Wilsey Estate Planning Blawg

Estate Tax in Limbo

Here's a case example that illustrates the confusion regarding the 2010 unlimited estate tax exemption.

I'm representing a client who is a beneficiary of an estate worth in excess of $100,000,000. My client will receive a portion of the estate. The problem is the estate tax, or more precisely, the lack of an estate tax…maybe. Let me explain.

In 2001, President Bush signed into law Internal Revenue Code Section 2001 which both increased the estate tax exemption AND reduced the estate tax rate. Estate Taxes are calculated by subtracting the estate tax exemption from the fair market value of the estate, and multiplying that by the estate tax rate.

For example, in 2007, the estate tax exemption was $1,500,000 and the estate tax rate was 45%. If a person died with a $3,500,000 estate, the taxable estate would be $2,000,000 ($3.5m estate less a $1.5m exemption) with a $900,000 estate tax ($2,000,000 taxable estate multiplied by 45%. However, in 2009, when the estate tax exemption was $3,500,000, there would be no estate tax, since the exemption covered the entire estate value.

In 2010, there is technically no estate tax, because the exemption is unlimited. However, it is widely speculated that the estate tax exemption will be put back to $3,500,000, retroactive to January 1, 2010. What does this mean in my client's case?

Well, if the estate is worth $100,000,000, then with an unlimited estate tax exemption, the estate tax is zero. If the estate tax exemption is $3,500,000, the taxable estate is $96,500,000. The estate taxes due would be about 45% of that amount, or $43,425,000. Big difference!

You might wonder about the legitimacy, of a retroactive estate tax. Well, I certainly feel that this case could likely wind up in court to determine whether a retroactive estate tax is indeed enforceable. While I think this type of assessment is unconstitutional under the due process clause, there is also authority in the IRS' favor, namely the 1993 Supreme Court case of U.S. v. Carlton, in which the Supreme Court upheld a retroactive assessment of a tax because it was "rationally related to legitimate legislative interest", namely raising revenue. I think this was the court's way of saying that they would permit any retroactive tax. However, the makeup of the Supreme Court has changed substantially since 1993, and I would not be surprised if a different result was reached. We'll see what happens in this case.

 

Upcoming Living Trust Workshop

The Wilsey Law Firm will be holding a series of Living Trust workshops designed to show the public how to protect themselves and their families.

Here's an invitation: Download March 31 EP SEMINAR FLYER

The Living Trust Workshops will be held at the Doubletree Del Mar, 11915 El Camino Real, San Diego, CA 92130 on the following dates and times:

• Tuesday, March 31, 2009 at 11:00am

• Tuesday, March 31, 2009 at 6:00pm

• Thursday, April 2, 2009 at 6:00pm 

Lincoln's Estate Plan

One interesting thing I learned about President Lincoln is that he died without a will. This is especially interesting in light of his profession as a lawyer.

It shows that the need to properly plan for ones estate exists at all levels, even if you're the President. Make sure you use this opportunity to make sure your estate is in order, something President Lincoln was unable to do.

Lincoln's Estate Plan

One interesting thing I learned about President Lincoln is that he died without a will. This is especially interesting in light of his profession as a lawyer.

It shows that the need to properly plan for ones estate exists at all levels, even if you're the President. Make sure you use this opportunity to make sure your estate is in order, something President Lincoln was unable to do.

The Family Bank Trust: Perfect for Troubled Times

I was browsing for articles on year end gifting and came across this gem from Lauren Young of BusinessWeek. You can find it here.

She makes the point that there are several ways for you to make gifts to loved ones in these troubled times that can help them out. Examples include:

1. Gifts of $12,000 cash using your annual exclusion (remember that this will be $13,000 starting next year).
2. Gifts of a session with a financial planner.
3. Gifts of Savings Bonds
4. Gifts of Brokerage Accounts

I thought all these ideas were interesting, especially the idea about the gift of a session with a Financial Planner. What a great way to get your family members on the right track financially in troubled times.

