Estate planning malpractice issues – Vaughn W. Henry & Associates

Once again estate tax relief is being discussed in Congress, one of the unforeseen consequences is that for many people, already reluctant to solve estate planning problems, this gives them just another excuse to procrastinate.  While 95 % of families aren’t faced with a federal estate tax problem, there are still many reasons to design a business succession strategy or complete an estate plan to preserve the security, control and value of their estate.  For any family that pays unwanted estate taxes, either their advisors were unskilled or the parents were negligently oblivious to the information provided by numerous print articles, books, news reports, seminars and advice from their professional counselors.  What brings this comment to the forefront?  Lately I’ve been receiving inquiries from litigation firms seeking referrals to heirs of families that have paid estate taxes and lost businesses or farms.  The obvious conclusion is there are disgruntled heirs out there who feel that their cut of the estate was diminished in some way because dad’s advisors somehow “fumbled the ball”.   After the dust from the great tobacco lawsuit war settles, the next target may be providers of estate planning solutions that didn’t work as the heirs expected.  Who’s on the hook?  Attorneys, trust officers, accountants, financial and gift planners and life insurance agents all provide estate-planning advice; a lot has backfired.  I expect some are now concerned about heirs looking to correct errors of omission and commission when the tax bill comes due.

• Clients create tax neutral living trusts believing they’ve solved tax problems and/or never bother to re-title their assets and properly fund the trust.
• Clients maintain joint ownership of significant assets when provisions should be made to preserve the clients’ exemptions (the applicable exclusion is $675,000 per person this year- 2000) or the will passes significant property back to the surviving spouse after ownership was previously split for tax purposes.
• Advisors fail to use ways to make gifts to heirs of assets by using tax-free annual exclusions.
• Advisors fail to test their client’s tolerance for charity.
• Advisors don’t “freeze, squeeze, stuff and spread” assets.
• Failure to make use of special tax elections like special use valuations or alternate valuation dates.
• Improper beneficiary designations for retirement plans and insurance have come back to haunt blended families when benefits are incorrectly paid to ex-spouses or unforeseen heirs.
• Owning insurance that improperly winds up being counted in the taxable estate can expose heirs to unnecessary tax.  Incorrect use of irrevocable life insurance trusts.
• The estate plan didn’t provide for adequate liquidity and didn’t preserve or stabilize the value of the family business.

The amazing thing about estate taxes is that so few semi-affluent families take a proactive role to effectively and legally avoid them.  Too many wealthy families don’t know that estate taxes are voluntary and, with a suitable plan, may be eliminated.  In a study of affluent business owners, the financial survey firm of Russ Prince & Associates, found that only 15.3% of heirs felt that estate taxes were going to be a significant problem in their own family’s business succession plans.  After those businesses failed, a follow up study of the same heirs who mistakenly thought taxes weren’t going to be an issue, 97.1% felt the founders’ own negligence in their estate and business planning contributed to the failure.  Now there’s an attitude that can be tweaked enough to shift blame to a target more accessible and financially better off than dad.  The damages are easy to assess; after all, the tax bill is an obvious place to start.  Since tax planners tend not to want to drag out litigation for fear of disrupting an ongoing business that depends on advisors keeping a low profile, they may be real targets of opportunity for unhappy family heirs.

The percentage of families with investable assets in excess of $1 million continues to rise and clusters of wealth exist in places where advisors still fail to provide appropriate advice.  What does this mean for planners and their clients?  More consideration should be given to creating teams of specialists who can craft a plan that meets the family’s need for liquidity, tax reduction, control and security.   Unfortunately, there are professional advisors who don’t feel a responsibility to save taxes or preserve an estate.  It’s not uncommon to hear “the kids inherited more than they deserved” or “it’s not my job to cut a tax bill” or “the client never asked me about taxes, they only wanted a simple will”.  Many commentators feel that an advisor has an ethical duty to present a range of options to a client that includes tax reduction and a discussion of family values an estate plan propagates.  One might contrast this situation with a patient going to a physician about a head cold, and the examining doctor observes a large irregular and discolored mole.  The patient didn’t ask the physician about skin cancer, but the doctor has a duty to pursue the diagnosis and treatment, not wave it off and later claim in a malpractice trial that the deceased patient never asked him to do anything about an obvious problem.  There should be no more excuses about clients not asking about whether or not tax saving techniques were available, clients generally don’t have enough background to judge what’s appropriate for their situation.  After all, they chose an experienced professional advisor instead of a cookie cutter approach that assumes one size fits all; clients should have a family friendly plan crafted to meet their unique needs for flexibility.  Professional tax and legal advisors should make a greater effort to educate their clients and help them understand the problem and provide solutions that meet all of their clients’ concerns.

Using an ESOP and a CRT to Preserve Family Wealth

 

 Using an ESOP with a CRT to Preserve Family Wealth

One of the most difficult tasks an entrepreneurial business founder must face is getting out of a family run enterprise, especially when there are no heirs involved in management. To create liquidity, one of the most creative tools available is the “chesop”. Actually, this technique is an employee stock ownership plan (ESOP) with an IRC §664 Trust (CRUT) designed to minimize tax liabilities on the transaction. Whether the non-income producing employer’s stock or, more commonly, the reinvested proceeds under the §1042 roll-over provisions are transferred directly to the CRUT, the effect is the same.

