Slides For IICLE Estate Planning Shortcourse Speech 2011 (Limiting Gifts )

Creative Ways to Limit the Value of
a Gift

Pamela Lucina, JP Morgan
(312) 336‐1694
pamela.l.lucina@jpmorgan.com
Natalie Perry 2011 IICLE Shortcourse
Shefsky & Froelich
312/836‐4116
nperry@shefskylaw.com
Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States;
Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; JSM, a Hong Kong partnership, and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is
associated. The Mayer Brown Practices are known as Mayer Brown JSM in Asia.

Agenda

• Introduction: legislation for 2011‐2012 created enormous
estate planning opportunities:
– $5 million gift/estate/GST exemption
– Low AFR and 7520 rates
– No legislation (yet) re: short‐term, zeroed‐out GRATs or FLP/LLC
discounts
– Illinois has an estate tax but does not tax gifts

• Do large gifts make sense? Is the risk/benefit worth it?

Wealth allocation example - Mr. and Mrs. Anderson

Mr. and Mrs. Anderson
– Both are age 45
– Three Children (Sophie, Bella and Josie)
– Residents of Illinois

Investment Assets: $10 million in a fully diversified portfolio1 Family Business Stock Fair
Market Value $15 million
Cash flow requirements: Annual cash flow needs2
– Spending: $500,000)
– Charitable gifts: $10,000
Total: $562,000 (2.2% of investment assets)

Core financial goals
– Maintain lifestyle: “We don’t want to run out of money.”
– Financial cushion: $10 million liquid assets3 at age 95
– Transfer “Enough” To Children

1 Balanced Strategic Portfolio asset allocation: 47% equity, 38% Fixed Income, 6% Alternatives, 9%Cash
2 Adjustedfor inflation at 3.0% annually
3 Nominal value

Note: A $13K gift tax exemption may be applied per child per year. 3

3

Agenda

• Three common scenarios:
– Individual “A” – Would like to gift a specific amount but has hard to
value assets and would like to cap gift tax exposure

– Individual “B” – Sees wisdom of wealth transfer but wonders whether
she can afford it

– Individual “C” – Worries about leaving too much to children and
becomes paralyzed

Individual “A” – Would like to gift a specific amount but has hard to
value assets and would like to cap gift tax exposure

Limiting Gifts to What is Intended and No More – Defined
Value Clauses

• Defined Value and Savings Clauses

• Why This May Resonate

• Types of Adjustment Clauses
– Savings Clauses
– Defined Value Clauses

Value Clauses

• Case Law
– Public Policy Argument – Procter v. Comm’r

– Condition Subsequent
• King
• McCord
• Christiansen/Petter

Value Clauses

• Practical Tips for Structuring
– Multiple Parties
– Allocation of Excess
– Charitable Interest
– No Excuse to Skip an Appraisal

Individual “B” – Sees Wisdom of Wealth Transfer but Wonders
Whether She can Afford It

Limiting Gifts for Individuals who Worry Whether
They can Afford to Gift – Financial Modeling

• The Challenge
• Wealth allocation example

Wealth allocation planning process

1 2 3 4
Determine goals Ranges of Define allocation Allocate and use
and financial projected future to core portfolio surplus
position wealth
Client Goals Client-specific “Core Needs” Aspirational
• Financial Ranges1
security • Annual spending goals
• Aspirations (inflation-adjusted) • Personal Passions
Strong Markets
- Consumption
(95th percentile) • Financial cushion of
- Investments
assets needed in old
Financial
Typical Markets2 age • Wealth transfer to
facts (50th percentile) • Target asset family
• Statement of
Weak Markets allocation and
financial assets
(5th percentile) portfolio based on • Philanthropy
• Statement of
cash flows risk/return
• Taxes preferences

Review the plan annually and adjust periodically

1 Based on proprietary J.P. Morgan asset class projections.
2Typical markets are median markets.
For further information, see Appendix pages entitled “Pre-tax equilibrium return and risk assumptions” and “Understanding ‘equilibrium’ estimates.”