I also thought that it would be a good idea to incorporate Estate Planning Trusts into these gifting techniques. For instance, what better time than now to create a Family Bank Trust, whereby your children (or other family members) could borrow if they run into tough times, and pay the Family Bank Back when they weather out the storm.

What an excellent way to benefit your family. At the same time, you can use such a Trust to (1) reduce estate taxes and (2) protect your assets from your creditors. This type of trust can also serve as a rainy day fund for you, if you would like. This is an excellent opportunity to use estate planning protect your family from more than just estate taxes.

Family Wealth Transfers Article by Bernstein

I found Keeping It in the Family: Planning for Efficient Wealth Transfer, written by the investment firm Bernstein, to be an excellent guide on the benefits of wealth transfer. Of particular focus in the article is:

1. The Power of Gifting. The article reminds the reader that the use of the $1,000,000 Lifetime Gift Tax Exclusion and the $12,000 Annual Exclusion are powerful tools that should be employed in order to transfer wealth. These tools are so effective, and yet most folks never take advantage of them properly.
2. The Grantor Retained Annuity Trust (GRAT). The GRAT is an interesting trust that allows a great deal of wealth to be transferred free of estate and gift tax.
3. The Intentionally Defective Grantor Trust (IDGT). This trust acts as an alternative to a GRAT. I use this more frequently in my practice than GRATs, since I think the administration is much easier on the client (among other reasons).
4. The Charitable Lead Trust (CLT). For Charitably minded client, the CLT, whether used during one's lifetime or at death, is an excellent way to both reduce the overall estate tax burden, while at the same time passing assets efficiently to the next generation.

I hope you enjoy the article!

The Dangers of the Durable Power of Attorney

I just read a great article about the potential dangers of the Durable Power of Attorney, written by Sandra Block of USA Today. You can read the article in its entirety right here.

Ms. Block's point is that the durable power of attorney is a powerful document, giving your Agent, the person acting on your behalf, unfettered access to your bank accounts and records, and must be planned for very carefully.

Financial disability planning, that is, the practice of taking care of your finances in the event of your incapacity, is one of the most important components of your estate plan. Statistically, you are 6 times more likely to become incapacitated than die in any given year. Your Durable Power of Attorney plays an integral part in Disability Planning.

But you should understand exactly what is controlled and what is not controlled by your Durable Power of Attorney. Not all your assets will be managed by your Durable Power of Attorney Agent. In California, most clients elect to use a Revocable Living Trust as the foundation of an estate plan. This is done in an effort to avoid expensive probate fees. All assets owned by the Revocable Living Trust, and thus avoiding probate, will be managed by the client's trustee named in the Revocable Living Trust, rather than the Durable Power of Attorney.

So if assets owned by the trust are managed by the Disability Trustee named in the Revocable Living Trust, do you even need a Durable Power of Attorney? The answer is yes, because not all assets will be owned by your Revocable Living Trust. For instance, Qualified Retirement Plans, such as IRAs and 401Ks, cannot be transferred to a Revocable Living Trust without triggering adverse tax consequences. Since some assets are not transferred to your trust, you must have a Durable Power of Attorney to deal with these assets.

Universally, your Durable Power of Attorney Agents should be the same as your Disability Trustees. This allows the same person to manage all assets in the event of your incapacity. However, as Ms. Block writes in her article, you must be extremely cautious about selecting your Agent for your Durable Power of Attorney. In addition, you (and your estate planning attorney) must be extremely diligent to make sure there are provisions in your Revocable Living Trust and Durable Power of Attorney to make the persons taking care of you financially in the event of your disability accountable.

The Perfect Storm for Estate Planning

It's an interesting time in the world of estate planning, according to an article by Janet Kidd Stewart of the Chicago Tribune. On one hand, conditions are such that there has never been a better time for wealthy clients to reduce their estate tax burden. On the other hand, there has never been a more unstable economic situation, making people hesitant to give away assets in an effort to reduce taxes. See a copy of the article here.

