Drafting your Last Will and Testament – You May Delay, but Time Will Not

 By Rose Wilson

You may have heard stories in the news recently about Roman Blum, the multi-millionaire from New York who died without a will, leaving an estate of $40 million without any named beneficiaries.  Today, almost a year and a half from the date of his death, it is possible that the money will stay in the hands of the state government as none of his heirs have been found.

Many people procrastinate when it comes to completing their estate planning, but what happens if you die without a will?  A common misconception is that the government will receive your assets.  In reality, the answer to this question depends on the “intestacy” law of the state in which you reside at the time of your death.  To die “intestate” means to die without a will.  When this occurs, the identity of your heirs will be determined by state law, and intestacy laws vary from state to state.

In the state of Georgia, the intestacy law generally provides for distribution of the estate in the following order.  If you are married and have no children at the time of your death, your spouse will receive all of your assets.  If you are married with children at the time of your death, then your spouse and your children share the estate in equal shares, although your spouse will receive at least one-third of the estate.  If you die unmarried and without descendants, then your property will pass in equal shares to your nearest living relatives (parents, then siblings if your parents are not alive, then your nieces and nephews, and continuing out along the family lines according to degree of kinship).

In the event that you die intestate and no heirs can be identified, then your estate will remain with the government.  The scenario in which an individual has no heirs seems unlikely because one must have a living relative somewhere on the planet.  The real trouble comes in identifying the heirs, but cases where no heirs can be identified are uncommon.

What if your heir under state law is your third cousin twice removed, whom you barely know, and you prefer that your money go to friends or charity?  Then you must sign a will to make that happen.  Whether you’re a multi-millionaire like Roman Blum, or simply an average Joe, a last will and testament may be one of the most important legal documents you will ever prepare.  Not only does it provide for the disposition of your assets in the manner that you desire, it can provide numerous other benefits to your estate beneficiaries, such as asset protection, tax savings, and more.

Estate Tax Exclusion Portability: Policy to Planning Ideas

 By Ashley Alderman

The introduction of the concept of “portability” in the Tax Relief, Unemployment insurance Reauthorization, and Job Creation Act of 2010 was the first time that a married couple could potentially take advantage of both spouses’ estate tax applicable exclusion amounts without engaging in complex estate planning and proper titling of assets.  Despite the significant opportunity, the law enacted by Congress left many holes in the application of portability, most importantly for 2012 planning, whether gifts by a surviving spouse used the Deceased Spousal Unused Exclusion Amount (DSUEA) first or whether they used the surviving spouse’s own basic exclusion amount first in the calculation of gift tax owed.   Additionally, the concept of portability will sunset with the Act on December 31, 2012.  Without Congressional action, portability of the estate tax exclusion amount will not exist in the estate tax law on January 1, 2013.

In June of 2012, the IRS and Treasury finally issued regulations on portability which clarified many of the open-ended questions from the statute.  These regulations are extremely taxpayer friendly, and the use of portability may provide a planning opportunity for practitioners, but reliance on portability is not without significant risks.

My article from the October 2012 issue of Estate Planning discusses some of the following issues regarding portability:

• Policy of treating married taxpayers as a single unit;
• Requirements to elect portability and report DSUEA;
• Computation of DSUEA;
• Coordination of DSUEA with gift tax liability;
• Advantages and planning opportunities;
• Disadvantages and planning risks; and
• Future of portability.

Scot Kirkpatrick Interviewed in the Atlanta Business Chronicle – Law & Accounting: Tax Guide on Upcoming Tax Exemption Changes

 by Scot Kirkpatrick

Trust and Estate Blawg author Scot Kirkpatrick discusses the upcoming changes to the gift and estate tax exemptions.

“If someone doesn’t use this exemption properly between now and Dec. 31, come Jan. 1, the rules will be quite different again…”

To read the full article regarding the current and future status of exemptions, please click here. You can also find the article in the recent August 17-23 issue of the Atlanta Business Chronicle.

