Personal Wealth Law News

The bad news of our economic downturn has created good news in estate planning. Clients often ask us for help in transferring wealth to children and grandchildren, as a way of minimizing future tax liabilities. There are many ways of doing this, but they all have limits on the value of what can be transferred free of tax. Our current economic problems will come to an end and, as difficult as it may be to believe, we’ll be back in the plus column very soon. But, meanwhile, now is a great time to transfer assets, when values are temporarily reduced. It’s a good idea to have your estate plan reviewed periodically, and now is a very good time to do that, when tax-saving opportunities are more valuable.
In addition, several changes have taken place in the law applicable to estate planning, and they have created some further opportunities for effective planning at this time.
1. The annual federal gift tax exclusion has risen from $12,000 to $13,000 per donee. Annual exclusion gifts permit donors to transfer wealth to family members and others every year. At today’s lower values, more can be passed on to the next generation.
2. The federal estate tax exemption has risen from $2,000,000 to $3,500,000. This is a very large increase and permits families to transfer, potentially, up to $7,000,000 of assets without estate tax liability. It may permit less complexity in some estate plans. It is important to keep in mind that getting the maximum benefit from the estate tax exemption for husband and wife may require some shifting of assets or techniques to ensure that both husband and wife can use the estate tax exemptions. But this is the largest increase in the federal estate tax exemption in history.
3. This change in the estate tax exemption is effective throughout 2009. Under the structure of estate tax law now in effect, there is no federal estate tax with respect to persons who die in 2010, while in 2011, the tax returns with a much lower exemption, $1,000,000 and a much higher maximum tax rate, 55%. It seems very unlikely that this sequence of tax changes will occur. There has been a proposal made, which is supported by the new administration in Washington, to continue the $3,500,000 exemption indefinitely, with a maximum tax rate of 45%. Given the precarious budget situation in Washington, any further reduction of estate tax rates or increase in exemption seems unlikely. So, we can expect to have a federal estate tax, and it makes sense to plan and take steps now to reduce potential estate tax liabilities.
4. The interest rate used by the IRS for determining the amount of the gift that is made for certain types of planning techniques has reached an all-time low. The percentage rate for February 2009 is 2.0%. What does this mean?
• Grantor retained annuity trusts (GRATs) are particularly effective right now, because the amount of the gift will be low. GRATs are a method of deferred gift-giving, and they permit larger amounts to be transferred to the next generation.

• The same is true for charitable lead annuity trusts (CLATs) , but the lower IRS rate makes charitable remainder annuity trusts less advantageous. These are techniques to make combination transfers to charities and family members.

• Qualified personal residence trusts, which are deferred gift techniques for a residence, could be a great idea in an era of greatly reduced real estate values.

• Intrafamily loans or loans to controlled entities, can now be made (or restructured) at very low interest rates, another way of transferring wealth.

5. The requirement that persons who have reached age 70½ must take a minimum distribution from retirement savings has been suspended for 2009, for most types of qualified retirement plans and IRAs.
6. There is once again an opportunity for individuals who have reached age 70½ to roll over a portion of their IRAs, up to $100,000 per year, directly to charities. This technique offers significant advantages over the method of withdrawing funds from the IRA and paying them to the charity.

Please contact us if you would like to discuss any of these issues, or other estate planning matters.

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In the midst of disturbing news about the economy, there are opportunities now available that make succession planning for businesses work well. There are two reasons: lower values for businesses and historically low IRS interest rates used in planning for wealth transfers.

It’s no secret that the economic downturn has reduced the value of many businesses. For those businesses that are well-run, it’s likely that this will be only a temporary drop, and that as the economy recovers, values should increase again. That means that this is a good time to transfer assets at the lowest gift tax cost.

In addition, the interest rates used by the IRS in determining the value of split-interest and deferred gifts is now at its lowest point ever, 2.0% for gifts made in February 2009. If a gift is made in the form of a grantor retained annuity trust, which allows a business owner to transfer ownership but defer the date when the transfer is completed, more can be transferred when the IRS rates are lower.

Succession planning is a complicated process, but the benefits of doing it correctly and at the right time are great. Now is the time to think about that kind of planning.

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Unless you’re Charles Dickens, or one of the people involved in recently revealed alleged embezzlements that seem incredible.

My investment adviser suggested, or perhaps prayed, that the revelation of spectacular wrongdoing was a sign that we are coming to the bottom of the investment cycle. It’s not unlike the comment by someone, I think Warren Buffett, that when the tide goes out, you see who’s swimming naked. As always, there’s a lesson here, and it applies to everyone who has responsibility, however slight, for the care and management of money and other assets.

The lesson, fairly obvious, is that you must know where everything is, what’s being done with it and what people are charging against it. The rules of fiduciary responsibility are related in exhaustive detail in Austin Wakeman Scott’s treatise, in the Restatement of the Law of Trusts, in the Employee Retirement Income Security Act of 1974, and in numerous state laws and cases in Pennsylvania. We will shortly see the filing of many cases against Bernie Madoff and Marc Dreier, in which these principles will be cited. Between human greed, and Congress, lawyers will never go hungry.

