lim e itations – Apply w hen ow lives in hom w tenant ner e ith – Lim deductions to rental incom it e –M ortgage interest and property taxes are subtracted first • Belowmarket rental arrangements – Risk treatm as Gift ent – Lack of profit motive –IRS Section 183 –denial of loss and subject to 2% item ized deduction limitations 23
  24. 24. Not on Title and Not Paying Expense - Options Taking Care of Hom or Kids e • Title Holder need not report the rental incom in e exchange for service (Helvering v Independent Life Ins Co., 54 S Ct 758). • Deem incom to non-title holder under IRC Section 61 ed e • Barter or Paym ents in-kind • Household Em ployee taxable on incom e • Con: Tax w ithholding could be required • Pro: Em ployee Benefits possible 24
  25. 25. Som Incom Tax Potential e e Benefits •Double the Section 179 im ediate expense m election for the couple. •Wash sale rules not applicable (§ 1091) – Sell Losers to Partner – Sell Loser and Dom estic partner buys back within 30 days 25
  26. 26. Incom Tax Planning e Reduce disparity by sharing or shifting income • Gift/Transfer incom producing assets to partner e • Em ployee in operating business • Form a partnership or LLC – Nam low incom partner as GP or m e er e anaging m ber em – Grant m anager an incom interest (Sol Diam e ond v. Com .) in exchange for m m anagem services –w ent atch RP 93-2 (defined and certain incom stream can be 7 e valued) • Create a Freeze Partnership w preferential return ith Chapter 14 does not apply • Create a Personal Holding Com pany for portfolio assets and em ploy dom estic partner to m anage 26
  27. 27. Strategies to Minim the Gift Tax ize •Annual exclusion $12,000 per year per donee •Educational and m edical expenses –Section 2035(e) •Interest free loans $10,000/$100,000 - Section 7278 •Use $1 M illion lifetim applicable exclusion e 27
  28. 28. Strategies to M inimize the Gift Tax (continued) •Joint Bank Account – Gift is com plete when other party withdraw funds s – Docum deposits and w ent ithdraw to avoid gift als •Real Estate – Joint tenancy grants im ediate rights to partition m – Avoid Gift w a w ith ritten agreement • Partnership Agreem or LLC is safer option ent • Label as a business or investm arrangem ent ent • Agreem should cover Sharing of expenses ent 28
  29. 29. Dealing w the Gift Tax ith Limitations • Replace Cash Gifts w Secured Loans ith – Cash is Dangerous –Hard to get back – Purchase of residence in Joint Tenancy risks loss of one- half – Child living w partner, rather than gift dow paym lend ith n ent the dow ns-paym and take subordinated m ent ortgage debt • Replace Cash Gifts w Restricted Property ith – Transfer value –keep control • Place liquid/incom producing assets inside of an control entity e • Gift restricted interest in S Corporation, FLP or LLC • Gift Term inable Interest • Gift assets to trust rather than outright – Part 4 –other transfer techniques 29
  30. 30. Incom Tax e Considerations Eligibility for the Dependency Exemption – M be Citizen, resident alien, or citizen of M ust exico or Canada(152(b)(3)) – M live w the taxpayer (152(d)(1)(A) and 2(h)) ust ith – Gross Incom not over $3,400 in 200 $2,500 in 2008 e 7; (152(d)(1)(B)) – Support > 50% (152(d)(1)(C) – Relationship m not violate local law(152(f)(3)) ust – If Dependant, m not file Joint w legal spouse (152(b)(2)) ay / •Shared Filing Issues – W claim eligibility for Head of Household? ho s – W claim dependency exem ho s ption for Minors? 30
  31. 31. Practical Considerations for em ployee benefits •Medical Insurance – Dom estic Partners not always covered – Prem s for Partner’ coverage is taxable if not a ium s dependent – No COBRA coverage, if job loss – No M edicare coverage for Dom estic partner – Custody of M inors •Long Term Care Insurance •Social Security Benefits •Retirem benefits ent •Death Benefits 31