 

What Gifts are Excluded from Gift Tax? The Answer is Not Always Easy

 By Rose Wilson

The federal gift tax annual exclusion is an easy to use and often overlooked planning tool.  Gifts qualifying for gift tax annual exclusions are not subject to gift tax and do not trigger gift tax reporting obligations.  The gift tax annual exclusion amount is $13,000 per donee in 2012.  With this exclusion amount available, a married couple could give away as much as $26,000 per year to every child and grandchild of theirs, every year, with no gift tax liability or reporting obligations resulting from such gifts (note, however, that these gifts need not be made to a relative to qualify for the annual exclusion from gift tax).  If the annual gifts to any one individual exceeds $13,000, all gifts must be reported. The application of gift tax annual exclusions can result in significant tax savings, especially if utilized regularly over a number of years.

The annual gift tax exclusion is only available for gifts of present interests in property.  I.R.C. § 2503(b).  A present interest in property is “an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property (such as a life estate or term certain).”  Treas. Reg. § 25.2503-3(b).  Any direct or indirect restriction on enjoyment of the transferred property can prevent the donor from using the benefit of annual exclusions.  Restrictions can be imposed in a number of ways, such as through written agreements governing the permissible uses of the property, state or federal laws governing the type of property given, or existing third party rights to the property.  Thus, the determination of whether a gift of property qualifies as a present interest depends on the legal rights and restrictions resulting from the nature of the property given and the method by which such property is transferred to the donee.  While this determination is relatively easy when the gift is an outright transfer of cash or publicly traded stocks, it can become quite difficult when more complicated property interests, such as gifts of closely held business interests, are involved.

The United States Tax Court recently analyzed a gift transaction involving gifts of interests in a closely held partnership.  In Estate of Wimmer v. Commissioner, T.C. Memo 2012-157, a married couple created a limited partnership and subsequently gave limited partnership interests to their children, grandchildren, and other relatives.  The couple made gifts of partnership interests over a period of years and claimed the benefit of annual gift tax exclusions against such gifts.  The IRS argued that the gifts did not qualify for gift tax exclusions because the partnership interests were restricted.

When gifts of partnership interests are concerned, the rights and restrictions affecting a donee’s use of the partnership interest or the income from the partnership is governed primarily by the partnership agreement and state law.  Therefore, the Tax Court in Wimmer examined the partnership agreement to determine if the donees’ rights to use, possess or enjoy the partnership interests or the income from the partnership were restricted by the agreement.  The Tax Court found that the donees’ right to use the partnership interests was restricted because the partnership agreement provided that a partner could not transfer his or her partnership interest without the prior written consent of the general partners and 70% in interest of the limited partners (with some exceptions for certain transfers to related parties).   However, the Tax Court found that the donees’ right to income from the partnership was not restricted by the partnership agreement or otherwise.  Accordingly, the Tax Court held that the gifts of limited partnership interests were not unduly restricted by the governing partnership agreement and therefore qualified for the annual gift tax exclusion.

Although the Wimmer case was favorable for the taxpayer involved, the case is an important reminder that the application of annual gift tax exclusions may be denied based on the facts and circumstances of a particular case.  Taxpayers who are concerned with the eligibility of a particular gift may be well advised to consult with legal counsel before claiming the benefit of gift tax annual exclusions.

Modern Families – Estate Planning for Same-Sex Couples

 by David Kovsky

Although President Obama has recently come out in support of recognizing same-sex marriages, the law of the land from a federal tax perspective remains the Defense of Marriage Act (“DOMA”).  Under DOMA, the federal government will only recognize marriage as a union between one man and one woman.

To the chagrin of many same-sex couples, the definition of marriage under DOMA precludes the use of fundamental estate planning mechanisms such as the unlimited transfer of wealth between spouses during life, the deferral of estate taxes until both spouses die and, for 2012, the portability of the estate tax exemption.  In many ways, the tax code is structured to benefit married couples.  Nevertheless, married same-sex couples have some unique planning opportunities available to them specifically because the federal government does not recognize their marriage as valid.

