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Estate Planning For The Business Owner Updated 1 5 2011 For 2010 Tax Act


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This presentation reviews federal and Massachusetts estate tax laws and applies the law and valuation discounting concepts to the closely-held business owner, and reviews pre-sale/appreciation event estate tax minimization planning opportunities.

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Estate Planning For The Business Owner Updated 1 5 2011 For 2010 Tax Act

  1. 1. Business Owner Presentation Minimizing Taxes and Maximizing Legacies: Pre-Sale/Pre-Appreciation Event Planning Deborah Pechet Quinan, Esq. Lisa Weinstein Burns, Esq. Ruberto, Israel & Weiner PC Boston, Massachusetts 617-742-4200 This summary is presented for informational and educational purposes only, does not constitute legal advice, and can not be used for the purpose of avoiding tax penalties. Use of this summary does not create an attorney-client relationship and is not a substitute for legal counsel.
  2. 2. Minimizing Taxes and Maximizing Legacies: Pre-Sale/Pre-Appreciation Event Planning Table of Contents Introduction: Estate Tax Framework 1 Estate Plan Flowchart 8 Pre-Sale or Pre-Appreciation Event Planning 9 Valuation Discounts 12 Grantor Retained Annuity Trust 14 Generation-Skipping Trust 16 Charitable Remainder Trust 18 Appendix: Biographies 21 1 3 4 5 2 IRS Circular 230 Required Disclosure: The information contained in this presentation is to be used for educational purposes only, does not constitute legal advice, and can not be used for the purpose of avoiding tax penalties. Use of this summary does not create an attorney-client relationship and is not a substitute for legal counsel. 6 7 8
  3. 3. Introduction: Estate Tax Framework 1 “ How do I cut Uncle Sam out of my Will (or at least leave him the minimum possible)?”
  4. 4. Introduction: Estate Tax Framework <ul><li>TRA 2010 effective January 1, 2010 to December 31, 2012 </li></ul><ul><li>Key provisions 2011 & 2012: </li></ul><ul><ul><li>Unified $5M exemption for estate, gift and GST tax (indexed for inflation in 2012) </li></ul></ul><ul><ul><li>Top tax rate 35% (equals the top individual income tax rate) </li></ul></ul><ul><ul><li>Unused exemption of a deceased spouse is portable to the surviving spouse’s estate </li></ul></ul><ul><li>TRA 2010 “sunsets” in 2013 – pre-2001 law, including all pre-2001 transfer tax provisions, will be reinstated on January 1, 2013 if Congress does not act to reauthorize TRA 2010 (or to enact new legislation) by December 31, 2012 </li></ul><ul><ul><li>Pre-2001 law: </li></ul></ul><ul><ul><ul><li>Estate and gift tax exemption is $1M per person; top rate is 55% </li></ul></ul></ul><ul><ul><ul><li>GST exemption is approximately $1.35m; top rate is 55% </li></ul></ul></ul><ul><ul><ul><li>No portability </li></ul></ul></ul>2
  5. 5. The Federal Estate Tax Under Current Law <ul><ul><li>Taxable assets at death include the date of death value of the home, life insurance death benefit, retirement plan balance, and other assets. </li></ul></ul><ul><ul><li>Everyone can transfer up to their remaining estate tax exemption amount to their loved ones, outright or in trust, free of estate tax at death. (The exemption amount is reduced by certain gifts made during life.) </li></ul></ul><ul><ul><li>With proper planning the federal and state exemption amounts can be fully utilized in the estate of both spouses. For example, a $7M Massachusetts taxable estate under 2011 law can save about $600,000 in federal and state estate taxes at death if all assets are left in trust via a properly drafted estate plan. </li></ul></ul>3
  6. 6. Estate Planning Goals <ul><li>A well-crafted estate plan remains critical to accomplishing intergenerational wealth transfer goals while preserving family harmony. </li></ul><ul><ul><li>Determining how to treat children fairly in light of their known (present) and unknown (future) goals, capabilities and circumstances </li></ul></ul><ul><ul><li>Determining how to transfer wealth to younger generations without encouraging a sense of entitlement </li></ul></ul><ul><ul><li>Determining when and how children should have some access to funds </li></ul></ul><ul><ul><li>Determining how to accomplish charitable goals in a manner that involves the children and is integrated with the client’s non-charitable wealth transfer goals </li></ul></ul><ul><ul><li>And, most importantly, choosing appropriate fiduciaries to ensure the execution of a well-coordinated plan that does not disrupt family harmony </li></ul></ul>4