11

Wealth allocation example - Mr. and Mrs. Anderson

– Both are age 45
– Three Children (Sophie, Bella and Josie)
– Residents of Illinois

Investment Assets: $10 million in a fully diversified portfolio1 Family Business Stock Fair
Market Value $15 million
Cash flow requirements: Annual cash flow needs2
– Spending: $500,000)
– Charitable gifts: $10,000
Total: $562,000 (2.2% of investment assets)

Core financial goals
– Maintain lifestyle: “We don’t want to run out of money.”
– Financial cushion: $10 million liquid assets3 at age 95

1 Balanced Strategic Portfolio asset allocation: 47% equity, 38% Fixed Income, 6% Alternatives, 9%Cash
2 Adjustedfor inflation at 3.0% annually
3 Nominal value

Note: A $13K gift tax exemption may be applied per child per year. 12

12

Wealth projections show even in weak markets Mr. and
Mrs. Anderson may exceed long-term financial goals
Assumptions1: initial wealth value = $25MM with an annual inflation rate of 3.0% and $500K in annual spending.
Range of projected wealth values
($MM) Balanced
95th percentile1
(Strong Markets)
Most probable 50th percentile1
cash flows1 (Typical Markets)
5th percentile1
(Weak Markets)
140

128.2
120

100

80 82.1

60
54.9
50.4 Meets $10MM
40 42.7 desired cushion
39.8
33.0
28.9
20 20.9 21.3 21.2 19.5

0

Year 5 Year 10 Year 20 Year 30
1 562K annual spending is inflation-adjusted
2 “Most probable wealth values,” denoted by the darkly shaded area, indicates the range in and around the 50th percentile. The “50th percentile” indicates the middle
wealth value of the entire range of probable wealth values. The “95th percentile” wealth value indicates that 95% of the probable wealth values will be equal to or below
that number; the “5th percentile” wealth value indicates that 5% of the probable wealth values will be equal to or below that number. Another way of looking at it is that
90% of the probable wealth values will be between those two figures.
Note: This is a projection used for illustrative purposes only and does not represent investment in any particular vehicle. References to future wealth values are not promises
or even estimates of actual returns you may experience, and projected end values in year 30 are not present values. Monte Carlo simulation is an analytical technique which
uses a large number of calculations of uncertain or random variables. Statistics on the distribution of results can help us infer which values of the simulated portfolio variables
are more likely. See appendix for further information on Monte Carlo simulation. Calculations are based solely upon assumptions listed; see asset allocation page for asset allocation detail. For
further information, see Appendix
pages entitled “Pre-tax equilibrium return and risk assumptions” and “Understanding ‘equilibrium’ estimates.” Please refer to the “Analysis assumptions” for tax rates and
cash goals (inflows and outflows) assumed in the analysis. 13

Mr. and Mrs. Anderson allocate $1MM surplus
capital to fund personal passions

$4MM

Mr. and Mrs. Anderson’s
personal passions

• Second home
• Global travel
Personal • Invest in a winery
Passions • Personal trading account
$1MM

Surplus Assets

Note: Examples for illustrative purposes only
14

14

The Andersons also seek to provide wealth to future
generations
• Intra‐family giving:
$4MM
– Children (annual gift exclusions)
– Grandchildren ($10MM available)

• They established and funded a Generation Skipping Transfer
(GST) trust for the grandchildren, leveraging a portion of their
combined lifetime gift exemptions
Family
$2MM Illustration of Generation-Skipping trust
Transfer
$2MM assets
Mr. and Mrs. to GST GST Trust
Personal Anderson
Passions
$1MM May continue in
perpetuity

Surplus Assets Future
generations
GST funded with $2MM, partially utilizing Mr. and Mrs. Anderson’s lifetime gift exemptions
Note: The GST exemption amount for 2011 is $5,000,000 ($10,000,000 if you are giving as a
couple).1

15

15

The Andersons have substantial philanthropic
interests

$4MM Mr. and Mrs. Anderson considered 2
philanthropic strategies:
Charity
$1MM
• Make annual gifts
Strategy selected by the
Family • Donor‐Advised fund Andersons
$2MM

Personal
Passions
$1MM

Surplus Assets

1 Private foundations’ Net Investment Income may be subject to a 1% or 2% excise tax.
16

16

They can Afford to Gift – “Recapture”

• Include Spouse as a Potential Beneficiary of an Irrevocable
Descendants’ Trust

• Why this may resonate
– Safety valve to get assets back to parents if they actually do run out of money
– Escape hatch to completely unwind the transaction if children behave badly

• Watch out for reciprocal trust doctrine


• Additional Flexibility – (caveat of implied agreement doctrine)
– Spouse’s Testamentary Limited Power of Appointment
– Spouse as Trustee

• GRAT planning as possible application

• Consider Possibility of divorce


• Self‐Settled Trusts


• Must carefully structure remainder trust under the laws of a
state that permits self‐settled irrevocable trusts

• Implied Agreement
– Emergency funds only
– Independent trustee


• Retention Powers

– Donor as Trustee?
– Donor as Co‐Trustee?
– Spouse/Close Friend as Trustee?
– Distribution Standard
– Limited Power of Appointment


