Essex County Estate Planning Council

							    Essex County Estate Planning Council

                     December 3, 2009


                   George L. Cushing, Esq.
                        K&L Gates

                 Carolyn R. Stall, CPA, CFP™
                   UHY Advisors, N.E., LLC

                  Michael L. Brown JD,CPA
           UHY Advisors/Boston Financial Management
1
    Highlights of Past Year
     Trillion $ Stimulus Package

     Stock market recovery

     Healthcare debate

     Interest rates still at historic lows

     Jobless recovery

2              What happens next?
Tax Rate Increases We Know Will Occur
                      2009-2010   2011 and
                                  Beyond
Ordinary Income         35%       39.5%+
rates
Capital Gains rates     15%         20%
Dividends rate          15%        39.5%
AMT rate                28%         28%
Estate tax rate         45%         55%
3
        Other Taxes in Your Future
     Medicare premiums being raised?


     Surtax on wealthy


     Employer and individual healthcare excise tax


     Limit mortgage interest and charitable deductions


     Future increases in payroll tax base


4                   And the list goes on and on…
    Other Expiring Tax Provisions
       Sales tax paid on new car purchase

       50% Bonus depreciation

       Higher Section 179 write offs for business assets

       Proposed changes to Net Operating Loss
       carrybacks
       AMT Exemption
       Deduction of real estate taxes for non
       itemizers

5
Good News -
First Time Home Buyers Credit Extended
     $8,000 “first time” credit extended to April 30,
     2010
     First time: “haven’t owned home within previous
     3 years”
     Home purchase limit $800,000

     Income limits – phase out at $125,000
     single/$225, 000 joint
     Supplementary credit of $6,500 for current
     homeowners

6
      2009 Year End Tax Strategies
     Harvest capital gains
     Harvest capital losses (watch wash sale rules)
     Avoid purchasing mutual funds late in year
     No RMD for 2009
     Increase tax withholdings to avoid
      underpayment penalties
     Donations of appreciated property to charity
     Donation of IRA to charity
     Charge 2009 year end donations to credit card
7
Other Tax Incentives to Keep in Mind

     Energy- Efficient Home Improvement
     Credit: $1,500
     Residential Energy Efficient Property
     Credit (for alternative energy equipment):
     30% of cost
     College credit (1st 4 years): $2,500 per
     student

8
                 Roth Conversion

     No income limit beginning 2010

     For 2010 only, can report in 2011 and 2012

       Re-characterize until 10/14/11

       No RMD at 70 1/2

9
                 Roth Conversion

      Can pass Roth to children

      Spread over beneficiaries life

      5 year minimum holding period

      Partial Conversion is OK


10
                   Roth Conversion

                     Not for Everyone

      Low tax bracket in 2010

           Low income
           Big loss ( ordinary…not cap loss)
           Significant deductions

11
                 Roth Conversion

      Higher bracket in retirement

      Elderly client with a taxable estate

      Don’t need RMD income

      Have cash for tax liability


12
                    RE-CHARACTERIZE
     Investment      01/01/10   10/14/11*   Difference
     S&P 500           $20         $30          10

     Small Cap         $20         $35          15
     Emerging          $20         $10         (10)
     Market
     Gold              $20         $5          (15)
     Bonds             $20         $20           0
     TOTAL             $100       $100          0

     *21 ½ Months
13
 Roth Quiz


     Do $1M Roth Conversion in 2010, pay tax, invest
     for 25 years?

                             vs.

      Don’t convert, defer tax, invest the deferred tax
                          amount?

14
 Roth Quiz

  Question:
    Say 25% tax rate now and 25% tax when
     retired.

        Answer:
          No Savings…except your ROI


15
 Roth Quiz

      Question:
        Say 25% tax now and 50% tax then.



       Answer:
         $1M more in 25 years
         $5M more in 50 years

16
                Roth Alternative
      Donate IRA to Charity, save tax

      Beneficiary receives stepped-up property
      vs. IRA*



     *With IRD Deduction as Itemized Deduction


17
         YEAR END PLANNING DURING
             TURBULENT TIMES
              I. Interest Rates – 7520 Rate

      7520 Rate (prescribed monthly by IRC §7872)
      Adjusted monthly based on 120% of average mid-
      term rate on US Treasury Securities
      Range 6% to 11.6% until 1999

      Range 2% to 6% from 2001 to present

      Current 7520 Rate (December, 2009) = 3.2%



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19
                       7520 Rate




                        0%
                        2%
                        4%
                        6%
                        8%
                       10%
                       12%
                       14%
            1/3/1989