  7. 7. <ul><ul><li>Unlimited Federal Marital Deduction </li></ul></ul><ul><ul><ul><li>Married couples can transfer assets to each other free and clear of federal estate and gift tax during life and at death, as long as the receiving spouse is a U.S. citizen. </li></ul></ul></ul><ul><ul><ul><li>Trusts are generally used to minimize federal estate taxes and to utilize the marital deduction </li></ul></ul></ul><ul><ul><li>Unlimited Massachusetts Marital Deduction </li></ul></ul><ul><ul><ul><li>Married couples can transfer assets to each other free and clear of Massachusetts estate tax during life and at death as long as the receiving spouse is a U.S. citizen. </li></ul></ul></ul><ul><ul><ul><li>Use of trusts to accomplish this is critical to minimizing Massachusetts estate taxes. </li></ul></ul></ul><ul><ul><li>$5,000,000 Gift Tax Exemption </li></ul></ul><ul><ul><ul><li>Allows each person to transfer $5M free of gift tax during his or her lifetime </li></ul></ul></ul><ul><ul><li>$13,000 Annual Exclusion </li></ul></ul><ul><ul><ul><li>Allows each person to give up to $13,000 annually to anyone free of gift tax, before utilizing the $5M exemption amount described above. This is scheduled to increase for inflation from time to time. </li></ul></ul></ul>Estate & Gift Tax Facts 5
  8. 8. The Separate Massachusetts Estate Tax Year Massachusetts Federal 2004: $ 850,000 $ 1,500,000 2005: $ 950,000 $ 1,500,000 2006–2008: $ 1,000,000 $ 2,000,000 2009: $ 1,000,000 $ 3,500,000 2010-2012: $1,000,000 $5,000,000* 2013: $1,000,000 unkown** Massachusetts exempt amounts differ from federal amounts and if estate exceeds exempt amount, tax is assessed on entire Massachusetts estate: Massachusetts estate tax due at first spouse’s death if no separate Massachusetts QTIP election is made and if full federal exemption is used: 2003: $ 33,200 2004–2005: $ 64,400 2006–2008: $ 99,600 2009: $ 229,200 2010-2012: $ 391,600 * Indexed beginning in 2012 ** TRA 2010 “sunsets” at end of 2012; law reverts to pre-2001 status unless Congress acts
  9. 9. The Separate Massachusetts Estate Tax <ul><li>The Massachusetts legislature adopted a new estate tax by “decoupling” the Massachusetts estate tax from the federal estate tax. </li></ul><ul><li>Prior to January 1, 2003 (the effective date of the new law), the exemptions from federal and Massachusetts estate taxes were the same. Massachusetts only received a portion of the federal estate tax, rather than imposing a tax in addition to the federal estate tax. </li></ul><ul><li>As of January 1, 2003, the Massachusetts estate tax was no longer tied to the current federal exemption. Rather, the threshold for filing a Massachusetts estate tax return is now based on federal law in effect in December 2000. See the chart on the previous slide for the Massachusetts threshold amounts for filing Massachusetts estate tax returns. </li></ul><ul><li>From a practical standpoint, estates above the Massachusetts threshold for filing a Massachusetts estate tax, but below the federal threshold, will need to file a Massachusetts estate tax return and may owe Massachusetts estate tax. For example, in 2011, a $5,000,000 estate that will not owe any federal estate tax may owe as much as $391,600 in Massachusetts estate tax. </li></ul><ul><li>Estates above the federal threshold will need to file both Massachusetts and federal estate tax returns and may owe both Massachusetts and federal estate taxes. In addition, married couples will be able to avoid federal and Massachusetts estate taxes on the death of the first spouse by implementing a properly drafted estate plan. </li></ul>