Here are two planning ideas that are only available to unrelated parties but may be very effective wealth transfer strategies for same-sex couples:

1. Grantor Retained Income Trust.  This strategy involves transferring assets that the grantor expects will grow and appreciate over time to a new trust while retaining an income interest for a predetermined period of years.  The value of the gift to the beneficiaries is reduced by the value of the income interest retained by the grantor.  The goal here is to freeze the value of the assets at the time of the transfer while permitting the growth and appreciation to occur outside of the grantor’s estate.  Congress recognized the potential for abusing this type of transaction through the investment in non-income producing assets.  Accordingly, Chapter 14 of the Internal Revenue Code was enacted to provide that among applicable family members, the value of a retained interest for transfers in trust is zero, unless that interest is a “qualified” interest.  One such qualified interest is an annuity (hence the common usage of grantor retained annuity trusts).  Since DOMA does not recognize a marriage between same-sex couples, the limitation to qualified interests that is imposed on these types of trusts among family members is not applicable.  Instead, a lawfully married same-sex couple can utilize this very effective (and often overlooked) estate planning device.

2. Qualified Personal Residence Trust.  This type of trust is designed to transfer the ownership of a residence to the trust beneficiaries following the completion of a term of years during which the grantor is entitled to remain in the residence.  The value of the gift to the trust beneficiaries is reduced by the value of the grantor’s right to remain in the residence.  The concept here is to transfer the residence (including all of the appreciation over the term of years) to the trust beneficiaries at a discounted price.  However, when the beneficiaries receive the residence, they are subject to carry-over basis and may incur a substantial capital gains tax on the subsequent sale of the residence.  Had the grantor died owning the residence, the beneficiaries would receive a step up in basis to the fair market value as of the date of the grantor’s death.  Consequently, the subsequent sale would trigger little or no gain.  One way to ameliorate this planning hurdle would be to purchase the residence back from the trust and have it pass through the grantor’s estate.  However, Treasury Regulations governing the use of qualified personal residence trusts specifically prohibit the grantor from buying the residence back when the trust beneficiaries are members of the grantor’s family.  The same prohibition, however, is not applicable to same-sex couples because in the eyes of the government they are unrelated.  To take advantage of this planning opportunity, the grantor should purchase the residence back from the trust (at no gain or loss, due to the grantor trust rules) prior to the conclusion of the trust term.  The same “value” passes to the trust beneficiaries in the form of cash while the residence will ultimately pass through the grantor’s estate and receive a step-up in basis at his or her death.

With the recognition of same-sex marriage quickly becoming a buzz worthy campaign issue, it is possible that we may see the repeal of DOMA sometime in the next few years.  However, until that happens, it is important to advise same-sex clients to double-down on the government’s definition of marriage as the union of one man and one woman and to take advantage of the unique planning opportunities available to them as “unrelated” parties.

Wandry v. Commissioner: Defined Formula Transfers Provide Significant Planning Opportunity in 2012

 By Ashley Alderman

As we continue to emphasize, 2012 is the year to make transfers to family members.  The current gift tax exclusion amount is $5.12 million, which will be reduced to only $1 million as of January 1, 2013, unless Congress acts.  Therefore, most wealthy clients should use their $5.12  million exclusion amount to the greatest extent possible by the end of the year.

Many clients, however, may not have the liquidity to make transfers of $5.12 million in cash.   Instead, these clients may have family-held business interests or other business interests that could be transferred to younger generations.  The inherent problem with the transfer of business interests is the valuation of those interests.  If the IRS audits the gift tax return and adjusts the valuation of the business interests, the client may have created an unintended gift tax liability.  For example, suppose that the client transfers 500 membership units in the family LLC worth $5.12 million therefore fully utilizing the exclusion amount.  Following the IRS audit, however, the value of each membership unit is increased.  Now, the client has transferred 500 units worth $6 million and caused an unintended gift tax liability because the gift now exceeds the client’s available exclusion amount.