            1/3/1991

            1/3/1993

            1/3/1995

            1/3/1997

            1/3/1999
                                   7520 Rate




     Date
            1/3/2001

            1/3/2003

            1/3/2005
                                               History of 7520 Rate




            1/3/2007

            1/3/2009
            Volatility of Stock Market
        History of Dow Jones Industrial Average
      1989 to October 9, 2007 – rose to 14,164

      By March 9, 2009 – declined 53.78% to 6,547

      April through June 1, 2009 – rose 33% to 8,721

      June through November 30, 2009 - rose 20% to 10,432




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        Volatility of Real Estate Market

      1992 to 2003 (13 yrs) – 50% GROWTH


      2004 to 2007 (3 yrs) – 150% GROWTH


      1/2008 to 2/2009 (13 months) – 62% DECLINE


      3/2009 to 5/2009 (3 months) – 31% GROWTH


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                II. Planning Options
     A. Applicable Interest Rates
        1. Loans:
           (a). Taxpayer must use “Applicable Federal Rate”
                  (“AFR”) under §7872 to avoid adverse gift
                  tax consequences


           (b). AFR varies, depending on term of loan:
                 o Short-Term Rate (3 yrs or less)
                 o Mid-Term Rate (4 yrs to 9 yrs)
                 o Long-Term Rate (over 9 yrs)


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     Applicable Interest Rate (continued)
                 Recent AFRs

     Month, Year   Short-Term   Mid-Term Rate   Long-Term Rate
                      Rate
       June,         0.75%         2.25%            3.88%
       2009
        July,        0.82%         2.76%            4.36%
        2009
      August,        0.83%         2.80%            4.26%
       2009
     December        0.69%         2.61%            4.09%
       2009

23
     Applicable Interest Rates (continued)
     2.(a). For GRATs and CLATs taxpayer must
       use
          §7520 Rate (120% of Mid-Term AFR)


      (b). For CLATs, taxpayer has special rights –
      taxpayer can select either (i) §7520 Rate for
      month in which CLAT is created/funded or (ii)
      §7520 Rate for either of prior two months

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     Applicable Interest Rates (continued)


       3. For SALES or EXCHANGES, AFR used should be
         lowest rate in effect for the three calendar
         months ending with the month in which there is
         a binding contract in writing for the sale or
         exchange




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                B. Intra-Family Loans
     Governed by §7872, a “below market loan” will be treated
      as a “gift loan”
        If a “gift loan” interest is imputed from borrower to
         lender at AFR and “foregone interest” is treated as
         taxable gift
        Lender subject to income tax on “foregone interest”

        Planning Goal: to lend funds to family members in
         order to permit borrowers to invest loan proceeds in
         assets which produce a higher total return over term
         of loan than AFR


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                      Term Loans
     If applicable interest rate ≥ AFR for term of
       loan, and compounded semi-annually, not
       treated as gift loan
     Requirements:
        Written note
        Fixed maturity date
        Provision regarding payment of
         interest/principal
        Provision regarding collateral, if any


27
                 Demand Loans

     If applicable interest rate ≥ short-term AFR,
     compounded semi-annually, for period in which
     loan is outstanding, not treated as gift loan

     WARNING  if Lender never demands payments
     or borrower does not have means to satisfy loan,
     IRS may reclassify loan as gift!



28
Intra-Family Loans – Tax Considerations

      Transferor must recognize interest income

      Transferee generally cannot deduct interest payments
      (exception for interest on loans secured by home
      mortgage or “investment interest”)
      To reduce impact of income taxes, consider making
      loan to irrevocable “grantor trust” for the benefit of
      “borrowers”



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                  Loan to Grantor Trust

      Transferor creates “grantor trust” & funds trust with
      “seed” money (at least 10% of total assets to be transferred
      to trust)
      Transferor makes loan to trust of remaining 90% in
      exchange for a promissory note
      Trust may be structured as “dynasty” trust for the benefit
      of future generations and continue as long as the law
      allows, which also provides protection from creditors
      “Grantor trust” status can continue throughout
      Transferor’s lifetime



30
                 Which rate to use?

      Make sure to check the rates - sometimes short-term
      rates are higher than mid-term and long-term rates
      Make sure to check spread between rates – sometimes
      it may be minimal
      AFRs published monthly about a week before the end
      of the prior month, so wait until next month’s rates
      are available to decide when to make the loan (use
      more favorable rate)
      Note should permit prepayment without penalty (to
      permit parties to refinance if AFRs change materially)

