By: Martin M. Shenkman, CPA, MBA, JD
Sample Longer Letter for Professional Adviser to Send To Client
Client Alert 2012 – Act Now
While you may have been bombarded with email newsletters, mailings, and more from your CPA, investment adviser, and others encouraging you to make gifts before the end of 2012, the reality is that many people who can benefit from this type of planning have yet to pursue it. You should pay heed to all these warnings as 2012 may be the last great year for favorable wealth transfers. While the main message is that, if appropriate for you, make gifts before the law changes in 2013, there are many important nuances to the message that the media and that many of the announcements for consumers have ignored. A key message is that many people, not just the ultra-high net worth families, should be considering the valuable 2012 planning options. If you’ve tuned out these messages because you don’t believe your wealth justifies planning, reconsider and be certain. Another critical issue that has been left out of the media blitz is that the large gifts that are being made should almost always be in trust. These trusts raise a host of issues, many of which have special implication to 2012 planning. This Client Alert will try to convey these key points in a really succinct amount of space, so many details will be left out, but hopefully enough can be conveyed to motivate you to act now, and act prudently.
Uncertainty: Uncertainty should not be the basis for inaction. If the weatherman says there is a chance of a horrible storm, you’d carry an umbrella, not stay home. Uncertainty may also mean opportunity. If you don’t act now 2013, is scheduled to bring a $1 million gift, estate and GST exemption and 55% tax rate. President Obama has continued to propose estate and gift tax changes that will undermine much of the planning arsenal, making his proposed 45% rate and $3.5 million exemption far more costly than most imagine. Consider that the left end of the tax continuum. True, the future is uncertain. Maybe the Republicans will sweep the election and repeal the estate tax. Consider that the right end of the tax continuum. If you don’t act now in 2012 while you can, and the left end materializes you (not only your heirs) may lose out on tremendous opportunities. If the right end of the spectrum happens, the worst case you’ve wasted the cost of the planning, but have you? The trust planning that should be at the heart of 2012 planning, will serve your estate planning needs and will also provide asset protection benefits, divorce protection for your heirs, and better control and management of your assets. So the planning in the best tax case scenario (estate tax repeal) won’t be for naught, you’ll just have one less benefit. Even if the estate tax is repealed (which few if any believe likely at this point) the gift tax may remain intact with a $1 million exemption. Most simply don’t realize the importance of the gift tax is an integral backstop for the income tax, not only for the estate tax. If that occurred transferring assets to protect them from lawsuits and claims would become incredibly difficult.
Planning Is For Many People, Not Only the Super Wealthy: Planning is not only for the very wealthy. If you have a non-married partner, a $1 million gift exemption in 2013 will make it costly to shuffle ownership of assets between you and your partner. Everyone, not just surgeons, should be concerned about asset protection. Nothing anyone in Washington does will change the litigious nature of our society. About a score of states have decoupled from the federal estate tax system so that much lower amounts of wealth may trigger a state estate tax. A simple gift today might be all it takes in many situations to reduce or eliminate state estate tax. Use the current favorable tax environment to shift assets into protective structures before the ability to do so is sharply curtailed. A $1 million gift exemption will render much of this planning costly, impractical, or impossible.
Financial Planning Is Key: Start with a financial plan since that must be the foundation of any major 2012 wealth transfer. How much can you afford to give away and be really assured that you won’t have financial difficulties in the future? Which assets can or should you give away? Do you need additional life insurance for coverage in light of components of the plan? Might you need access in the future to the money you give away and if so how much? This analysis will support your potion that you’re left with more than adequate assets for your lifestyle after the transfers. This can deflect an IRS challenge that you had an implied understanding with the trustees of a trust to which you make a gift to receive distributions, loans or other access to the assets you purportedly gave away. It can also make it harder for a creditor to prove at a later date that your transfers constituted a fraudulent conveyance, since you will have appropriate financial backing for your decisions.
Use Trusts: Make gifts to trusts, not to heirs. Whatever amount you determine to give away, give it to one or more trusts, not directly to an heir. Trusts provide asset protection, divorce protection, preserve generation-skipping transfer (GST) tax benefits (i.e., they can keep the assets out of the transfer tax system forever). Trusts can be structured as “grantor trusts” so you can sell assets to them without triggering capital gains. When a trust is established to be a grantor trust, you can pay the income tax on trust income thereby growing the value of the assets inside the trust faster while shrinking the assets left in your name to reduce assets reachable by creditors or subject to estate tax. Many of these benefits are on President Obama’s list of “loopholes” he hopes to close. So, these are benefits you might want to try to secure now, so that they will be respected even if the law changes in the future (they may be “grandfathered”). Perhaps the biggest benefit of gifting assets to a trust is that you can retain the ability to benefit from the assets in trust in the discretion of an independent (e.g., bank) trustee. For example, you can establish a trust for your spouse/partner and your descendants. So long as your spouse/partner is a beneficiary you can indirectly benefit. But what if your spouse/partner dies before you? Instead, for more financial security, you can set up a domestic asset protection trust (DAPT) and be a beneficiary of your own trust. Even if you are wealthy, but much of your wealth is concentrated in a business, be very cautious about cutting off your access to trust assets. Don’t forget the harsh economic lessons of 2008-2009 you need to be assured of adequate resources even under adverse future economic conditions. If you simply make large gifts to your intended heir (e.g., child) it will be inexpensive and simple, but the many benefits that will be lost are substantial.
Consider Sales to Trusts: Depending on the size of your estate, the type of trust you might opt to use, your matrimonial considerations, and a host of other factors, it may be beneficial for you to sell some assets to a trust, instead of merely giving them to the trust. While so many people have focused on the importance of making gifts to use the $5 million exemption, the special 2012 planning opportunities go far beyond that. This is especially important for those wealthy enough that the $5 million exemption is not sufficient to address all of their tax exposure. Sales of assets to trusts that can provide a potentially substantial gift and GST benefit now, that may disappear with changes in the law. This can be illustrated with a simple example. If you sell 45% of your interest in a family business to a trust that interests may be valued with a discount or reduction in value to reflect the reality that a 40% interest is not readily marketable, and it also lacks control. Discounts provide great leverage and there have been more than several proposals to restrict or eliminate them. So selling assets to the appropriate trust may lock in these significant discounts before the law changes and help leverage wealth out of your estate. Since few trusts will have sufficient cash to pay for these purchases they are typically structured as sales for an installment note. Since interest rates are at historic lows the interest payments on these notes will be modest. This note sale technique might permit you to transfer well beyond the $5.12 million in value.
Plan the Trusts to Achieve Your Goals. The trust or trusts you’ll use should not be the simple children’s trust commonly used in estate planning. Some of the issues to consider include:
Act Now: Time is fleeting. Everyone should review planning options for themselves and their family/loved ones to ascertain what might be beneficial and how to expedite the process so planning is completed in advance of year end, preferably before the election.
IRS Circular 230 Legend: Any advice contained herein was not intended or written to be used and cannot be used, for the purpose of avoiding U.S. Federal, State, or Local tax penalties. Unless otherwise specifically indicated herein, you should assume that any statement in this communication relating to any U.S. Federal, State, or Local tax matter was not written to support the promotion, marketing, or recommendation by any parties of the transaction(s) or material(s) addressed in this communication. Anyone to whom this communication is not expressly addressed should seek advice based on their particular circumstances from their tax advisor.
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