But I think, with a little crafty planning, clients can have their cake and eat it too. What I mean is that we can help clients take advantage of this unique opportunity to reduce estate taxes, while at the same time making sure the estate planning will never cause the client to run out of money.

Why is this time such a great opportunity for estate planning? Well, the factors of extremely low interest rates and low assets values combine to create great opportunities:

1. Low Interest Rates. The Applicable Federal Rate is extremely low right now. This rate, published monthly by the IRS, is the minimum rate of interest one can charge for interfamily loans without such loan being characterized as a gift. The most commonly used application of this technique in my practice is to have my clients sell assets, such as investments or real estate, to an Irrevocable Trust in exchange for a Promissory Note bearing interest at the Applicable Federal Rate. If the assets grow at a rate higher than the Applicable Federal Rate, then that excess growth grows out of the client's estate. Given that the Applicable Federal Rate is as low as 1.36% right now, this is not hard to accomplish.
2. Low Asset Values. Given market conditions, both real estate and investments are extremely low values. These assets are sure to regain the value upon the recovery of the economy. However, their low value for the time being presents a great opportunity to move those assets out of your estate, which means all subsequent appreciation will grow outside of your estate.

In addition to the low interest rate and low asset value environment, I have developed techniques to make sure that client retain an adequate interest in assets they give away, in order to meet living expenses.

For instance, my Family Wealth Protection Trust allows clients to sell assets in exchange for a Promissory Note to move assets out of their estate. The trust offers the following advantages:

1. Frozen Value. Assets sold to the trust are frozen in value, meaning that all future appreciation is removed from the estate. This makes the sale a "freeze" transaction. Done properly, we can make sure that client estate tax burden does not increase as their wealth increases.
2. Access Provision. We can include a provision in the Family Wealth Protection Trust that allows the client to access the trust assets if all other assets are exhausted. This give the client the assurance that while they are saving a great deal in estate tax, they are not doing so at the expense of their lifestyle needs.

In summary, there has never been a better time for wealthy clients to reduce their estate tax burden. While this is an economic time of uncertainty, this should not prevent wealthy clients from taking advantage of this unique opportunity.

Avoiding the Inherited IRA Nightmare

Here's an interesting article from Jamie Downey of the Boston Globe. You can read the article by clicking on this link.

Her basic premise is that unless adequate planning is done, IRAs, 401Ks, and other qualified retirement plans, when inherited by one's children or grandchildren, can be subject to combined federal income, federal estate, and state income taxes of over 70%.

Her recommended strategy is to "Stretch" the IRA or 401K. This is a great idea. It is accomplished by naming your beneficiaries directly on the beneficiary designation form. This allows tax deferred growth over the beneficiaries life-time, generally referred to as a "Stretch". As a side note, great care needs to be taken in naming beneficiaries on the beneficiary designation form. While a full discussion is beyond the scope of this blog post, realize that you should consult an estate planning attorney or tax advisor prior to filling out your beneficiary designation form.

While it may not be hard to create a stretch, Stretch IRAs are very rare in practice. Why? Because most beneficiaries elect to withdraw the IRA or 401K, and just pay the taxes. This ruins the Stretch, and forces all taxes to be due immediately, making Uncle Sam the real beneficiary of the IRa or 401K.

To avoid this scenario, it is imperative that you leave your IRA or 401K to a Stretch IRA Trust, rather than outright to your beneficaries. A Stretch IRA Trust is a trust that ensures that your beneficiares will receive the full "Stretch" benefit, and will not pull the money out early. This will avoid your beneficiary exposing themselves to a great deal of unnecessary taxation.

For more information on the Stretch IRA Trust, please read my article The Stretch IRA Trust: Don't Let the IRS and Creditors be the Beneficiary of your IRA or 401K. You can find a copy of the article here: Download Stretch IRA Trust .

Financial Advisor Bootcamp on November 13, 2008

The Wilsey Law Firm will be hosting a free Estate Planning Bootcamp for financial advisors on Thursday, November 13, 2008 from 1pm to 4pm. For more information, click below:

Download 20081113_invitation.pdf