31
                     C. Outright Gifts
                Tax Benefits of Outright Gift – Example

      Donor has $40M estate and 2 children
      Assuming 50% estate tax rate, no state estate tax & no
       remaining estate tax exemption, and
      If at least 3 years prior to death, Donor gives $10M to each child
       ($20M total):
        Gift taxes = $10M
        Donor’s remaining assets ($10M) after estate tax ($5M) pass to
          children; each child receives $2.5M
        Each child receives $12.5M total inheritance plus gifts
        If no gift made, net after estate tax = $20M (each child
          receives only $10M)
        If gift property appreciates in value during remainder of
          Donor’s lifetime, even more transferred out of estate

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        Outright Gifts (continued)
     Most advantageous in low-interest rate
     environment and/or depressed market conditions
     Considerations
        Impact of income taxes on donee’s disposition of
        transferred property (can be avoided through use of
        grantor trust)
        Impact of loss of basis adjustment to transferred
        property upon Donor’s death
        Potential impact of discounts on transfer of
        fractional interests


33
       D. Sale to Intentionally Defective
                Grantor Trust (IDGT)
     Freeze” technique to transfer future growth in assets to
       next generation without adverse transfer tax
       consequences
     Asset sold to grantor trust for balloon note at AFR at time
       of the transfer
     Goal –
        Transferred assets appreciate at a rate greater than AFR
        Income from transferred assets available for annual interest
         payments
        Portion of assets can be sold to pay off note at maturity
         without capital gain taxes owed by trust
        Remaining property passes to remainder beneficiaries –
         estate, gift and income tax free


34
                 E. Private Annuities
      Transferor (senior family member) transfers assets
       for promise to pay annuity for remainder of
       transferor’s life to junior family member(s)
      Annuity based on 7520 rate and life expectancy of
       Transferor
      Transferred assets not includible in transferor’s
       estate at death (since decedent has no continuing
       interest in transferred assets and annuity payments
       terminate at death)



35
       Private Annuities (continued)

      Traditionally transferor could use installment
      method to report gain on sale of transferred assets –
      not available under proposed regs. But gains tax
      can be avoided if grantor trust is used to purchase
      assets
      Best in low-interest rate environment

      Best when asset values are depressed




36
 F. Grantor Retained Annuity Trusts(GRATs)
     Freeze” technique to transfer future growth in assets to next generation
     with nominal transfer tax consequences (gift only of “remainder”)

     Assets which are expected to appreciate at a rate faster than the §7520
     rate transferred to trust for term of at least 2 years
     Donor receives back annuity equal to initial value of assets transferred
     to GRAT over GRAT term, plus interest at AFR
     Payments to Donor can be “back loaded” to increase at 20% per year.
     Result –
         Small gift of remainder upon the initial transfer

         Any property remaining in GRAT at end of term passes to
          remainder beneficiaries – estate, gift and income tax free


37
     GRATs (continued)
     Most GRATs are “short term”, but longer term GRATs
     are becoming more popular
     Short term GRATs are preferred for volatile assets
     because:
      a) short duration GRAT maximizes opportunities to
         capture upswings in market value; and
      b) downswings in value have minimal negative tax
         consequences. (Worst case is that 100% of GRAT
         assets revert to Donor; only cost is “wasted”
         taxable gift of remainder)
     Benefit of “Rolling GRATs”

38
     GRATs (continued)
      Generally not a good vehicle for generation-
      skipping transfer (GST) tax planning because
      grantor cannot allocate GST Tax exemption to GRAT
      until end of ETIP period (i.e., end of term)
      Best in low-interest environment and/or time of
      depressed market values
      If grantor dies during term of GRAT, all or portion
      of GRAT assets will be included in grantor’s estate
      Can guard against risk of owing estate tax on GRAT
      assets through ILIT purchase of life insurance on
      grantor’s life for term of GRAT


39
             G. Charitable Lead Annuity
                   Trusts(CLATs)
      “Freeze” technique for clients who are charitably
       inclined to consider, particularly in low interest
       rate environment

      Donor transfers assets to trust (either during
       lifetime or at death) which will distribute an annual
       annuity amount to a charitable organization for a
       term certain (or for the life of the Donor)

      Assets remaining at end of term will pass to
       remainder beneficiaries


40
     CLATs (continued)
      Can be structured as “grantor” trust for income tax
       purposes
      Will result in transfer taxes (gift tax), but such taxes
       will be greatly reduced in low interest rate
       environment and/or time of depressed market
       values
      Some GST tax planning possible since GST Tax
       exemption may be allocated at the time of initial
       transfer (but later GST Tax exemption allocation
       may also be required).