• Grantor Retained Annuity Trusts (GRATs)

• Financial modeling is key
– Valuation discounts
– It is ok to give back more than initial fair market value

• Incorporate flexibility to reallocate remainder
• Protect trustee (or special trustee)


• A tax efficient charitable giving “option” using a private
placement variable annuity (PPVA)

– Interested in giving to charity but worried about running out of money
– Segregate in income tax friendly vehicle but allow individual to
recapture


• What is a PPVA?
• Annuities offer a stream of distribution in the future in exchange for an
upfront payment
– Income tax is not paid until the owner receives income
– 10% excise tax for those under age 59 ½ applies
• Retail annuities usually have hefty fees and charges in exchange for
guaranteed return
• Private placement annuities strip out the bells and whistles associated
with annuities
– Investment flexibility
– Lower costs


• What is “private placement”

– Non‐registered investment vehicle

– Available only to accredited investors/qualified purchasers

– Available only through Private Offering Memorandum


• How may a PPVA strategy accomplish client’s goals?

– Client allocates investment assets to a PPVA contract

– Investments inside PPVA contract grow income tax free
• In some products, client can withdraw assets any time in any
amounts, or cancel annuity contract at any time without fees
• Any distributions out of PPVA contract back to client in excess of
basis taxed as ordinary income
• If charity is beneficiary, no estate or income taxes at death

Individual “C” – Limiting Gifts for Individuals who Worry About
Descendants Receiving Too Much Money

Limiting Gifts for Individuals who Worry About

• Profile
– Often first generation wealthy
– Paris Hilton effect
– Entitlement/Stewardship

• The Dilemma
– Sees value in planning
– paralyzed


• The Challenge: To present flexible planning options to the
individual that allow for tax‐efficient transfer of wealth but
provide a “safety valve” so the individual doesn’t feel locked‐in
to a strategy that might transfer too much

• Two Approaches:
– Payment or “Stipend” Approach
– Diversion Approach

Descendants Receiving Too Much Money – Stipend

• Stipend Approach

• First Step: Modeling for “right amount” or what is “enough”
per clients vision
– How many generations does grantor wish to support?
– Quantify costs to fund lifestyle targeted by grantor.
• Is trust a backup support? (implies discretionary payments)
• Or true stipend? (implies mandatory or periodic payments)
• Or combination of the two?

Estimated estate disposition for wife (having survived husband) under will dated month day,
20XX using ATLAS
Est im at ed Est at e Disposit ion f or Jane Sm it h (having survived John Sm it h)

Execut or: William Sm it h
Successor execut or: JPM

Jane Sm it h's non-probat e est at e Jane Sm it h' s probat e est at e

401(k) & IRA Residuary M arit al Deat h Benef it of Jane' s Int erest in Real Tangibles Out right Bequest Jane' s 9.9% Insurance 10% of Residuary M arket able 1996 Charit able
Trust Lif e Insurance 13 Est at e of ABC Com pany Int erest in LLC14 proceeds Jane Jane received Securit ies Rem ainder
under John's received at John' s Out right under Unit rust 11
Will 14 deat h John's w ill

$ 254,413 $ 112,668,484 $ 156,000 $ 10,852,868 $ 2,711,214 $ 568,451 $ 1,485,000 $ 10,135,000 $ 21,846,827 $ 5,000,000 $ -

Children Trust f or Foundat ion Trust f or Children Children 1% of ABC 1% of LLC t o Cash Gif t s t o Residuary 15 Charit ies
Siblings' s Com pany t o Each Each Child Individuals
Children Child (2% t ot al)
(2% t ot al)

2/3 in Trust f or
10% 20% 70% 1/3 t o Foundat ion Children
$ 74,091 $ 5,313,624 $ 22,533,697 $ 37,195,366 $ 2,711,214 $ 11,369 $ 29,700 $ 1,200,000 $ 14,876,119 $ 11,943,302 $