  32. 32. Planning Opportunities for Em ployee Benefits • General Partner or Managing m ber em – Generally Subject to Social Security – Forty Quarters of W history w earn M ork ill edicare Eligibility • Employ Partner in operating business or PHC • Employ Dom estic Partner in Schedule C or Household – Medicare Eligibility – Medical Insurance can be provided as a benefit – Social Security Benefits – Retirem benefits ent 32
  33. 33. Beginnings and Endings In Illinois, “ Cohabitation” can term inate of maintenance paym ents in a divorce [750 ILCS 5/510(c)]. The courts typically exam the follow factors: ine ing 1. The length of the relationship. 2. The am ount of tim the couple spends together. e 3. The nature of the activities engaged in. 4. The interrelation of their personal affairs. 5. Whether they vacation together, and 6. Whether they spend holidays together. In Re Marriag e of S now , Appellate No. 3-00-0369, 3rd District, filed June 14, 2001. 33
  34. 34. Part 4: Asset transfer techniques for unmarried couples 34
  35. 35. Estate Tax Considerations • Credit Shelter –$2M in 2008 ($3.5M in 2009) M M • No Marital Deduction for unmarried couples OBSERVA TION: It is just as important as for m arried clients to avoid w asting exem ption am ount and potential double estate tax as unm arried clients 35
  36. 36. Estate Tax - Exclusions • Incom Interests that expire at death e – Life Estate in Real Estate (I.e., a residence or vacation hom e) • Limited Pow of Appointm ers ent • Death Benefits paid to irrevocable beneficiary – Estate of Schelberg v Com . m •“Term inable Interest Property” trusts • Charitable Split Interest Trusts 36
  37. 37. Estate Tax – Inclusion Traps • Retained Interests – Section 2035 [certain transfer w ithin 3 years of death] – Section 2036 [right to enjoy incom or benefit] e – Section 2038 [revocable transfers] – Section 2039 [annuities] • Incidents of Ownership over Life Insurance (Section 2042) – Right to Borrowcash value – Right to Change Beneficiary • General Pow of Appointm (Section 204 ers ent 1) 37
  38. 38. Terminable Interest Property Trusts • Beneficiary of Trust has a right to enjoy the incom e and principal of the trust, but that right w term ill inate at death or e nd of re lations hip – No need for the trust to qualify for the marital deduction – No need to include the value of the trust in the taxable estate of the survivor • If beneficiary has Limited Pow of Appointm er ent, the assets of the trust m be exem from the claim of ay pt s the beneficiary’ creditors s • Use Trust Protector to add a beneficiary or change trust 38
  39. 39. Life Insurance • Protect surviving partner and young children – Replace incom stream e – Pay off Mortgage and debts • Replace Wealth lost to Estate Tax payment • Advantages: – Death benefit is free of Incom Tax e – Death benefit is free of Estate Tax if beneficiary is owner • Issues: – Source of Annual Prem ium Dollars – If paid indirectly by insured represents a gift – M have an Insurable Interest ust 39
  40. 40. Life Insurance Issues – 2 Year Contestability • Insurable Interest –M arriage presum an insurable interest in one’ es s spouse –Issue is only relevant at day of issue –Create partnership for hom ow e nership w buy ith sell funding –Docum shared expenses and support for ent econom interest ic –Ow nership and beneficiary gift trap 40
  41. 41. Viatical Settlements • Purpose to help terminally and/or chronically ill – Section 101(g) adopted in 1996 – Allow insured ability to factor death benefit receivable to s cover health care and long term care costs – Insured m be term ust inally ill or chronically ill •Market currently offers much broader applications – Funds created to purchase w range of policies ide – Buyer (fund) w lose Section 10 incom exclusion ill 1 e • Rather than allow a policy lapse or rolling over ing policy yourself, consider selling the policy 41