41
 III. Estate Tax Reform – December 2009

     Now a moving target, due to other congressional
     legislative priorities

     Estate tax legislation may not be enacted until 2010,
     with retroactive application to January 1,2010 likely




42
     Short Term Legislative Proposals

     Most likely legislative enactment appears to be
     extension of 2009 exemptions and tax rates through
     the end of 2010 and not provide a longer term “Fix”

     If one-year extension takes effect, 2011
     reinstatement of pre-2001 tax law under EGTRRA
     remains a possibility (even though we thought it
     could never happen)



43
                Longer Term Proposals
     a) Continue current Estate/Gift/GST Tax Regimes
          (without carryover basis)
     b)   Reintegrate estate tax and gift tax exemptions
     c)   Extend minimum term of GRATS to 10 years
          (Treasury “Greenbook” proposal)
     d)   Eliminate valuation discounts on family entities
          (Treasury “Greenbook” proposal)
     e)   Create “portable” exemptions for married couples
          (this proposal has traction and is included in several
          legislative proposals)
     f)   Complete repeal of “Death Tax” seems unlikely (but
          this was true in 2000 as well)
44
     Major Estate Tax Reform bills introduced in
                   Congress in 2009
                                              H.R. 2023 H.R. 436   S. 722       H.R. 498
Sponsor                                       McDermot Pomeroy Baucus           Mitchell
Date introduced                               4/22/09 1/9/09      3/26/09       1/14/09
Effective date                                1/1/10    1/1/10    1/1/10        1/1/10
Estate and GST tax exemption                  $2 mil.   $3.5 mil. $3.5 mil.     $5 mil.
 Exemption phased in                                                            By 2015
 Exemption indexed for inflation              Yes                    Yes        Yes
Estate tax rate(s)                            45%/50%/ 45%           45%        15%/30%
                                              55%
Brackets                                      $5 mil/$10 mil                    $25 mil.
  Brackets indexed for inflation              Yes                               Yes
5% surtax                                     Yes
Gift tax reunified with estate tax            Yes         Yes        Yes        Yes
Credit for state death tax restored           Yes
Deduction for state tax repealed              Yes                               Yes
Unified credit made portable                  Yes                   Yes         Yes
  Privity between spouses required                                  Yes
Stepped-up basis retained                     Yes         Yes       Yes       Yes
GST, etc. rules made permanent                Yes         Yes       Yes       Yes
Other provisions                                          Discounts §2032A;   15% income tax
                                                          limited   AMT, etc rate
     (courtesy of Ronald D. Aucutt of McGuire, Woods, LLP, Washington, D.C. Ron’s excellent article
     about estate tax reform may be found at his firm’s website: www.mcguirewoods.com))
45
         Costs of Reform/Repeal

     Maintaining estate tax “at its 2009 parameters”
     projected to result in revenue of:

        $121B for the period 2010 – 2014
        $288B for the period 2010 – 2019


     If pre 2001 estate tax is reinstated in 2011, ten
     year revenue estimated at $544B

46
     Planning in Light of Proposed Changes-
                    Example
                      10 Year GRAT Requirement

       This new requirement, if enacted, would eliminate
        “rolling GRATS” as a strategy and volatile investments
        would no longer be favored in GRAT planning

       Consider long term cash flow investments, like
        commercial real estate, for long term GRATs

       Consider, also, creating an investment vehicle (FLP or
        LLC) which provides cash flow through the use of
        “preferred interests”

47
     Planning in Light of Proposed Changes
                  (continued)
       Example: Taxpayer with $100M in investment assets (stocks and bonds with
       3.75% annual yield) creates FLP with spouse and/or children

       FLP has 30% preferred interests ($30M) with 12% cumulative dividend and
       70% common interests ($70M)

       Taxpayer creates 10 yr GRAT using $30M preferred FLP interests which pays
       12% annuity to Taxpayer

       Taxable gift, using December 2009, §7520 rate = $23

       Annuity=$3.6M per year for 10 years. Taxpayer receives $36M in
       distributions

       Note: 12% annuity is derived from income of entire FLP portfolio-which is
       3.75% dividend yield, or $3.75M/per year. After GRAT terminates, preferred
       interest can be held in continuing trust for younger generation
       beneficiaries. §2701 not a problem since transferred property is a
       “preferred interest”
48
     QUESTIONS?




49
     Essex County Estate Planning Council
              December 3, 2009
                              Presented By:

Michael L. Brown, JD, CPA                     George L. Cushing, Esq
Boston Financial Management                   K&L Gates LLP
One Winthrop Square                           State Street Financial Center
Boston, MA 02110                              One Lincoln Street
MikeB@BFMinvest.com                           Boston, MA 02111-2950
617-338-8108                                  george.cushing@klgates.com
                                              617-261-3180
Carolyn R. Stall, CPA,CFP™
UHY Advisors N.E, LLC
53 State Street
Boston, MA 02109
cstall@uhy-us.com
617-994-0066

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