Personal Wealth Law News

 In Lieu of a Tax Refund, a Chevy Nova 

by Robert H. Louis

OK, that’s not part of the President’s tax proposals, at least not yet.

The Obama Administration has released some of its tax proposals and, under the rubric of closing “sort of” loopholes, there is a suggestion that grantor retained annuity trusts (GRATs) must have a minimum length of ten years.  GRATs of two years’ duration had become popular, as a technique that improves on the benefits of longer term GRATs, and commentators had suggested that even greater benefits could be obtained with very short term GRATs.  GRATs are a useful technique for transferring wealth, but some in Washington apparently thought the technique was being pushed beyond its intended level of tax benefit.  Similarly, a proposal has been made to limit the kinds of discounts that may be obtained in transfers to family limited partnerships (FLPs).  FLPs are also a popular transfer technique, and an important part of the value proposition is the reduction in value that results from restrictive provisions in the partnership agreements.  Again, it is apparently someone’s view that discounts based on provisions of the partnership agreements are not always supported by reality.

These views, of course, were not formulated since January 20, 2009.  They have been percolating in Washington for years, and represent the tension between those who want to push the envelope of tax planning techniques and those who view most tax planning as somehow unfair or undemocratic.  When these proposals are taken up in earnest later in the year, there might be additional restrictions placed on planning techniques.  In fact, that’s just about certain to happen.  For now, the proposals being made are stated to become effective on enactment.  It is possible for changes to be made retroactive to the beginning of the legislative session but, for now, that’s not the stated intent.  For that reason, there is now a flurry of planning taking place.

One item that Congress still hasn’t taken care of is the federal estate tax or, as PR hacks like to call it, the death tax.  Under the current law, the exemption from tax is $3,500,000 and the tax rate is 45%.  In 2010, the tax disappears, but for one year only, then comes back in 2011 with a graduated rate up to 55% and an exemption reduced to $1,000,000.  The Administration has proposed continuing the 45% rate and the $3,500,000 exemption indefinitely, but attention seems about to turn to the health care reform bill, with the hope that a bill will be passed by October 1.  Will this effort, on top of the variety of other issues now before Congress, including one or two wars, a Supreme Court nomination and the financial crisis, give adequate time to amend the estate tax law by the end of the year?  As noted above, Congress could make the change next year and have it retroactive to January 1, 2010, but that would only add more uncertainty to what is becoming an uncertain federal tax system.

The next six months are likely to see significant changes in how we and our clients are taxed, as well as how we receive and pay for health care.  It’s not too early to think about a moon roof with that tax refund.

 (from the Legal Intelligencer)

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Planning for Parents’ Expectations Or, I was A Co-Star of Beach Blanket Bingo

by Robert H. Louis

I read an obituary for Jody McCrea, son of famed movie star Joel McCrea. How quickly they forget.

As everyone knows, Joel McCrea was a well-known movie star of long ago. His son, Jody, who died recently, had roles in beach movies of the 1960s that starred Philadelphia native Frankie Avalon and Annette Funicello. In later years, he became a cattle rancher in New Mexico. I hope he had a satisfying life and did what he wanted after retiring from the silver screen. There’s a lesson here for those who help successful families plan their futures.

The aim of many business owners is that the business will continue after the founder has passed on. Men and women who start businesses and make them a success have characteristics that aid in their work, such as determination to succeed, diligence and a willingness to take intelligent risks. It’s not always the case that the children share those characteristics. They may have been sheltered from risk and disappointment in ways their parents were not. That doesn’t always mean that the children can’t succeed in the business. I can think of many examples where second, third and fourth generations continued successful businesses. But there’s clearly an art to raising children and helping them to carry on a family business.

How can lawyers and other advisors help with this process? We can offer suggestions on how children can start with a business, perhaps in ways that allow them to back out if working in a family business isn’t for them. We can advise parents not to assume that a child or children will want to be in a family business. Rather than a child committing fully to the family business at a young age, we can suggest a “training wheels” approach to working in the business. If the children decide that they don’t want to take part in the family business, we can suggest alternatives for the business, such as a sale to inside management, to an ESOP or to outsiders. Mostly, we can listen, ask a few questions about the parents’ intentions and be ready to share our experiences and advice on the future(s) of family businesses.