  10. 10. Draft Estate Plan For June Cleaver Assumes June dies first Note: Ward’s plan mirrors June’s plan in all major respects. 8 Theodore’s Share Income and principal to Theodore and his descendants in trustee’s discretion. At Theodore’s death, trust terminates and property is distributed to his descendants. Each child has a limited power of appointment exercisable via their will Descendant’s Fund Pot for children until youngest is age 25 Income in the trustee’s discretion. Principal is payable for the children’s health, support and education. At Ward’s death he has a limited power of appointment to change June’s trust via his will. He can redistribute the trust property among June’s descendants and their spouses (spouses are limited to an income interest) and charities. If he does not do so: Family Trust Income and principal for Ward and children in the independent trustee’s discretion Marital Trust All income to Ward for life; principal as the independent trustee considers advisable <ul><li>June is Alive </li></ul><ul><li>During life, June has full control </li></ul><ul><li>If June becomes unable to manage her financial affairs, the independent trustee may apply property for family’s benefit </li></ul>Will Executors: Ward Successor to Ward: Fred Smith The June Cleaver 2003 Trust Trustees: June and Ward Successor to June: Independent Trustee and Ward then Fred Smith Wally’s Share Income and principal to Wally and his descendants in trustee’s discretion. At Wally’s death, trust terminates and property is distributed to his descendants. June has died June and Ward have both died Ward Joint Property & Qualified Plans Probate Property June
  11. 11. Special Issues for Business Owners 9 “ How do I preserve the value of my business, ensure that my children are treated equally, and minimize estate taxes on this valuable, but illiquid, asset?”
  12. 12. Minimizing Taxes and Maximizing Legacies: Pre-Sale or Pre-Appreciation Event Planning <ul><li>Estate Planning Issues Common to Business Owners </li></ul><ul><ul><li>Lack of an Estate Plan </li></ul></ul><ul><ul><ul><li>What happens in Massachusetts if the business owner dies without a Will? </li></ul></ul></ul><ul><ul><li>Lack of a Funded Buy-Sell Agreement </li></ul></ul><ul><ul><ul><li>How will the family be provided for? </li></ul></ul></ul><ul><ul><ul><li>Will the surviving owners wish to have the surviving spouse, children or trustee as co-owners? </li></ul></ul></ul><ul><ul><ul><li>How will estate taxes on the value of the business be paid? </li></ul></ul></ul><ul><ul><li>Buy-Sell Agreement is not Coordinated with Estate Plan </li></ul></ul><ul><ul><ul><li>Will the buyout terms provide adequate liquidity by the time the estate tax must be paid? </li></ul></ul></ul><ul><ul><ul><li>Are lifetime transfer restrictions adequate to allow pre-appreciation event estate tax minimization planning? </li></ul></ul></ul><ul><ul><li>Lack of Time to Address Above Issues </li></ul></ul>10
  13. 13. <ul><li>An individual who is planning on selling a business interest in the near term and is interested in estate, gift and income tax planning opportunities </li></ul>Minimizing Taxes and Maximizing Legacies: Pre-Sale or Pre-Appreciation Event Planning 11 Pre-Sale/Appreciation Event Planning – Individual Profile Pre-Sale/Appreciation Event Planning – Benefits <ul><li>Income taxes can be deferred through the use of a Charitable Remainder Trust for owners of C corporations or partnership interests </li></ul><ul><li>The business owner’s retirement planning needs can be addressed simultaneously </li></ul><ul><li>Estate taxes can be minimized by making gifts to children at discounted values, thereby increasing overall family wealth </li></ul><ul><li>Family wealth can be transferred to children during life to save estate taxes, without jeopardizing non-tax family goals </li></ul>
  14. 14. <ul><li>An individual who is in the highest marginal (35%) estate tax bracket, and who owns stock, a partnership interest, or real estate that is expected to appreciate substantially in the near term, and who is interested in minimizing estate, gift and income taxes </li></ul>Valuation Discounts 12 Valuation Discounts – Individual Profile Valuation Discounts – Benefits <ul><li>Discounts allow partial interests in property to be gifted to the next generation at a value that is 20% to 40% less than the interest’s proportionate share of the enterprise’s fair market value </li></ul><ul><li>Discounts create pre-sale and pre-I.P.O. estate planning opportunities </li></ul><ul><li>Discounts can accelerate a gifting program designed to implement a business succession plan </li></ul>