Fortunately, on March 26, 2012, the Tax Court issued an opinion in the case Wandry v. Commissioner, T.C. Memo 2012-88 that may provide significant assistance to taxpayers interested in these types of transfers.  In Wandry, the taxpayers made gifts of “a sufficient number of [membership units of the LLC] so that the fair market value of such Units for federal gift tax purposes” was a stated amount to their children and grandchildren.  In the assignment documents, the taxpayers acknowledged that the gift could be “subject to challenge by the Internal Revenue Service,” and that if a final determination was made by the IRS or a court of law that was different from the taxpayer’s appraisal, “the number of gifted Units shall be adjusted accordingly so that the value of the number of Units gifted to each person” equaled the stated amounts.   By making this defined value formula gift, the taxpayers intended to limit the value of the property transferred, thus eliminating the possibility of incurring unintended gift tax liability.   The Tax Court rejected several objections by the IRS to this type of formula gift and upheld the transfer.

Prior cases have upheld similar formula clauses when the excess value (if determined by audit or court) was transferred to a charity.  In those cases, no additional gift tax was incurred because the excess value received a charitable deduction.

Wandry, however, is the first case to address this formula transfer when a charity was not available as a back-stop.   Therefore, Wandry provides a significant planning opportunity for clients who have not fully utilized their $5.12 million exclusion amount.   Now, pursuant to Wandry,  using the example above, a client could make a gift of the number of units in the family LLC worth $5.12 million.  At the time of the gift, pursuant to an independent appraisal, the client may anticipate that this gift will equal 500 units, but if the IRS audits the return and a final determination results in the increase in the value of each unit, it might actually be that only 425 Units are transferred by the client, pursuant to the gift worth $5.12 million.   Rather than transferring a set number of membership units and adjusting the value later, Wandry allows the client to transfer a set value and adjust the number of units transferred later.

Because of the nuances in the Wandry case, a client should seek professional assistance before making these types of transfers to ensure that the transfer complies with the Tax Court’s opinion in Wandry.  If done correctly, however, the client will now be able to fully utilize his $5.12 million exclusion amount in 2012 without incurring any gift tax liability.

Facebook, Instagram and the Zuckerberg Estate Plan

 by David Kovsky

Forbes Magazine ran an article on March 7, 2012, explaining how Mark Zuckerberg transferred approximately $37 million, tax free, to unknown beneficiaries.  The author of the article speculates that the ultimate beneficiaries are Mr. Zuckerberg’s unborn children.  When this article ran, it generated a fair amount of buzz in the estate planning world.  Now, with the lightning quick acquisition of Instagram for a cool $1 billion barely in the rearview mirror, it is worth resuscitating the discussion of estate planning for young entrepreneurs.

In Mr. Zuckerberg’s case, the article points to his use of a specific type of a trust known as a Grantor Retained Annuity Trust.  Without getting into the mechanical details of this type of planning, the ultimate goal was to transfer the growth and appreciation in value of Facebook stock to the trust beneficiaries (assumed to be Generation 2), free of any wealth transfer tax, while retaining the original value in Mr. Zuckerberg’s estate.  The tremendous growth in value of Facebook over a short period of time made this an excellent vehicle for Mr. Zuckerberg.  Likewise, with historically low IRS interest rates (a Grantor Retained Annuity Trust must pay an interest factor to the Grantor), this is a great tool for more modest clients who expect a sale or strong appreciation within a defined period of years.

For young entrepreneurs who may not see an exit or rapid growth on the horizon, there are other techniques that should be considered.  To keep the planning straightforward, some of these clients may benefit from simply gifting a slice of their company to an irrevocable trust (it is important to not “over plan” young clients, so using a small but meaningful portion of a client’s business is advisable).  The trust assets may be held for the benefit of the client’s children.  If the client is married, his or her spouse may be a permissible beneficiary.  Of course, each dollar that is distributed back to the spouse is counterproductive from an estate planning perspective, but it gives the client the flexibility of having an “out valve” in the event the assets are needed at his or her generation.  This planning is especially important for young entrepreneurs whose financial wherewithal is much less certain than that of an elderly client.