A family business can benefit families in a variety of ways, providing a comfortable income to the extended family and a source of employment for future generations. But if children are not meant to be part of a family business, it’s a mistake to push them into it. And it’s a mistake to think that if a family business doesn’t continue in the family, it’s not a success. Family businesses can be a source of wealth that permits succeeding generations to follow other paths. Perhaps Jody McCrea’s salary from Beach Blanket Bingo helped to pay for his cattle ranch. 

 (from the Legal Intelligencer)

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He Signed Into Law One of the Largest Tax Increases in History

By Robert H. Louis

And his initials are RR. No, it wasn’t Roy Rogers.

For many years, retirement account balances were exempt from federal estate tax. This was a valuable benefit, as retirement accounts grew to become a large portion of people’s wealth. During the Reagan Administration, these assets were gradually subjected to federal estate tax and are now fully taxable (with some grandfather provisions that are fading away). But retirement benefits are generally also subject to ordinary income tax (with more grandfathering and recent provisions on Roth benefits, which can be free of income tax). This means that these benefits are frequently subject both to income tax and estate tax. The combination of those two taxes can wipe out most of the value of the retirement accounts (that portion that the stock market hasn’t already wiped out). A very useful planning program from Steve Leimberg, which calculates the amount left after paying both taxes, is aptly titled “Confiscate”.

Many people, of course, will need their retirement benefits for support in retirement. But it probably makes sense to spend savings that do not generate income tax first, which means postponing the withdrawal from retirement accounts as long as possible. Withdrawals must begin shortly after reaching age 70 1/2, but the required distribution amount is small enough in early years that the account could continue to grow, at least in normal times. So, for some people, at least, there’s a good chance that amounts will remain at the participant’s death.

For those people who are married, most will be well-advised to name the surviving spouse as the beneficiary. This will avoid federal estate tax, and it’s possible that in the spouse’s remaining lifetime, the benefits will be withdrawn, taxed and spent. But in an era of second marriages, that won’t always be the favored choice: benefits may instead be divided with children from a first marriage. In this case, it may be necessary to use part of the estate tax exemption, which is $3,500,000 this year and seems likely to remain there for future years. That relieves the benefits from federal estate tax.

Another technique that has been suggested, for people with charitable interests, is to leave retirement benefits to a charitable entity. This relieves the benefits from both federal estate tax and income tax. At the death of the account owner, the balance is simply paid over immediately. There’s no need to worry about minimum required distributions. A similar technique names as the beneficiary of the retirement benefits, at the owner’s death, a charitable remainder trust. But this won’t always be the best result. Why? Because in naming a charity as the beneficiary, the ability to postpone withdrawals of taxable benefits over a long period of time is lost. Studies have been done by commentators that show the significant benefits of being able to postpone the distribution of benefits over very long periods of time (such as by naming grandchildren as the beneficiaries). Neither technique is always correct.

There is no one correct method of dealing with the problem of double taxation of retirement benefits. It is an important part of the estate planning process, and it illustrates the necessity of considering spending patterns during life as part of the estate plan. Estate planning, in this context, is the process of planning wealth transmission and its estate tax and income tax consequences during the working years and the retirement years, as well as at death

 (from the Legal Intelligencer)

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The Solution for Lawyers: AbstinenceBy Robert H. Louis 

That’s financial abstinence, of course.  The other kind, the Mrs. wouldn’t appreciate.

Perhaps you’ve checked your retirement account balance.  Neither have I, but it’s probably off a little from it’s peak in late 2007.  If history is a guide, the market will recover before the economy in general, and that could happen over the next few months.  But it’s likely that a full recovery of your retirement account will take a year or two, perhaps longer.  That’s not too serious a problem if you have many years left before retirement.  But, what to do if you’ve just reached your retirement age or will do so in a year or two?