  15. 15. Valuation Discounts <ul><li>Lack of Marketability: Takes into account that the interest is in a closely-held business and that there is no ready market for the stock </li></ul><ul><li>Minority Interest: Takes into account that the interest being transferred by gift is a non-controlling interest. The IRS does not currently aggregate family interests for this purpose </li></ul><ul><li>Built-In Capital Gains Tax: Takes into account the unrealized appreciation in value that tax would have to be paid on if the business were sold </li></ul><ul><li>Blockage: For publicly traded stock, takes into account that the per share value of the stock might decline if a significant shareholder sold a large block of stock </li></ul>13 Discounts Available For:
  16. 16. <ul><li>An individual who owns stock or other property that either is expected to appreciate at a rate in excess of the Section 7520 rate (changes monthly – historically, the rate has been around 5% – 8%; in the past two years it has been much lower), has strong cash flow, or is pre-IPO </li></ul>Grantor Retained Annuity Trust (GRAT) 14 GRAT – Individual Profile GRAT – Benefits <ul><li>Allows the appreciation in the property’s value that is projected to exceed the Section 7520 rate to be transferred to children at a minimal gift tax cost </li></ul><ul><li>Annuity is retained for a term of years </li></ul><ul><li>Children receive property remaining in trust at the end of the trust term free of additional gift or estate tax payments </li></ul>
  17. 17. Grantor Retained Annuity Trust (GRAT) 15 Company stock proportionately valued at $5 Million; discounted for minority interest and lack of marketability by 40% to $3Million for gift tax purposes Remainder after 3 Years*** $1,118,193 Annual Annuity* (Estimated total payments received over term of trust: $3,180,149) ***Assumes 20% rate of return over 3 year trust term Projected Estate Tax Savings at 35%: $1,564,393 Children or Trust for Children $4,469,694 (undiscounted) Grantor Retained Annuity Trust 3 Year Term Parent Age 50 **Current law allows gift to be zeroed-out resulting in no taxable gift. *Assumes Sec. 7520 rate is 2.8% (July 2010 rate) Taxable Gift Property Transferred $3,000,000 Retained Annuity ($2,999,999) Taxable Gift* $ 0**
  18. 18. Generation-Skipping Transfer Trust <ul><li>An individual who has substantial assets that are expected to appreciate and wishes to make gifts or bequests to grandchildren and subsequent generations </li></ul>16 Generation Skipping Trust – Individual Profile Generation Skipping Trust – Benefits <ul><li>Vehicle allows for the transfer of appreciation to future generations at virtually no gift, estate or generation- skipping transfer tax cost </li></ul><ul><li>Donor avoids paying estate tax on transferred assets </li></ul><ul><li>Donor’s children may receive income and principal from the trust at the trustee’s discretion, but undistributed trust funds are kept out of reach of children’s creditors and out of the children’s estates </li></ul><ul><li>Grandchildren and subsequent generations receive property remaining in trust at the end of the trust term </li></ul>
  19. 19. Generation-Skipping Transfer Trust 17 Discretionary Income and Principal Gift or bequest of $2 Million (Cash or Property) Great-grandchildren (90 years of growth; 7% After-Tax Return; 3.5% Inflation) Present Value: $56.5 Million Parents GST Trust Children Grandchildren Great-grandchildren Value at end of joint life expectancies (year 32)*: $17.4 Million Approximate estate tax savings: $6 Million *Donor age 60 and Spouse age 57; Joint life expectancy = 32 years
  20. 20. <ul><li>An individual who owns highly appreciated assets* and who wishes to diversify without incurring an immediate capital gains tax, while increasing cash flow and satisfying charitable intentions </li></ul>Charitable Remainder Trust (CRT) 18 *S Corporation stock not an eligible asset for contribution CRT – Individual Profile CRT – Benefits <ul><li>Increase lifetime income </li></ul><ul><li>Cost-effective way to satisfy charitable intentions </li></ul><ul><li>Avoid paying current capital gains tax on sale of assets </li></ul><ul><li>Receive current income tax deduction </li></ul><ul><li>Avoid paying estate tax on transferred assets </li></ul><ul><li>Can use life insurance to replace wealth </li></ul>