  42. 42. Irrevocable Life Insurance Trusts • Trust is funded w gifts ith – Annual Premium Dollars – Incom Producing Property e • Real Estate • FLP or LLC Interest • S Corporation Stock • Trustee of Irrevocable Trust ow policy ns – Insured has No Incidents of ownership – Death benefit excluded from taxable estate • Trust should be a Terminable Interest Trust – Asset Protection – Generation Skipping Provisions • Trust Protector feature can provide flexibility 42
  43. 43. Transfer Scenario Joe (age Jan (age 30) 59) creates Jo e wis he s to trust and le ave $ 5 MM to keeps right Jan to all incom for e 30 year Joe’ estate = s $20M M 43
  44. 44. Gift or Transfer at Death Joe (age Jan (age 30) 59) creates Jo e wis he s to trust and le ave $ 5 MM to keeps right Jan to all incom for e 30 year Joe’ estate = s $20M M Tax on $5,000,000 at 45% would be $2.25M before gift or estate M tax credit offset. 44
  45. 45. Life Insurance (The “Private ” Gift) Joe (age Jan (age 30) 59) gifts Jo e wis he s to cash to le ave $ 5 MM to purchase a Jan 20 year level term policy on his Joe’ estate = s life $20M M Tax on annual premium paym in excess of $12,000 annual ent exclusion once cumulative total exceeds $1M . M 45
  46. 46. Utilizing leveraged techniques to m axim gifts ize – Gifts to Dynasty Trusts – Grantor Retained Incom Trusts (GRITs) e – Qualified Personal Residence Trusts (QPRTs) – Grantor Retained Annuity Trusts (GRA Ts) – Split Purchase – Voting and Non-voting Equity Interests – Intentionally Defective Incom Only Trusts (IDIOTs) e – Charitable Rem ainder Trusts (CRA and CRUTs) Ts – Nonqualified GRITs or GRA Ts 46
  47. 47. Utilizing leverage techniques to m axim gifts ize (continued) Estate freeze Rules of Chapter 14 – only apply to “applicable fam ily m bers” spouses, lineal em fam m bers of ow ily em ners or spouses, and adopted children. Does not apply to dom estic partners. – Sec 270 and 2702 for zero value of retained interests 1 in corporations, partnerships and trusts for transfers involving fam m bers ily em – Sec 2703 for zero value of certain rights and restrictions disregarded for fam m bers ily em – Sec 2704 for zero value of certain lapsing rights and restrictions 47
  48. 48. Chapter 14 – Definition of “Applicable Family Members” excludes domestic partners SPOUSE HAS Unm arried SAME friend or LIMITATION dom estic ON SAME partner MOM DAD FAMILY MEMBERS YOU BROTHER SISTER NEPHEW NIECE SON DAUGHTER 48
  49. 49. Grantor Retained Incom Trust e Joe (age Jan (age 30) 59) creates trust and Jo e wis he s to keeps right le ave $ 5 MM to to all Jan incom for e 25 years Joe’ estate = s $20M M Joe transfers $5M to GRIT keeps right to receive incom for 24 M e years. Regardless of the actual incom earned and paid by the trust e to Joe, the value of the gift is reduced by the present value of the right to receive incom m e easured at the current Section 7520 Rate of 3.2% (44.68%) and the risk that Joe w die during the term ill selected (35.6%). The Present Value of this Future Interest gift is $917,200. 49
  50. 50. Grantor Retained Incom Trust e Joe (age Jan (age 30) 59) creates trust and Jo e wis he s to keeps right le ave $ 5 MM to to all Jan incom for e 25 years Joe’ estate = s $20M M M 2006 –Section 7520 Rate 5.8%, the value of the gift is reduced ay by the present value of the right to receive incom w e, hether or not actually earned, at the current Section 7520 Rate (62.366%) and the risk that Joe w die during the term selected ill (27.786%). Present Value of Future Interest Gift $492,400. 50