Putting aside these spectacular examples of possible wrongdoing, the duty of care extends to many financial matters. Several of my clients have pension plans, where a third-party adviser handles investments. I am not the trustee and have no responsibility for the plans’ investments. Statements for the plans are sent to me monthly or quarterly. What is my responsibility with respect to those statements? I’m not to second-guess the investments, but perhaps there is at least a responsibility to make a cursory review of the statements. Either that, or I should either stop the statements from coming to me or advise the client that I cannot conduct any helpful review of the statements.

Here’s another example: A client has a retirement plan for which the investments are managed by one entity and the administration by another. Given the involvement of these two groups of experts, the client suggests that its office really need do nothing and has been able to supply few of the documents that it should have on hand. There’s probably nothing happening to cause concern, but I have advised the client that its responsibility is to have copies of all relevant documents, financial reports, and contracts setting forth who gets paid what for doing what. You can’t be criticized for having too much documentation of financial assets, but you can look like a great fool if you have to tell a judge, “I thought someone else was taking care of that,” or “They seemed honest.”

It’s not very likely that we will be involved in alleged embezzlements of the types reported recently, or the New Era scandal of a few years ago, or that we will meet up with the modern version Augustus Melmotte. But we will experience the need to be responsible in advising our clients on keeping good and careful records on the management of money and other assets, and this will help them from reading about themselves in newspapers or case reports.

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Which is far better than lemonade. Here are some things that are likely to happen soon.

The new administration is still more than a month away, but there are definite ideas about what might be proposed and implemented next year. Some of those changes involve estate-planning issues. Legislation that is proposed some time next year can be made retroactively effective to Jan. 1, 2009. It seems likely that there will be legislation to fix the estate tax craziness that was enacted in 2001 ($3.5 million exemption in 2009, no tax in 2010, $1 million emption in 2011). One method of fixing the problem is to continue the tax in effect permanently at the current flat rate of 45 percent, with an exemption of $3.5 million, the 2009 amount. The problem with that solution is that it brings in a lot less revenue than the $2 million exemption in effect this year. An alternative is to leave the exemption amount at $2 million until our budget deficits fall below a trillion.

In addition to changing the estate tax exemption or the rate of tax, or both, it’s possible to affect the tax collected by changing the law on what’s included in the taxable estate. One of the largest increases in the estate tax base took place during the Reagan administration, when retirement benefits were subjected to estate tax. Some suggestions are now being heard in Washington, ideas that have been percolating for a while and that address someone’s notion of tax fairness.

One proposal that has been discussed relates to transfers of family limited partnership interests. Because these kinds of assets are not publicly traded, a practice has developed of discounting the underlying value of the partnership assets when a transfer, such as a gift, takes place. Percentage discounts are a matter of opinion, and the IRS has been concerned that these discounts are not valid in every case. We are likely to see a proposal to end these kinds of discounts, especially where the partnership assets are investment assets, as compared to an operating business.

Another technique that has been extremely popular for many years is making gifts by taking advantage of the unfortunately named Crummey powers (Crummey refers to the name of a successful litigant against the IRS). Crummey withdrawal rights, which are almost never exercised, permit gifts that are not outright transfers to come within the gift tax annual exclusion ($12,000 this year, $13,000 next year). The IRS has never liked this concept, and may use the circumstance of the large budget deficits to propose its discontinuance.

Other suggestions made include cutting back on other discounted gift techniques, such as grantor retained annuity trusts and qualified personal residence trusts. It’s possible to maintain the fiction that you haven’t raised taxes by cutting back or eliminating these techniques, since they don’t change tax rates. Many practitioners are trying to close as many transfer transactions as possible this year, to avoid greater restrictions that could affect the ability to do estate planning next year. We’re entering a time of change, and those practitioners who are knowledgeable on the opportunities created by that change will prosper in the next four years.

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Sometimes it seems that our federal tax policy is written by the Marx Brothers. Here’s a curious example.

The Pension Protection Act of 2006 added a provision regarding distributions from retirement plans to beneficiaries who were not the surviving spouse. Why is this important? Under existing law, if a participant in a qualified retirement plan died, and the participant named the surviving spouse as the beneficiary for whatever remained, there were some tax options. Although most retirement plans require that death benefits be paid out promptly after death, in a lump sum, the surviving spouse could roll over the distribution to an Individual Retirement Account and avoid immediate taxation. The spouse could instead take out distributions as needed, and be taxed when distributions were made (subject to certain minimum requirements).

But if the beneficiary were not the surviving spouse, but, instead, the participant’s children, this option wasn’t available. The children would have to take out the balance immediately, under most plans, and be taxed on it. This was a much less favorable income tax situation. So, the Pension Protection Act authorized plans to allow distributions to non-spouse beneficiaries to be transferred to IRAs and avoid immediate taxation.

Many people thought that this meant that qualified plans had to permit such rollovers. But the Treasury indicated, initially, that it was an option for plans; they didn’t have to do it. Treasury representatives asked at the time why any plan would not have such a provision, but it appeared that some employers had decided not to offer this option.