Many financial advisors remain confident that the securities markets will recover after a year or two, but that’s little comfort if you’ve cashed out of investments and are taking withdrawals.  You will be better off if you can wait to take withdrawals from your retirement account.  And you can do that.  The Internal Revenue Code rules on minimum distributions from qualified retirement plans, such as 401(k) plans, require that distributions begin by April 1 of the year following the year in which you attain age 70 1/2.  Even then, required minimums for the first few years hover around the 4-5% rate.  This means that, at least in normal times, your account could actually continue to grow for a few years after you start taking distributions.  As an alternative, take the funds you need for retirement from non-tax-deferred accounts for as long as possible.  Since you’re withdrawing savings, much of what you take for living expenses will not be taxable income, which means that your income tax liability will fall.  Compare that to distributions from qualified plans, nearly all or all of which will be fully taxable as ordinary income.

Another retirement topic being discussed in today’s economic environment is the wisdom of converting a traditional IRA into a Roth IRA.  Roth IRAs have the advantage that, after a period of time, all distributions are completely free of income tax.  The cost of doing so is that the traditional IRA must be subjected to income tax at the time of conversion.  But if the values of assets are low, the cost of conversion, that is, the payment of income tax, will be lower as well.  There is an income limit that prevents many people from converting to Roth status, but that income limit will disappear next year (unless the law is changed).  The premise of this type of planning is that although you pay tax now, all of the future growth will be tax free.  That’s a strategy, but you have to consider how long you will have to experience that growth.  If you’re at or near retirement age, and you will need the IRA for retirement expenses, you might not have the time for growth that offsets the disadvantage of paying tax up front.  As with all retirement planning strategies, one size does not fit all.

(from the Legal Intelligencer)

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“PEOPLE ARE FUNNY”

By Robert H. Louis

Was a classic TV show in which people did humiliating things for money. Sound familiar?

Sometimes, you can suggest  to a client a very sensible course of action in deciding on the future of a family business, but find that the client doesn’t want to do it.  Often, it’s because lawyers are acting in a logical way to think of a solution to a problem, taking into account tax and corporate law.  But the client is thinking in a different way, adding in the cost in personal relationships in doing or not doing something.  The client might agree that the proposal makes sense, but know that members of the family will view it from an emotional viewpoint, with the baggage of family relationships that have developed over many years.  So the lawyer might find that carefully made plans go nowhere, for reasons that aren’t always clear or clearly explained by the client.

A situation of this type was faced by a client a few years ago.  The client had a son and a daughter working in the business.  He had hoped that both of them would be successful in the business, but that didn’t happen.  One child was a hard worker, in at 6 AM, while the other drifted in at 9:30.  The right planning technique would have been that the industrious child be recognized as the business successor, but the parent didn’t want to do that.  The client loved and cared for both children and didn’t want to hurt either of them.  The problem this created, obviously, was that the more industrious child began to feel that hard work was not paying off.  It took several years of talking around the point for the client to understand that two paths were necessary.  The children could be treated fairly equally from a financial standpoint, but one would become the business owner, while the other would be guided into another endeavor.  Was this entirely fair?  Perhaps not, but it reached a resolution that allowed a family-owned business to continue on and to prosper, which surely would not have happened if both children had remained in the business.

The psychological aspects of family business planning were brought home in a recent meeting in Philadelphia.  A group of lawyers, bankers, investment advisors, accountants and other professionals is organizing a chapter in this region of the Family Firm Institute, an international organization for family business advisors that sponsors research and study on the issues facing family businesses and how to resolve them.  At the meeting, which featured members of a family who described their history of forming a business, growing it and selling it, there were a large number of psychologists, psychiatrists and family business consultants in attendance.  In discussions at the meeting, they brought home the value of bringing their expertise into the mix of family advisors, for the express purpose of helping businesses to run more smoothly and their transition to be accomplished successfully. 

Lawyers often act as counselors to family businesses, stepping a little beyond the task of telling clients the law.  But there are circumstances in which psychological/family issues interfere with carrying out worthwhile planning ideas in ways that go beyond the lawyer’s ability to help.  It’s here that the lawyer might consider bringing in, and sharing the stage with, professionals trained in a different discipline who can help clients reach an understanding of personal and family concerns that interfere with the success of a family business.  In doing so, the lawyer can increase the likelihood that the clients will adopt the lawyer’s planning suggestions and improve the chances of family business success.

(from the Legal Intelligencer)

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Criminals I Have Known

by Robert H. Louis

Not the high class kind, with a mask and a gun, but the financial type.