  51. 51. Grantor Retained Annuity Trust Joe (age 59) Jan (age 30) creates trust and keeps right Jo e wis he s to to 5.802% per le ave $ 5 MM to year (Quarterly) Jan for 25 years Joe’ estate = s $20M M Section 7520 Rate 3.2%, the value of the gift is reduced by the present value of the right to receive annuity (79.744%) and the risk that Joe w die during the term selected (21.255%). Present Value ill of Future Interest Gift $2.72. 51
  52. 52. Grantor Retained Annuity Trust Joe (age 59) Jan (age 30) creates trust and Jo e wis he s to keeps right to le ave $ 5 MM to 11.70373% per Jan year (Quarterly) for 10 years Joe’ estate = s $20M M Section 7520 Rate 3.2%, the value of the gift is reduced by the present value of the right to receive annuity (79.744%) and the risk that Joe w die during the term selected (21.255%). Present Value ill of Future Interest Gift $1.67. 52
  53. 53. Charitable Lead Annuity Trust Joe (age Jan (age 30) 59) creates trust – Jo e wis he s to charities le ave $ 5 MM to receive Jan 5.802% per year 25 years Joe’ estate = s $20M M Section 7520 Rate 3.2%, the value of the gift is reduced by the present value of the right to receive annuity (99.99%). Present Value of Future Interest Gift $395.23. 53
  54. 54. Charitable Lead Annuity Trust Joe (age Jan (age 30) 59) creates trust – Jo e wis he s to charities le ave $ 5 MM to receive Jan 11.70373% per year 10 years Joe’ estate = s $20M M Section 7520 Rate 3.2%, the value of the gift is reduced by the present value of the right to receive annuity (99.99%). Present Value of Future Interest Gift $395.23. 54
  55. 55. Structuring Co-ownership • Types – Tenancy in Com onm – Joint Tenancy w Rights of Survivorship ith – Tenancy by the Entirety (only available w Spouse) ith – Split Interest Purchase – M arried couples are assum to contribute 50% each. ed (Regulation 20.2040-1) • Unm arried owners need to prove survivor’ contribution s to exclude that portion from decedent’ estate. M s arried couples are assum to contribute 50% each (see ed regulation 20.2040-1). 55
  56. 56. Structuring Split Interests • Split Interest Purchase – Avoid retained interest by having each party com to the e purchase event w independent funds ith – Each party to purchase m have separate funds ust • Older generation purchases life estate or term interest • Younger generation (or trust) purchases rem ainder – Calculate the present value of the respective income interest and the remainder interest • Tw Variables Term of Years and AFR (Section 7520) o 56
  57. 57. Discount vehicles • Best assets m be the assets w the highest rates of ay ith return to the investor • Low the value of w you gift, by howit can be used er hat – Restriction on Use – Restricted stock – Buy Sell Agreem ent • Gifts of asset that lack marketability, constitute a minority interest or represent a lack of voting pow er – C Corporation (pays little or no dividend) – S Corporation Stock – Limited Partnership Interest – Limited Liability Company 57
  58. 58. Gifts to Irrevocable Trusts • Section 2503(b) –“Present Interest” • Clifford Crum ey v. Com issioner m m – Gift to Trustee of Trust – Donee beneficiary m have Pow to W ust er ithdrawgift – Notice generally required – Lapse of W ithdraw Pow (5x5 pow al er er) – Hanging Pow ers • Crum ey on Steroids m – Cristofani v. Com issioner (2 kids and 5 grandkids) m – Kohlsaat v. Com issioner (18 kids, grandkids and m spouses) • Supercharged Trusts – Intentionally Defective Incom Only Trusts (IDIOT) e – Section 6 through 6 (Grantor Type Trusts) 71 78 – Grantor (not the trustee) pays the incom taxes e 58
  59. 59. Situation #2 - Before Tax Planning Joe’ estate w s ithout Joe’ s Jon’ estate w s ithout business = $600,000 Joe’ business = s $200,000 Original com on = $10M m Total gross estate = $10.6M Joe’ business s value doubles from Jo e re c e ive s $10M to $20M all the c as h divide nds . 59