For gift tax reporting purposes, the client’s company must be appraised to establish the value of the gift.  The general concept here is to leverage the low (or nominal) value of a client’s startup and allow all of the growth and appreciation to blossom outside of his or her estate.  Since the client will likely assert only a nominal value for the company on his or her gift tax return (and thus utilize very little of his or her gift exemption), pursuing this strategy in 2012 is advantageous.  If the IRS audits the gift tax return and asserts a higher value for the company (even substantially higher), the $5.12 million exemption for 2012 will serve as a cushion protecting the client from a potential gift tax liability.

Startups like Instagram and Facebook were unmitigated homeruns.  While few clients will have Facebook’s level of success, this type of trust and gift planning is a very effective early-stage estate planning strategy for entrepreneurs, with the potential to pay huge dividends in the long run.  If the company does modestly well, the client may save future wealth transfer taxes (at multiple generations).  Moreover, trusts for the ultimate benefit of Generation 2 and Generation 3 may be protected from creditors and divorcing spouses.  As a client begins to have a track record of success, the trust may also be used to facilitate angel investing in other startups (a common side project for many successful young entrepreneurs).  Alternatively, if the company goes belly-up, the client has incurred the legal expense of establishing the trust, but will have a vehicle in place to receive gifts of interests in future companies.

It’s often very difficult to get young clients to focus on estate planning.  At age 24 when the trusts were established, Mr. Zuckerberg should be commended for focusing on estate planning and having the wit to heed the advice of his counsel.

President Obama’s Estate Plan Reminds Us of the Power of the Annual Exclusion

 by David Kovsky

On April 13, 2012, The Washington Free Beacon ran an article deriding President Obama’s reliance Section 2503(b) of the Internal Revenue Code to transfer $48,000 to his daughters, free of any federal wealth transfer taxes.  Under that section of the Code, each taxpayer may transfer $10,000 to any number of individuals on an annual basis, free of the federal gift tax.  This is the so-called “annual exclusion.”  Section 2503(b) further provides that the annual exclusion will be indexed for inflation.  As such, the amount that may be transferred to each donee in 2012, free of the federal gift tax, is $13,000.”

The rationale behind the annual exclusion is to not mire the taxpayer or the IRS in tracking the aggregate of annual birthday presents, holiday gifts or dinners on “mom and dad.”  Only when the amount rises to the level of what is deemed wealth transfer, will the gift tax be triggered.

Although the article run by The Washington Free Beacon had a political slant, it is also a great reminder of how useful the annual exclusion can be from an estate planning perspective.  Take, for example, the following hypothetical:  Grandmom and Grandpop have three married children and six grandchildren.  By utilizing the annual exclusion, Grandmom and Grandpop can transfer an aggregate of $312,000 of wealth to Generation 2 and Generation 3, without incurring a gift tax or a generation-skipping transfer tax (another federal wealth transfer tax with its own set of annual exclusion rules), every single year.  If these gifts are made in December of year 1 and January of year 2, our hypothetical Grandmom and Grandpop can transfer over $600,000 during a several week period, free of any federal wealth transfer taxes.  Here is breakdown of the transfers in year 1 (which may be replicated in year 2):

Donee:	Grandmom	Grandpop:
Child 1	$13,000	$13,000
Spouse 1	$13,000	$13,000
Child 2	$13,000	$13,000
Spouse 1	$13,000	$13,000
Child 3	$13,000	$13,000
Spouse 3	$13,000	$13,000
Grandchild 1	$13,000	$13,000
Grandchild 2	$13,000	$13,000
Grandchild 3	$13,000	$13,000
Grandchild 4	$13,000	$13,000
Grandchild 5	$13,000	$13,000
Grandchild 6	$13,000	$13,000
TOTAL:	$156,000	$156,000

This type of estate planning could be as simple as writing checks to all of your immediate family.  However, for many clients, these transfers should be made in conjunction with the establishment of a specially designed trust that qualifies for the annual exclusion and assists clients in meeting their goals of providing the children (and grandchildren) with a measure of asset management assistance, creditor protection and future transfer tax savings.