Much has been written about the psychology of people like Bernard Madoff, who apparently can invite people to invest with them in the knowledge that their money will eventually disappear. None of my clients dealt with Mr. Madoff, but I have met with advisors who, at a later date, were accused of having used client funds for their personal expenses. The two I have in mind presented themselves as intelligent and savvy investment advisors. I’m not sure they intended to convert funds from the outset, but it’s alleged that that was their eventual course. Both spoke knowledgeably about the market, in a way that impressed less sophisticated investors, which is just about all of us. This came to mind over the weekend. On a flight from Munich to Philadelphia, I was the third party beneficiary of a passenger who spent about three hours telling the person next to him that his advisor was the greatest and had exactly predicted the market downturn. (For the record, I have one wealthy client who, on his own, correctly anticipated the market decline and suffered no losses. I’m fairly sure that he finished high school.)

What is the lawyer’s role in dealing with investment advisors? It’s certainly not to give investment advice to the client, but it’s also not to remain silent. I have written before that these uncertain times have led many to consider investing through large organizations, because of their deep pockets and internal protective procedures. Others prefer individual or small firm guidance. In either case, it is the lawyer’s task to ensure that all of the necessary paperwork has been completed and copies given to the client. It’s important to remind the client to have regular meetings to review investment strategies and results. It’s also appropriate, if the advisor is achieving investment results that are significantly better than others are achieving, to ask how this is being done. That is, due diligence. In some cases, it might be advisable to bring in another advisor, just to review what the first one has done. I once suggested this to the board of an industry pension plan, because its advisor had done extremely well with investments no one on the board could understand, and unwitting uncovered a massive fraud and theft by the advisor. So, the lawyer is not an investment advisor, but he or she should be asking the client if steps are being taken to ensure that what is promised or advertised is in fact happening.

This is a little off the point, but my recent travels also took me to Vilnius, the capital of Lithuania, a country where the protection of rights by lawyers was, until recent years, subject to the control of an overbearing Communist regime. I had an opportunity to visit a KGB prison, where I saw cells used for torturing political opponents. The Lithuanians have opened these cells to public view, so that they will not forget the horror of living under a regime that condoned and practiced torture.

(from the Legal Intelligencer)

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What Philadelphia Has Plenty Of

by Robert H. Louis

It’s family businesses. Actually, it’s a worldwide phenomenon.

Throughout the world, family ownership is the predominant form of business operation. This is true in India, Australia, Germany and, of course, in the U.S. The Philadelphia area, including New Jersey, Delaware and southeastern Pennsylvania, has many thousands of family-owned businesses. They are the primary engine of business and employment growth in this region.

Family-owned businesses offer many advantages. A business school professor told a client’s son who was in one of his classes: “there’s nothing like a family business.” But there are challenges in family-owned businesses. The ability of a family-owned business to continue for succeeding generations is dependent upon finding the right leadership qualities in the next generation and also navigating family relationships to minimize discord.

There are many areas of family business that benefit from the help of lawyers, as well as accountants, financial advisors and business planning consultants. The services that lawyers offer include business counseling, gift and estate planning, buy-sell agreements, retirement planning and other assistance in helping the older generation feel secure in turning over the business and the younger generation feel confident in taking over.

One organization that helps lawyers and others to understand family business issues and to serve the needs of business owners is the Family Firm Institute. This national and international organization provides books, courses and web site information to help business advisors throughout the world understand and guide business owners. A group of lawyers, accountants, financial advisors, psychologists and other consultants has decided to establish a chapter of FFI in the Philadelphia area, and FFI has approved the formation of the Mid-Atlantic Chapter. We plan numerous kinds of programs in Pennsylvania, New Jersey and elsewhere in the coming year. If you would like more information about the new chapter of FFI, contact me at rlouis@saul.com.

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It’s A Holiday Miracle

By Robert H. Louis

Congress has fallen below even the lowest expectations of tax practitioners.  It’s like a (bad) dream come true.

For the past eight years, I’ve been describing our estate tax system to clients: we’ll have gradually lowering rates, and the exemption will eventually rise to $3,500,000.  Then, if you can believe it, there will be one year, 2010, when the tax will disappear.  The next year, the tax will reappear, at the higher rates and lower exemption that existed before the law was changed.  Then, I would explain that Congress would of course have to fix the law because that made no sense.  We would laugh and I would send them a bill.

