Personal Wealth Law News

The IRS has announced the interest rates applicable to various planning techniques, and they have fallen again, this time to 2.4% for transactions in September. We wrote last month that the falling IRS rates made GRATs and intra-family loans more attractive, and the same is true of charitable lead annuity trusts (CLATs). The further lowering of rates means that these types of planning can be even more effective. And while it’s disheartening to see stock market values continue to fall, those lower values also make gift planning more effective.

Part of planning for retirement is deciding how much to save, as well as what to spend those savings on and when. An article from the 8/8/10 New York Times descibes some experiences and learning on what makes people happiest. It appears that Americans are saving more and spending less, which is making them happier, and that when they spend, the greatest satisfaction comes from experiences rather than things. Here is a link to the article: http://www.nytimes.com/2010/08/08/business/08consume.html?ref=business

Social Security has been described as the most successful Federal program ever established. For some reason, perhaps related to politics, there have been claims in recent years that it was unsustainable and had to be drastically overhauled or scrapped. But several studies and reports in just the past few weeks have shown that this is not the case. An article in Bloomberg Businessweek includes this statement: “fact is, there is no Social Security crisis. The system isn’t broke. There’s financial trouble down the road but it’s manageable.” Another article, commenting on the annual report of the Social Security Trustees, says: “long term, Social Security is doing just fine, thank you very much.”

But there are issues regarding future benefit payments, and if nothing is done, there could be problems. The solution is to do something. The Congressional Budget Office has just issued a comprehensive report, titled “Social Security Policy Options”. In that report, there are 30 options suggested that, in various combinations, could ensure the long term viability of the Social Security system. They are categorized as follows:

• changing the taxation of earnings
• changing the benefit formula
• increasing benefits for low earners
• raising the full retirement age
• reducing cost of living adjustments

As the summary of that report states: “long-run sustainability for the program could be attained through various combinations of raising taxes and cutting benefits; such changes would also affect the Social Security taxes paid and the benefits received by various groups of people.”

A business school professor told the son of a client: “there’s nothing like working in a family business.” That’s true in several ways. Working in a family business can give someone a clear, eventual path to ownership and allow him or her to learn about all aspects of the business by moving from job to job within the business. But there are also pitfalls to consider: is there really a path, or will the family member not be taken seriously, by the family members and the non-family employees? Will the family member feel that it was all fixed for him or her, no matter how hard he or she works in the business? An interesting article in the Business Section of the 8/1/10 New York Times discusses some things to consider before joining a family business.

A study by the Employee Benefit Research Institute concludes that many people will be at risk of running out of funds sufficient to pay living costs at some point after retirement. Not surprisingly, the results differ based upon the level of pre-retirement income. For people in the highest quartile of pre-retirement income, 5% are at risk of running out of funds within 10 years of retirement, and 13% within 20 years. But at the lowest income quartile, 41% could run out of funds within 10 years and 57% within 20 years. Yet another reason for doing whatever is possible to maximize retirement saving.

The Florida Supreme Court has just issued an opinion denying asset protection for single member LLCs. We’ll write more about this later, but it points up the importance of thinking about protecting the wealth you have accumulated.

The IRS has just announced that the applicable federal rate under Code Section 7520 will fall to 2.6% in August, down from 2.8% in July and 3.2% in June. These very low rates make certain planning and wealth transmission techniques far more effective. For example, the use of grantor retained annuity trusts (GRATs) is far more effective when interest rates are lower. This means that larger amounts can be transferred to succeeding generations= more efficient estate planning.

 In addition, low interest rates mean that intra-family loans are more effective. For example, under the August rates, you can lend to a child, for example, for a term of less than three years at annual rate of just .53% per year. The child can then invest the money and keep the difference in rates. This is a way of transferring wealth without using annual gift tax exclusions or lifetime exemptions.

 Combined with the continued low values in many assets, these low interest rates make this an ideal time for estate planning.

At the beginning of this year (2010), there was discussion in the press and in legal publications about the ability to convert IRAs and qualified plan accounts to Roth IRAs. This conversion involved paying taxes now and then being free of them thereafter, plus avoiding the necessity of minimum distributions during life. In effect, for those people who really didn’t need the amount being converted, conversion was a very effective multi-generational planning technique. To the extent you believe income tax rates will be higher in the future (a good bet), conversion makes sense. There’s a choice you can make when converting, whether to pay taxes this year at this year’s rates or over the next two years at whatever the rates will be then. Some people prefer to pay this year, because they like knowing what the tax rates will be.

Another advantage of conversion now is that security values are still low. The stock market is still far off its high values of a few years ago, so conversion now, before (we hope) the stock market recovers, is a good idea. Conversion is not for everyone. It requires some thinking about the future and personal planning. But there is still time to begin that process.

Is it possible that Congress will do nothing for the rest of the year to restore the federal estate tax? Given the other items on its agenda, and the fact that this is an election year, it’s very possible. But then what? At the end of the year, the so-called Bush tax cuts expire. That means that the estate tax will return, at its earlier rates and exemption level: a maximum graduated rate up to 55% and an exemption of only $1,000,000 (as compared to the $3,500,000 that was in effect in 2009). Many more people will be subject to federal estate tax, and that will affect the planning they should be doing now.

In addition, the lower income tax rates that were in effect will expire. Capital gains rates will return to their prior, higher levels, and regular income tax rates will also rise. Congress has the ability to extend the lower rates, but it must take some action to do that. And we have seen that on tax issues, it’s difficult to get changes enacted. What if Congress does nothing, or if efforts to extend the lower tax rates fail? Higher taxes. It’s probably a good idea to start planning with respect to income taxes now, in anticipation of eventual higher tax rates: possibly postponing deductions to next year and accelerating income into this year. All of this could change, but it’s probably wiser to assume that nothing will happen.

The IRS has announced the rates of interest used in valuing gifts and other transfers for the month of July, and they have fallen again. This means that transfers to the next generation can be made at a lower cost in gift tax exemption. But here’s something else affected by these lower rates: intra-family loans. An individual can lend money to a child or grandchild, for example, for a period up to just under three years, and charge interest at the rate of .61%. That means that a loan at that rate will not be considered a gift. How does this work? The person who receives the loan invests the money and earns some rate of return. To the extent that the rate exceeds the required loan rate of .61%, the borrower gets to keep the difference, and that can be substantial if the loan is big enough. The difference is not considered a gift to the borrower, which makes the intra-family loan an effective technique of transferring assets without worrying about the gift limitations in the Internal Revenue Code.