• More income
• Lower taxes
• More assets to heirs
• Family Control of “social capital” for community resource

Ken Wiggins (63 widower) owns an automobile dealership and wants to create liquidity and slow down. He has been active as a volunteer at the local hospital since his wife of 38 years passed away, and prefers to continue community service during his retirement. His two daughters are already well provided for through his wife’s trust and he is faced with a business that requires more time and patience than he is willing to provide. His advisors suggested that his management staff and long term employees might be better able to continue operating the dealership profitably, and an ESOP would be an effective tool to transfer the business ownership. In order to qualify for tax deferral, Mr. Wiggins must put at least 30% of his corporate stock into the ESOP, but then he has up to 15 months to reinvest the proceeds into other qualified replacement property and postpone any recognition of his capital gain. While the original basis and tax liability remain, he would have a more diversified portfolio with which he could make cost-effective retirement planning decisions. Knowing full well, on exchanged stock, there will be some stocks that perform poorly, but when sold would trigger the deferred capital gains tax, he needs further alternatives to better manage his $4 million estate. By selecting those under performing assets to be sold, and contributing this stock to a §664 Charitable Remainder Uni-Trust, the repositioned asset is now capable of producing a stream of retirement income. One advantage of this technique is that instead of creating a taxable liability, there is an income tax deduction that may be used to offset the redemption of his other qualified §1042 stocks*. Besides producing more income, the remainder interest serves to create a family philanthropic fund that his daughters and grandchildren will oversee. For further information on this or other case studies, contact our office

ESOP CRT –http://members.aol.com/CRTrust/CRT.html	Sell Business – Pay Tax	ESOP – §664 Trust
Fair Market Value of Stock Contributed to ESOP	$2,500,000	$3,000,000
Less Adjusted Cost Basis	$65,000
Gain on Sale	$2,435,000
Capital Gains Tax at 30% (federal and state)	$730,500
Capital Controlled – Available to be Reinvested @ 8%	$1,769,500	$2,910,000
Annual Return from 8% Income Fund	$141,560
Avg. Annual Return 6% Payout §664 Trust with 8% Portfolio		$186,129
Avg. After-tax Cash Flow From Repositioned Assets	$81,255	$106,838
Taxes Saved – Deduction of $1,031,425 @ 42.6% Tax Rate		$439,387
Total After-tax Cash Flow and Tax Savings After 22 Years	$1,787,620	$2,789,830
After Estate Taxes, Asset Value Owned by Mr. Wiggins’ Heirs	$887,750	$0
Transferred to Wiggins’ Family Fund / Community Foundation	$0	$3,864,949

* The IRS has released a private letter ruling permitting §1042 “ESOP replacement stock” to be transferred to a §664 CRT and avoid immediate capital gains recognition. See PLR 9715040 (January 15, 1997). The seller may reinvest ESOP proceeds in “qualified replacement property” sec. 1042(c)(4) and that includes most publicly traded stock.

Henry & Associates

Life Estates (Estate Planning Tools That Pay Off Now) – Vaughn Henry & Associates

Estate Planning Tools That Pay Off Now

Vaughn W. Henry

Did you know, you don’t have to be filthy rich (or even have a taxable estate) to make use of some advanced estate planning maneuvers? One estate-planning tool an older client may use is a “life estate” arrangement with a local charity. This allows the donor to transfer a partial interest in a personal residence, vacation home or farm to a charitable organization and still retain the right to live there for either a stated number of years or through a specified lifetime. The advantage of such a contractual agreement is that the donor does not give up cash, income or lifestyle but still receives a charitable income tax deduction. This has real appeal to a donor whose estate isn’t large enough to be taxed at the federal level, but who still pays income taxes and could make use of the deductions. For those with taxable estates, a bequest that creates a charitable deduction might be helpful, but since most estates aren’t taxed, an income tax deduction from a deferred gift at fair market value is almost always useful.

Keep something while you’re giving it away.

So who might make use of such a life estate?

• donors who want to benefit a charitable cause but who are unable to make current cash contributions
• donors without heirs or those who don’t plan to pass a family home or farm to heirs
• donors who have a close relationship to a charity, especially if the nonprofit has plans to expand physical plant facilities or programs and the real estate fits into their expansion plans
• donors who would like for the nonprofit organization to have the property without restrictions or legal battles with uncooperative heirs in the future

What are the down sides to such gifts?

• It is an irrevocable gift to charity and if the donor’s financial or health situation changes, that asset is no longer available to convert to cash.
• The property becomes hard to sell or lease because the charity owns a remainder interest.
• The donor usually is responsible for paying maintenance, taxes and insurance.
• The donor may become disabled and be compelled to move into assisted care housing. Without any prior planning, what happens to the property?
• The charity has to agree to take the property, no guarantees today in light of zoning, environmental restrictions and management concerns.