But time passed and the law wasn’t fixed.  Congress flirted with repeal of the estate tax, but never reached that point.  It was assumed that they would do something to avoid this strange sequence of tax law changes, which originated in artificial budget constraints.  There was some continued grumbling about repeal, mostly from people trying to get the attention of wealthy donors.  Earlier in this month, it appeared that there would be a one year extension of the current law ($3,500,000 exemption, 45% tax rate), then maybe an extension of a few months.  Now, the effort to extend the law has been abandoned for the year, and the estate tax is scheduled to be reduced to zero in 2010.

Leaders in Congress promise that the law will be changed early in the year.  But that means that the law would have to be amended retroactively to the first of the year.  Otherwise, the lucky people who die in the first week (or actually their families) would have a windfall for no particular reason.  Congress has the power to pass tax laws on a retroactive basis, at least back to the beginning of the year, but every time this happens, there are lawsuits, and we can expect those again (“Grampa died with a smile, knowing we wouldn’t owe any estate tax”), but it’s likely that a retroactive change would be upheld.

The absence of an estate tax in 2010 has another consequence.  Under the current law, when someone dies, his or her assets are stepped up in basis to their date of death value, which is a valuable tax benefit.  Without an estate tax, assets won’t be stepped up.  Instead, those who inherit will carry over the basis the decedent had, which will add to the complexity of the tax law administration and increase tax liabilities on the heirs, in many cases more than the estate tax would have done.  When carryover basis was added to the law in the 70s, it was so complicated that it had to be repealed.  Let’s hope that a new year will bring a resolution of this problem.

(from the Legal Intelligencer)

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Congress Finally Abandons Common Sense

by Robert H. Louis

Perhaps the only surprise is that someone thought they had common sense.

In the week since the dawning of the (temporarily) estate tax free world, it has now been suggested that Congress will not try to reenact the federal estate tax retroactive to the beginning of the year. There was considerable uncertainty expressed as to whether Congress could do such a thing.  If they did so, there would surely be litigation challenging such action, and that would have resulted in delay in settling estates.  The effect of leaving the estate tax in abeyance for a period of time, which might continue for the entire year, is that anyone dying during the period would have no estate tax assessed on his or her estate.  Of course, very few people have enough assets to be subject to the estate tax, under the $3,500,000 exemption in effect in 2009.  But the news for families of those who die during the lacuna period is not all good, because of the carryover basis problem.

If the assets of a decedent are not subject to estate tax, then the basis of those assets is not automatically stepped up to date of death value.  There’s an exception to this rule, as there is to everything in the Internal Revenue Code. A certain amount of assets may be stepped, more if they pass to a surviving spouse.  But this requires additional work to determine which assets should be chosen for stepup.  And for those assets not stepped up, it will be necessary to keep records of the basis of the asset when it was owned by the decedent.  That could be difficult for assets acquired by the decedent many years earlier.  And it has the tax effect of subjecting those assets to capital gains tax upon sale that would have been avoided if all assets had been stepped up to date of death value.

But there’s another wrinkle.  Many wills that were written based on the existence of the federal estate tax might not work as intended if there is no such tax in effect.  For example, many wills have been written in this way: give my surviving spouse the smallest amount necessary to reduce the estate tax as low as possible, and the balance to a trust for my family.  When the tax was in effect, that meant that the exemption amount would go into the trust, and the balance would pass to the spouse, outright or in another trust.  But now, the amount that must pass to the trust to minimize estate taxes is zero, so nothing would be allocated to the spouse.  The spouse might benefit from the remaining trust, but only if the will is written so that the spouse might benefit from that trust, and not all wills are so written, particularly those where there is a second marriage.  So this change in the will might result in estate plans not working as intended, possibly leading to surviving spouse electing to take a statutory share in lieu of the will provisions.  And lawyers may be called to account if they haven’t advised clients of the effect of the change in the law, and the possibility of amending wills to correct the problem.  Our firm has been contacted by our insurance carrier to advise us of our responsibilities toward clients as a result of the lapse in the tax.  So the failure to extend the tax has possible effects beyond the simple freedom from estate tax for those who die before the tax is reimposed.

(from the Legal Intelligencer)

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