  21. 21. Sale of $1M Low Basis Stock Without a Charitable Remainder Unitrust (CRUT) 19 Outright Sale Diversification without CRUT After-tax proceeds without a CRUT: $800,000 First year income yield of 2% without CRUT: $16,000 To generate more liquidity stock will be sold and additional capital gains tax paid *7% Annual Total Return is 2% income and 5% capital appreciation; Donor age 60 and Spouse age 57; Joint life expectancy = 32 years Donor and Spouse Sell $1M low basis stock IRS $200,000 Capital Gains Tax Invest after-tax proceeds and receive 7% annual return for joint lives* (lifetime cashflow projection: $1.2 M) $1,000,000 Sale Proceeds ( $0) Basis $1,000,000 Taxable Gain ($ 200,000) 20% Tax $ 800,000 Net Proceeds
  22. 22. Sale of $1Million Low Basis Stock With a Charitable Remainder Unitrust (CRUT) 20 CRUT Trustee Sells $1M Low Basis Stock (Zero Tax Due) Diversification with a CRUT After-tax proceeds with CRUT: $1,000,000 First year cash flow at 6% with CRUT: $60,000 Cash flow will increase annually if trust return > 6% Trust payments are taxable income to donor Income tax savings from gift: $33,066 Projected Trust Assets Remaining at Death Tax Deduction: $100,200*** * Assumes 6% Unitrust Payout; 7% Return in Trust; 33 % Tax bracket; Donor age 60 and Spouse age 57; joint life expectancy = 32 years ** S Corporation stock not an eligible asset for contribution *** Assumes Section 7520 Rate = 3.6% (must use highest of current month or previous two months) $1M Low Basis Stock** 6% of Trust Assets Paid Annually For Joint Lives (Lifetime Cash Flow Projection: $1.97M) $463,000 to Family’s Favorite Charities Donor and Spouse *
  23. 23. Appendix 21 Biographies
  24. 24. Biographies: Deborah Pechet Quinan, Esq. <ul><li>Deborah Pechet Quinan is a shareholder of Ruberto, Israel & Weiner PC and a co-chair of the firm’s Trust & Estates Group. Her practice is concentrated in the areas of estate planning, tax planning, and the administration of trusts and estates, with an emphasis on estate and business succession planning for individuals, closely-held business owners, entrepreneurs and corporate executives. Her practice includes estate planning for retirement assets, international estate planning and charitable giving. Deborah also coordinates closely with other advisors in assisting clients with their financial planning needs. </li></ul><ul><li>Previously, Deborah was a director in the Trusts & Estates department at Rackemann, Sawyer & Brewster, a Boston law firm. </li></ul><ul><li>Before that Deborah was the National Director of Estate & Financial Planning Services at State Street Corporation in State Street Global Advisors’ Private Asset Management division. In her role, Deborah was responsible for a department that provided integrated financial, estate and investment planning strategies to SSgA’s individual investment management clients. She also advised clients with respect to sophisticated estate and charitable planning strategies. </li></ul><ul><li>Prior to joining SSgA in 1997, Deborah was the New England Area Director of Estate and Business Succession Planning for Ernst & Young and an Associate Director of the Ernst & Young Center for Family Wealth Planning. Prior to Ernst & Young, Deborah practiced law in the Estate Planning and Probate Department of the law firm Mirick, O'Connell, DeMallie & Lougee in Worcester, Massachusetts. </li></ul><ul><li>Deborah is a member of the American, Massachusetts, and Boston Bar Associations and the Boston Estate Planning Council. Deborah is a past Co-Chair of the Boston Bar Association’s (BBA) Trusts & Estates Section and is also a past Co-Chair of the BBA’s Estate Planning Committee. Deborah served on the Board of Trustees of The Essex County Community Foundation for several years. In addition, Deborah serves on the Board of Trustees of Temple Ner Tamid, in Peabody, Massachusetts, and is active on several of the Temple’s Committees, including serving as Chair of the Temple’s Planned Giving Committee. In addition, she was elected one of the top 100 lawyers in the country by Worth magazine in 2006 and 