  60. 60. Situation #2 –Step A: Shrink the Value Exchange old stock for NewCom on m & Newpreferred Joe’ estate w s ithout Jon’ estate w s ithout Joe’ business = s Joe’ business = s $600,000 $200,000 Newcom on = $0M m Preferred stock Joe’ business s ($10M Liquidation value doubles from value plus dividend) $10M to $20M Total gross estate = $10.6M 60
  61. 61. Situation #2 –Step B Gift Com on m Keep Preferred Com on Gift = $0 m value because Joe’ estate w s ithout business is only w orth Jon’ estate w s ithout Joe’ business = s $2M . Joe’ business = s $600,000 Put option is allocated $200,000 full am ount Preferred stock Com on grow = m s (remains at $10M ) $10M all grow th inures to the Total gross estate = Com on m $10.6M 61
  62. 62. Situation #2 –“ Preferred Stock Recap” Stock Freeze – Joe’ business value s now= $2,000,000 In 10 year on Joe’ s Joe’ estate w s ithout death = $20,000,000 Jon’ estate w s ithout Joe’ business = s Joe’ business = s $600,000 $200,000 Preferred stock (up Com on = $10M m to $10M put option) Total gross estate = = $10M $10.2M Total gross estate = $10.6M W orks be s t w ith LLC or LP. Not e conomic to pay C Corporation div ide nds . 62
  63. 63. Situation #3 Before Tax Planning Joe’ estate w s ithout Jon’ estate s Joe’ business = s without Joe’ s $600,000 business = Joe’ business = s $200,000 $1M Total gross estate = $1.6M Joe receives all income distributions and appreciation 63
  64. 64. Situation #3 - Sale to an IDIOT The Seed M oney Joe creates trust and Granto r Trus t gifts $12K with Jo n as on 12/31/x1 be ne fic iary and $12k on 1/1 /x2 Joe’ estate s Jon’ estate s without Joe’s without Joe’ s business = business = $600,000 $200,000 Joe’ business value = $1,000,000 in Year 1; In 10 year on Joe’ s s death = $20,000,000. A 36.9% stake w ould be $369,000 m inus discounts of perhaps 35%. Discounted value $239,850. 64
  65. 65. Situation #3 Sale to IDIOT –IDIOT should be w orth 10% of Purchase Transfer De fe c tive note for Granto r $215,850 Trus t with + the Jo n as trust’ s be ne fic iary $24k seed $24,000 Jon’ estate s m oney for seed without Joe’ s 30% Joe’ s money buys business = business 36.9% of $200,000 Note: NOT a sale for stock incom tax purposes e because the defective grantor trust and Joe are treated as the sam e person for incom tax e return purposes 65
  66. 66. Situation #3 –Im ediately After m Note Exchange De fe c tive Granto r Trus t with Jo n as be ne fic iary 36.9% interest Joe’ estate w s ithout Jon’ estate w s ithout in business Joe’ business = s Joe’ business = s Note Payable $600,000 $200,000 $215,850 63.1% interest in business plus Note Receivable $215,850 In 10 year on Joe’ s Receive 100% of death = business is Incom distributions e w orth $20,000,000 until Note receivable is fully paid. 66
  67. 67. Situation #3 –at Date of Joe’ s Death De fe c tive Granto r Trus t with Jo n as be ne fic iary Joe’ estate w s ithout Interest in Jon’ estate w s ithout Joe’ business = s business $10M Joe’ business = s $600,000 $200,000 63.1% interest in Cash distributions business split between Joe and defective grantor trust. Joe and Jon’ business s value = $2,000,000 Versus Total In 10 year on Joe’ s gross estate = death = $20,000,000 $20.6M 67
  68. 68. Alternatives to Sale to a Defective Grantor Trust • Self-Canceling Installm Note –(SCIN) ent The installm note cancels at the date of the ow s ent ner’ death. Trade off that interest rate needs to be higher to com pensate for the additional risk. Could cause capital gain at death on unpaid balance of note. Frane • Private Annuity The paym is structured like an annuity and ent disappears at death. 68
  69. 69. Conclusion • Personal Issues and Objectives of client •M inim value ize • Transfer Value Keep Control • Chapter 14 available to help domestic partners 69

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