Tax Tips for Uncertain Times

When we were kids we’d take turns twisting each other’s arm’s until someone screamed “uncle.” Accountants across the country are screaming “Uncle” as in “Uncle Sam” as they continue to get barraged by new tax rules and related changes, court cases and other developments. The following tidbits are barely a drop in the proverbial bucket but hopefully will alert you to some of the planning ideas or tax changes you might have missed.

◙ The Dark Side of Estate Planning.  Lower the limbo stick for this one, ‘cause you’re gonna sink way low (if you miss the play on words with “limbo” Google the term). Neither Darth Vader nor Jack Kevorkian would even go where this planning tip goes. Consider the following idea that a well known estate planning guru recently advised a conference.  The Guru suggested that attorneys contact any client whose age or health indicates that they may not survive the 2010 year. There is no estate tax in 2010 (well so far!). The guru recommended advising these clients of the tax consequences of dying in December 2010 versus January 2011. He then suggested that the client might make a decision about updating his living will and health care proxy. Hey what a Christmas present! Pull the plug just before year end. If there is no estate tax this year and in 2011 we get a $1 million exclusion and 55% rate that could be a whopping gift to the kids. But hey, why stop there. The guru then intimated that perhaps the client might take a trip to Washington State or Holland? Those aren’t red or blue on the CNN map. They’re Kevorkian Black. The only planning point he left out was buy a one way ticket and save a few more bucks for the grateful heirs.

◙ Re-think Testamentary Charitable Gifts. If you bequeath money to charity in your will, that bequest won’t save any estate tax as it had in the past (since there is no estate tax). So, instead of a tax-useless charitable bequest, make a specific bequest to your heirs with a non-biding request that they make the requested charitable contribution. The heir will obtain an income tax charitable contribution deduction which is quite a tax improvement. Great tax deal, but just hope Junior is able to resist writing the check out to the local Porsche dealer.

◙ Generation Skipping Transfer (GST). The GST tax remains repealed. This could mean a once-in-a-lifetime opportunity or a costly tax trap if the GST tax is retroactively reinstated. Consider out right transfers of property to skip persons (e.g., grandchildren).  Simple -- just write a check to a grandchild. If there is a family trust that is not exempt from the GST (perhaps a bypass trust for grandma when grandpa passed away) and grandchildren are beneficiaries, the trustee can just write check. The gift should be made outright and not to a trust (custodial accounts are treated like trusts). If the GST tax is reinstated the gift or distribution to a trust may later be subjected to GST tax so keep it simple and outright. If your gift triggers gift tax the rate now is 35% not 45% (like 2009 law) or 55% (which is what it will be next year if Congress doesn’t act). Doing an Alfred E. Neuman -- “What me worry?” Then use techniques to hedge your GST tax bets. If the grandkid is tax savvy, they can refuse (renounce) the gift if the GST tax is reinstated.  Don’t trust the grandkid to give the dough back? Make the gift subject to the grandkid’s obligation to pay GST tax if there is any. If you gift interests in a family rental property or business, the grandkid won’t have the cash and will have to renounce. Need to hedge the bet on a trust distribution? The trustee can make the distribution subject to a contractual arrangement that includes a formula. The grandkids get the amount of the gift x a fraction. The numerator is the maximum amount that can be given away GST tax free (that’s the whole shebang right now). The denominator is the value of interest given. If the GST is reinsated and you’ve used up all your GST exemption the grandkids get nothing but the tax is avoided.  Another GST approach is to put big bucks into a marital trust (QTIP) for your spouse. The trust should say that if spouse renounces the funds go to grandchildren. If the GST is not reinstated your spouse can renounce within 9 months and the dough passes outright to grandchildren listed in the trust. This gives you a 9 month Ouija board to see the status of the GST tax. If the GST is reenacted file a gift tax return electing for the trust to qualify for the unlimited gift tax marital deduction and skip renouncing. If the GST is not retroactive then your spouse can renounce and bring Kodak smiles to all the grandkids.