To correct this situation, a technical corrections bill was offered, which contained language making the non-spousal rollover provision mandatory. Then, the Treasury indicated that, in its opinion, the rollover provision was voluntary for the current year, but would be mandatory in future years. However, that technical corrections bill was not enacted, and the Treasury appeared to go back to its original view that the provision was voluntary.

Finally, the matter has been resolved in the recently enacted Worker, Retiree, and Employer Recovery Act of 2008. Non-spousal rollover provisions will be required in qualified plans. Why is this important? For those non-spouse beneficiaries, it can make a huge difference in the incidence of taxation. What should you do about it? If you are participating in a qualified retirement plan (401(k), profit-sharing, etc.), you should find out what provisions the plan has for distributions at death. If the plan has an immediate payout provision, and you have named children or others as primary or secondary beneficiaries, be sure there is an understanding of the tax options if they inherit the retirement account. This could be by way of a memorandum added to your estate-planning file, for example. This is also a good opportunity to review your beneficiary designation for your retirement benefits. Do you know where that designation is? Of course, you don’t; neither do I. But it’s an important addendum to your will, along with beneficiary designations for life insurance policies. It’s a good idea to be sure your assets go where you wish at the appropriate time.

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We are a few days away from the beginning of an era of change. There are some things to do right now.

In 2009, some changes in our federal tax system are very likely to occur, and some are already in effect.

The federal estate tax exemption will rise substantially, from $2,000,000 to $3,500,000. This is a wonderful opportunity to shelter assets from federal estate tax, which seems likely to continue at a rate of 45 percent. Taking advantage of this change might require the shifting of assets between spouses. There are several ways of doing this, depending on how willing one spouse is to transfer assets to the other. There are some planning techniques that can be used to make transfers that are effective for estate tax purposes but do not transfer control of assets.

The gift tax annual exclusion has risen from $12,000 to $13,000 per year per donee. This isn’t a dramatic change, but for those who are able to engage in gift-giving programs, it’s an increased opportunity.

Under the current law, the federal estate tax will disappear in 2010 and then come back in 2011 with higher rates and with a $1,000,000 exemption. No one thought we would get this far without this crazy law being amended, and we now have just under 12 months to fix it. So, we should look for legislation this year, and who knows what it will include. If the present trend continues in Minnesota, we might have a professional comedian in the U.S. Senate, but he’ll have a lot of competition from the amateurs.

In the area of income taxes, we can expect to see scrutiny of various deductions and exclusions. This is often a method of raising taxes without increasing rates. When someone else’s deductions or exclusions are limited, it’s called closing loopholes. For example, early in the Reagan administration, the federal estate tax was amended to include retirement benefits in the taxable estate, perhaps the biggest tax increase of all time. But rates of tax didn’t change.

Alternative minimum tax remains a problem, with Congress applying an ineffectual bandage each year rather than finding a way to solve it. One of my partners sent around an e-mail toward the end of the year to remind people to make payments of estimated state taxes, to get a federal tax deduction, but another responded that the deduction was mostly taken away by alternative minimum taxes.

As with many areas of federal law (employment law and employee benefits law being prime candidates), 2009 promises to be a year in which tax laws will change. Whether or not it’s change we can believe in, it will be change to which we must and should pay attention.

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Tax legislation that was passed unanimously by both houses of Congress and quickly signed by the President offer some helpful ideas for retirement and estate planning.

First, required minimum distributions from defined contribution retirement plans and individual retirement accounts are suspended for 2009. This means that if you have reached age 70 1/2 and are required to take out a calculated minimum amount for 2009, you will not have to do so. This relief is to help account owners who suffered substantial losses in 2007 and 2008, by not requiring them to liquidate assets with depressed values to make the minimum payments. Most people who have retirement accounts and have reached age 70 1/2 need to take distributions for their living expenses, but for those who do not, this temporary change in the law might be helpful. It does have a revenue effect for the Treasury, because if less than the minimum amounts are withdrawn, less will be paid in taxes for 2009.

Second, a change has been made in distribution rules from qualified plans. This is how it works. Most qualified plans provide that if the participant dies leaving an account balance, that balance must be paid out promptly to the participant’s beneficiary. If the beneficiary is the participant’s spouse, the spouse can roll over the balance to an individual retirement account and avoid immediate taxation. But if the beneficiary is a child, for example, it was long the rule that no rollover was permissible. Therefore, the child would be taxed on the distribution immediately, rather than being able to stretch out distributions through an IRA rollover. A few years ago, legislation was passed to permit rollovers by non-spouse beneficiaries, but it appeared that this would only be permitted if the retirement plan specifically allowed it. There was confusion as to whether Congress meant that this provision should be optional, and the recently enacted tax legislation has now made it mandatory for qualified plans, beginning for plan years after December 31, 2009. This can be a very valuable planning technique for retirement benefits. It’s a good idea to find out what your employer’s plan provides at a participant’s death, and to ask that the non-spousal rollover provisions be added as soon as possible.

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