In whatever form it takes, outright transfers or in trust, fully utilizing the annual exclusion is a powerful estate planning tool that is often overlooked.

Fractional Interests in Real Estate: The Unintentional But Effective Partnership

 by Jeff Waddell

A gift of a small interest in real estate can have a greater benefit than intended.  So you decided to transfer a one percent interest in the family farm to your daughter last year.  The values were such that the 1% worked out to about $13,000 so you were within your annual exclusion and that was the plan.  You may have done a lot better than you thought from an estate tax perspective.

By creating a fractional interest situation, the farm is now effectively owned by a partnership between you and your daughter.  No third party is going to buy your 99% interest without the ability to obtain her separate 1% interest so effectively you have created a non-marketable interest in real estate.  Additionally, you cannot independently obtain financing on the property or enter into agreements affecting the property without your daughter’s consent. That means you also have a lack of control over the property.  Both of these factors, lack of marketability and lack of control, are recognized discounts which, at present, can be taken for estate and gift tax return purposes.  The amount of the discount depends on a number of factors; but, even with a discount as low as 20%, the effect of your 1% gift can be dramatic, as illustrated below.

Property Value: $1,300,000 prior to gift.  Transfer 1% for $13,000.  Undiscounted remaining value in estate $1,287,000.

Property Value: $1,300,000 prior to gift. Transfer 1% for $13,000. Discount for lack of control and marketability 20%. Remaining value in estate $1,029,600.

Fractional ownership of real estate can be burdensome, but when used effectively can have significant transfer tax benefit as illustrated above.  Consideration of this technique in a fully developed estate and business plan is certainly appropriate for those who have significant real estate holdings.

Intentionally Defective Budget Proposal: President Obama’s Attack on Grantor Trusts

 By Erica Opitz

On February 13, 2012, President Obama proposed the budget for 2013.  The budget proposal has been reported to be dead on arrival.  Notably, however, President Obama’s budget proposal went after intentionally defective grantor trusts, which is not a proposal that we have seen previously.  If this were to pass, the results would wreak havoc on a top estate planning tool. With the sun setting of the current estate tax code provisions at the end of this year, it is possible that President Obama’s grantor trust proposal will be used as a bargaining chip and could potentially reappear in future legislation.

Under the proposal, the legislation would only be effective for transfers on or after the date of enactment.  As a result, transfers to a grantor trust prior to enactment would remain outside of the grantor’s estate.  For this reason, it is important to take advantage of the grantor trust while the benefits remain available.

Current Law:

In an intentionally defective grantor trust, the grantor retains certain rights and powers over the property held by the trust.  For income tax purposes, a grantor trust is not a separate entity from the grantor, and as a result, the grantor pays all income taxes on the trust earnings.  Under the current regime, the assets placed in the grantor trust are held outside of the grantor’s estate.  The transfer of property into the trust is treated as a completed gift for estate and gift tax purposes.  As a result, future appreciation on the assets placed in the trust is not subject to estate or gift tax.  Furthermore, a sale from the grantor to the grantor trust is ignored for income tax purposes.

Proposed Law:

President Obama’s budget proposal would include the assets of the grantor trust in the grantor’s gross estate.  Additionally, any distributions from a grantor trust would be subject to gift tax as would the assets of the trust if the grantor ceased to be the owner of the trust.  President Obama’s proposal would apply income tax to a sale from the grantor to the grantor trust if the sale would be subject to capital gains tax if the sale was made by someone other than the grantor.  The Department of Treasury’s green book states the reasoning behind the proposal.  “Taxpayers should be required to take consistent positions in dealing with the Internal Revenue Service.  The basis of property acquired from a decedent generally is the fair market value of the property on the decedent’s date of death.”