2008, one of the top ten lawyers in the Women’s Business Journal 2005 Readers’ Poll, and has been elected a Massachusetts Super Lawyer for the last five years. </li></ul><ul><li>Deborah is a frequent speaker on estate planning topics for both lay and professional audiences. For many years she has spoken for Massachusetts Continuing Legal Education panels, and she currently serves on MCLE's Estate Planning Curriculum Committee. Deborah has been quoted in Bloomberg Wealth Manager magazine , The Wall Street Journal, Bloomberg Personal Finance magazine, Money magazine, American Banker , and The Boston Business Journal . </li></ul><ul><li>Deborah graduated from Hamilton College with honors in Comparative Literature. She received her JD, cum laude, from Suffolk University Law School and her LLM, in Taxation, from Boston University Law School. Deborah lives in Topsfield, Massachusetts, with her husband Kevin, and their daughter Dana. </li></ul><ul><li>Phone: 617-570-3521 E-mail: [email_address] </li></ul>22
  25. 25. Biographies: Lisa Weinstein Burns, Esq. <ul><li>Lisa Weinstein Burns is a shareholder of Ruberto, Israel & Weiner. As co-chair of the firm’s Trusts & Estates Group, she focuses her practice in the areas of tax planning, multi-generational wealth transfers business succession planning, estate planning and estate administration. Such planning often include charitable components such as the creation of private foundations and charitable trusts. </li></ul><ul><li>Her work with clients includes drafting a variety of estate planning documents including wills, revocable trusts, irrevocable insurance and generation-skipping trusts, qualified personal residence trusts, charitable trusts, durable powers of attorney and healthcare proxies. Ms. Burns also assists executors and fiduciaries with estate and trust administration matters. </li></ul><ul><li>In the April 2008 issue of Women's Business Boston, Ms. Burns was named one of The Top 10 Lawyers by readers.  She has also been recognized by Boston Magazine and Law & Politics magazine as a &quot;Super Lawyer Rising Star&quot; in the area of Trusts and Estates. </li></ul><ul><li>In addition to her work with clients, Ms. Burns was a member of the Nominating Committee for Shir Tikvah synagogue in Winchester, Massachusetts. Ms. Burns is currently serving on the Board of Governors for the University of Massachusetts Club and as the Chair of the Women’s Initiative Committee of the Boston Estate Planning Council. She is also a lecturer for Massachusetts Continuing Legal Education (MCLE) and has published several articles on various legal topics. Such publications include Charitable Remainder Trusts, A Win-Win Tax Planning Technique , The Washington Lawyer, Nov./Dec. 1995; Just Say No Thanks , The Legal Times, May 20, 1996 (an article regarding disclaimers); The Golden Egg? Variable Universal Life Insurance , The Washington Lawyer, Nov./Dec. 1996; and Gifting the House to Save the Home: Qualified Personal Residence Trusts , The Washington Lawyer, Nov./Dec. 1997. </li></ul><ul><li>Most notably, Ms. Burns has been recognized as a leader in Tax Law by being selected as an author in the recently released book, Tax Law Client Strategies: Leading Lawyers on Understanding and Allocating Risks, Assessing Settlements and Negotiations, and Developing Deal Strategies , published by Aspatore Books in 2007 as part of its “ Inside the Minds” series. Tax Law Client Strategies is an authoritative, insider’s perspective on best practices for successfully representing a client to resolve tax disputes. </li></ul><ul><li>Ms. Burns received her undergraduate degree from the University of North Carolina – Chapel Hill (B.A., 1992), her law degree from the American University (J.D., cum laude, 1995) and her masters in taxation law from Georgetown University (LL.M, with distinction, 1998). While in law school, Ms. Burns was a member of the American University Law Review where she served as a Note and Comment Editor. </li></ul><ul><li>  </li></ul><ul><li>Ms. Burns' most recent association was as a Director with Rackemann, Sawyer, & Brewster, Boston, Massachusetts. </li></ul><ul><li>Phone: 617-742-4200 ext. 251 E-mail: [email_address] </li></ul>23
  26. 26. Business Owner Presentation Thank You