Q. My children have no interest in continuing with either the farm or the business I started years ago. The current income generated really isn't enough to keep both the business going and still provide for retirement, but I don't want all of the tax problems that come with selling my business interests. Any suggestions?
A. One of the little known results of the Tax Reform Act of 1969 created opportunities which might be of benefit. Owners of low earning, but highly appreciated assets (stock, real estate, businesses, farms, etc.) can avoid capital gains tax, and when properly done, reduce income and estate taxes while simultaneously increasing annual income. With the recent tax changes in the Revenue and Reconciliation Act of 1993, this technique is now even more powerful because the Alternative Minimum Tax (AMT) liabilities are improved. Although it's a little complicated, I can use an example of a successful asset transfer to show you how it has worked well for others.
Tom and Mary Smith had an agriculture operation generating only a 3% annual return, based on the fair market value of their 1,200 acre farm and its assets. Because they acquired the property so long ago, they were faced with capital gains taxes that would take nearly one-third of the sale value. If they were to pass away after the sale, the federal estate taxes would take an additional one-half of the remainder. You might as well say that government taxation is a form of painful and involuntary philanthropy. Given that bleak outlook, they decided to pursue a "voluntary philanthropical program" with a Charitable Remainder Trust (CRT). This Section 664 trust avoids the excessive tax burdens and provides them with a flexible plan which allows them to give something back to their community, while at the same time increasing their retirement income. Their rationale was, "There's too much waste in government and we're more aware about what's really needed to help our community. Since it's obvious our family is going to give up some value in our estate, we'd prefer to control 100% of where and how it's used." Estate planners refer to this as capturing "social capital". Once you acknowledge that a portion of your assets are already lost to government taxation, the questions are then - "how can we maintain control over those assets and can we use that control to leverage and improve our estate's remaining assets?"
To accomplish this four step process, they first transferred ownership of the farm business to the Smith Family trust. Their tax-exempt trust subsequently sold the farm assets and reinvested those proceeds in a group of stocks, bonds and other income producing investments. The Smiths were able to claim a tax deduction for the future value of their gift to the charitable trust, while they still retained the rights to additional income generated from the much improved investment portfolio. The only discordant note in this transfer was from the Smith's children and their spouses who were concerned about the gift of the family farm and the loss of a future inheritance. To provide an equitable solution and keep peace in the family, the Smiths created a wealth replacement trust with some of their tax savings. This trust will provide their children with cash, which ultimately will be their preferred choice of assets anyway, and it avoids the typical family squabbles about dividing an inheritance. Their family foundation named several charities to receive the bequests generated by the appreciated value of proceeds in the Smith trust after Tom and Pat pass away. Their children would then have an advisory role in deciding how funds are used, so the family's influence in the community continues.
Charitable gifting programs are very popular, and a number of community projects have been rejuvenated by increased support from private foundations funded through these specialized trusts. Many firms and individuals see that charitable works are really a form of enlightened self-interest. Although trusts require sophisticated investment, legal, accounting and tax advice, they are becoming increasingly popular for all ages. To cater to this increased popularity, there are specialized firms that do nothing but set up and administer private charitable trusts. With the advent of the personal computer for analysis and management, the power of these personal trusts is now available to any interested person. As little as $2,000 in assets qualifies for management by one of the largest trust administrative firms in the U.S. No longer an exclusive tool for the ultra-wealthy, the CRT offers the same advantageous tax regulations to many middle and upper income families. As a result of recent tax changes, many self employed professionals and highly compensated individuals are also using these trust instruments as a way of enhancing wealth accumulation and their personal retirement plans. Now they set aside savings without the reduced IRS 415 limitations on contributions. This is advantageous for anyone interested in increasing retirement compensation. Is there any reason you don't want more income from your property? Then for older clients, the improved long term income is appealing when they have been depending on highly appreciated or expensive property that does not produce income or payments commensurate with its value.
In this case, the Smith family was in a much better position as a result of the CRT -
* they doubled annual retirement income
* they retained control over more assets
* they redirected estate taxes to local works instead of inefficient bureaucracies
* they were guaranteed that neither Tom nor Mary could outlive their pension
* it didn't adversely affect their other retirement or social security accounts
* they minimized the capital gains and estate taxes on their property
* they received an income tax deduction for the significant gift to their foundation
* their long term family benefits are much improved
Additionally, they will pass on a much larger estate to their children, while ultimately benefiting the community with their multi-million dollar gift of social capital. In the end, the Smiths decided that they wanted to have some say in how their money was spent by influencing good works locally, instead of having government bureaucracies micro-managing a project through the existing tax system. The "Zero Estate Tax Plan" seemed to be the best solution for their needs, and it has been of tremendous use to others in their community as well. Voluntary philanthropy made a great deal of practical economic sense compared to their involuntary and traditional options.
For further information, on charitable gifting programs that maintain flexible control and save taxpayer's money on the "big three" (capital gains, income and estate taxes), contact a trained financial planning specialist who can show you how it may apply to your situation.
Vaughn W. Henry works with estate planning clients to prepare charitable estate plans.
Failing to stabilize and protect estate values is one of the classic errors in most estate plans. Avoid this situation
by consulting your tax, financial and legal advisors. Learn about tools to retain control of family wealth. Maintain community influence with dollars which would have otherwise defaulted to the IRS. Develop your potential for economic citizenship.
CONTACT US FOR A FREE
PRELIMINARY CASE STUDY FOR YOUR OWN CRT SCENARIO
Vaughn W. Henry Henry & Associates Gift and Estate Planning Services
22 Hyde Park
Springfield, IL 62703 USA
Phone: (217) 529-1958 Fax: (217) 529-1959
E-mail: VWHenry@aol.com
Home