Not e: Not e: Not e: Not e: Not e: Not e:
• Residuary t rust • 70% t o t rust f or children. • Ruby & diamond • Jane makes cash • 1/3 t o Family Foundat ion and 2/3 iis • A port ion of t his
divided int o 3 Unt il benef iciary at t ains age engagement ring; gif t s if t he divided int o shares f or each child and f or t rust w ill be
shares: 21, Trust ees t o pay income and emerald & individual survives issue of predeceased child (“ benef iciary” ) includible in Jane's
• 10% t o Trust t o be and, unt il benef iciary at t ains diamond pin t hat her: and unt il benef iciary at t ains age 21, est at e.
divided int o shares age 35, t o pay principal as belonged t o mot her • $400,000 t o Trust ee t o pay income and, unt il • Upon Jane's
as any brot hers and Trust ees det ermine. Af t er in law , t o M ary. brot her. benef iciary at t ains age 35 (not e—t his is deat h: great er of
sist ers of John and age 21, benef iciary has right • Emerald & • $200,000 t o each dif f erent age t han under John's w ill w hich $1 million or 25%
brot hers and sist ers t o w it hdraw income. Af t er diamond ring; and of niece and uses age 30), t o pay principal as Trust ees t o M iddlesex School
of Jane have age 30, benef iciary has right t riple st rand pearl nephew s det ermine. Af t er benef iciary at t ains age and 75% t o Family
children t hen living t o w it hdraw 10% of FM V of necklace w it h • $100,000 t o M ary 21 he or she has right t o w it hdraw Foundat ion.
and issue of t rust . Upon at t aining age emerald & diamond • $100,000 t o Jake income. Af t er age 30, he or she has right
predeceased child. 35, benef iciary has right t o clasp t o John. These gif t s pay t heir t o w it hdraw 10% of FM V of asset s. At age
Each share f or issue w it hdraw 1/3, and upon age • Balance of jew elry share of deat h 35 (not e-is dif f erent t han age 30 under
of a sibling w ho has 40, ½ of t rust ; and at age 45, is divided bet w een t axes. John's w ill) may w it hdraw 1/3 of t rust ; at
at t ained age 35 t he remaining t rust ; children as t hey age 40, ½ of t rust ; and upon age 45, may
goes out right . For provided t hat Trust ees may agree. w it hdraw t he remaining t rust ; provided
issue (“ benef iciary” ) w it hhold if pending legal • Jane direct s Trust ees may w it hhold dist ribut ion if
under age 35 share claims payable by t he Execut or t o sell t here are pending legal claims. Upon t he
held in t rust . benef iciary. Upon w orks of art and deat h of benef iciary, t rust goes as
benef iciary’s deat h, t rust ant iques w it h value benef iciary appoint s by t est ament ary
goes as benef iciary appoint s each of $20,000 or general POA. In def ault , t o benef iciary’s
by w ill (general POA). In more and add issue per st irpes, or if none, t o Jane's issue
def ault , t o benef iciary’s issue proceeds t o per st irpes; provided t hat propert y going
per st irpes, provided t hat residuary t hough t o a benef iciary w ho has a t rust shall be
any propert y going t o a children have 1st added t o t hat t rust .
benef iciary w ho has a t rust opt ion t o purchase. • Trust s end at expirat ion of perpet uit ies
shall be added t o t hat t rust . Balance of t angibles period.
• Trust s end at expirat ion of goes t o children.
perpet uit ies period.

Est im at ed gross est at e: $165,678,257
Est im at ed adm inist rat ion expenses: ($3,313,565)
Debt s: ($861,154)
Est im at ed est at e t axes16 : ($65,569,162)
Est im at ed incom e t axes17 : ($45,894)

Descendants Receiving Too Much Money – Stipend

• Second Step: Trust considerations for the stipend approach
– Lifetime distributions to childe, balance to charity
– CRT
• CRAT
• CRUT

Descendants Receiving Too Much Money – Diversion

• Diversion Approach
• Donors Power to Divert
– Why this may resonate
– Trustee


• Power to Add Beneficiaries

– Who should hold the power?
• Donor
• Donor’s spouse
• Beneficiary
• Trustee (individual or corporate)
• Special Trustee

– Limits to power



• Powers of Appointment
– General Power of Appointment
– Limited power of Appointment
• Beneficiary – Lifetime/Testamentary
• Non‐beneficiary
– Delaware Tax Trap


• GRATs revisited
– Capping the Distributions
– Power to Add Beneficiaries

• 529 Plans
– Ability to Change Beneficiaries
• Tax Consequences
• Member of the Family
• Changes to Non‐Family Members
• Changes to Next Generation

Limiting Gifts for Individuals - Conclusion

• First Step: Financial Modeling
• Second Step: Incorporate Flexibility into Plans

Please keep in mind
IRS Circular 230 Disclosure:
J.P. Morgan Chase & Co. and its affiliates do not provide tax advice.
Accordingly, any discussion of U.S. tax matters contained herein
(including any attachments) is not intended or written to be used, and
cannot be used, in connection with the promotion, marketing or
recommendation by anyone unaffiliated with J.P. Morgan Chase &
Co. of any of the matters addressed herein or for the purpose of
avoiding U.S. tax-related penalties.

.

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