◙ Carried Interests. Hedge Fund fat cats are struggling. It’s tough to get by on a few hundred million a year when you have to pay income taxes. So, they want those buckaroos taxed as favorable capital gains, not as compensation subject to ordinary income tax rates and payroll taxes. The tax tide may be turning. Movement is afoot to tax what are called “carried interests” as ordinary income regardless of character of the income at partnership the managers have interest in. HR 4213. It’s been estimated that the tax revenue from these changes could add $24 billion to the federal fisc. Green book JCX-59-09 p.5. Code Section 83 may be amended to tax partnership interests as compensation. New Code Section 710 will tax flow through items from partnerships as ordinary income without regard to normal flow through rules of partnerships. What is especially cool about this proposed new provision is it gives us tax geeks a new acronym “IPSI”. That’s important because if proposed legislation eliminates GRATs, this will avoid a disruption in the force by replacing the useless GRAT acronym with a new one of equal size. Just to give you a leg up on the others in your golf foursome, IPSI stands for Investment Services Partnership Interest. That’s an interest in a partnership attributable to services rendered with respect to “Specified Assets” (you’ll have to wait for your decoder ring to understand that one).  Code Section 1402 may be amended to make carried interests subject to employment tax. While you might not loose sleep over the fat cats paying more tax, be wary of the common Congressional approach of using a sledgehammer instead of a scalpel. Lots of business deals on main street (e.g., real estate development) may get snared in these changes. There could be a lot of collateral damage on these changes.

◙ Expatriation Provision. A tough mark to market exit tax applies to US citizen and green card holders who expatriate or give up their green card. Folks may assume expatriation doesn’t apply to them but the rules cast a wide and unsuspecting net. Green card holder executives if reassigned back to their home country are in jeopardy of loosing green card when this happens. That may trigger the expatriation tax. IRC 877A; Notice 2009-85.

◙  FBAR Goes to Far. Persons with signature authority over foreign accounts, but no interest in them, have an extension to June 30, 2011 to file for FBAR relief. An agent holding power of attorney over foreign assets has to file even if foreign entity would not respect the US document. Notice 2010-23, 2010-11 IRB 441, 02/26/2010; IRC Sec. 6011. If you make an FBAR filing inform the people you’ve named agent under your power of attorney and possibly the trustees under your revocable trust.

◙  Trust Protectors.  Lot’s of folks have integrated a raft of new fangled positions into the ever increasingly complex trust instruments that have become more common. There is little law on these positions so that while potentially helpful, caution is in order. In a recent case the trust protector was sued for not monitoring trustees, not preventing theft of trust assets, breach of loyalty (they argued that the protector was more loyal to trustees then to the beneficiaries). The Court struggled with the issues since state law didn’t provide direction. See UTC Sec. 808. This was a case of first impression. The Court considered the trust document which gave powers and said trust protector was a fiduciary. It gave the protector the power to remove the trustee and appoint successor, but no standards for these acts were provided. The trust protector had power to resign and appoint a successor. The Court held that the trust protector had a fiduciary duty but did not define the scope of those duties. The trust exonerated the trust protector for acts taken in good faith. The Court said this implied that the protector would be liable for acts which were not in good faith. What if the Trust Protector doesn’t even know they are appointed trust protector. What are the duties? Are they a fiduciary? Is the protector supposed to do the same things that a trustee is required to do? Some states require that the protector submit to jurisdiction in the state of situs. Did trust protector sign document accepting the position? If not, how can you hold them liable. So given all the above, how can you protect the trust protector? Can you protect the protector by stating that if they make a mistake they should not be sued. Robert T. McLean Irrevocable Trust v. Patrick Davis, P.C., 283 S.W. 3d 786  (Mo. Ct. App. 2009).   Hey folks, you’ve read it hear dozens of times, hold an annual trust meeting with all advisers, fiduciaries and other key people present. You cannot operate a sophisticated trust successfully without doing this. It just won’t work! Got it?