A good case study of the technique involves Elizabeth Hopper (72) who owns a retirement home in Florida. The house sits next to a local church she attends when visiting, and she has become active in the congregation. Since her husband passed away three years ago, she makes less use of the residence since it takes too much effort to close up and reopen the house. It was a popular place for her family to gather during the winter holidays, but the $120,000 house is not used enough to fully justify the expense. Possessing a lot of sentimental value, she’s unwilling to give it up completely now. The church would like to acquire the house as a residence for their staff, but is unable to purchase the real estate outright. Since the resort community continues to grow, it looks like the house will probably become more valuable, but her estate is modest and an outright bequest to the church will not solve planning problems. On the other hand, the church endowment committee has offered her a life estate in her residence if she passes the house to their organization at her death. In the meantime, she’s entitled to an income tax deduction of $66,676. The tax deductions would be available for her use over six years and she feels this will free up other income and still allow her the right to continue using the house as she wishes during her lifetime. After Mrs. Hopper passes away, the church acquires the property and may use it as needed without the outlay of additional funds. For some donors, this is as close as it gets to having your cake and eating it too.

For additional information, the web-site http://members.aol.com/crtrust/CRT.htmlhas case studies, software and articles on estate and gift planning tools.

The income tax deduction may need to be offset by depreciation or depletion if the transferred asset’s value would be impacted by a limited useful life. IRC §170(f)(4) and Treas. Reg. §1.170A-12.

Tax Efficient Giving – Henry & Associates

Tax Efficient Charitable Giving

Vaughn W. Henry

With $203 billion given to charities in 2000, donors are more likely than ever to use planned gifts.  “Planned or deferred giving” refers to a popular charitable gifting technique that provides valuable tax benefits and/or income benefits for the donor.  Whether a donor uses stock, cash or other hard to value assets (real estate, art, or business interests), a planned gift can make charitable giving a powerful tool benefiting both donor and the non-profit organization.  Where to get help? Well-trained development officers or financial advisors craft a planned gift to meet both the donor’s charitable and financial or estate planning goals.  These gifts are made by bequests, trusts or contracts between a donor and a charity.

Advantages of many planned gifting programs

· Increases current income by repositioning assets

· Reduces income tax with current charitable tax deductions

· Lowers estate tax liabilities by strategically shrinking estate size to levels that pass tax free to heirs

· Avoids capital gains tax on appreciated assets

· Increases opportunity to pass additional assets to heirs in an organized plan

· Creates significant tax efficient charitable gifts benefiting the donor’s community

· May empower families through the concept of economic citizenship

· Controls and redirects social capital which otherwise would have defaulted to the government

Types of Planned Gifts

Bequest — When a donor leaves assets to charity through a will, he or she is making a bequest. The donor’s estate will receive a charitable estate tax deduction at death, when the gift goes to charity.  Some gifts are better at death; for example, savings bonds may be listed individually and given to charity through the will, otherwise, a gift of bonds may trigger income tax if given outright.  This is a common tool, but usually not well thought out or designed with tax efficiency in mind.

Life Insurance and Beneficiary Designations — Insurance policies (new or existing) may be given to charities in most states.  Depending on the contract’s paid-up status, the charity may need to continue paying premiums.  Donors may also name a charity as a beneficiary of an existing policy, either entirely or in part.  Additionally, a charity may be named as a beneficiary of a retirement plan (e.g., IRA, 401k, profit-sharing, etc.) or annuity contract.  The advantage of this strategy is that the charity usually receives the proceeds without the accompanying income tax liability.  This allows surviving family members to inherit assets that “step-up” in value and the charity receives assets that would otherwise be reduced by taxes paid as income in respect of a decedent (IRD).  Check with your tax advisors on this technique, as it will affect minimum required distributions.

Charitable Remainder Trust  — This § 664 trust makes payments, either a fixed amount (annuity trust) or a percentage of trust principal (unitrust), to whomever the donor chooses to receive income. The donor may claim a charitable income tax deduction and may minimize any capital gains tax if the gift is of appreciated property.  At the end of the trust term, the charity receives whatever amount is left in the trust.  Charitable Remainder Uni-Trusts (CRUT – paying a fixed percentage) may provide some flexibility in the distribution of income, and thus can be helpful in retirement planning, while Charitable Remainder Annuity Trusts (CRAT – paying a fixed dollar amount) are more rigid and restrictive.

Charitable Lead Trust –This trust makes payments, either a fixed amount (annuity trust) or a percentage of trust principal (unitrust), to charity during its term. At the end of the trust term, the principal can either go back to the donor or to heirs named by the donor. The donor may claim a charitable tax deduction for making a lead trust gift.  However, a non-grantor lead trust does not usually generate a tax deduction, but it does eliminate the asset (or part of the asset’s value) from the donor’s estate.

Charitable Gift Annuity — A gift annuity is a contract between a charity and donor. In return for a donation of cash or other assets, the charity agrees to pay the donor, (or a friend or family member if the donor so chooses), a fixed payment for life. The donor can also claim a charitable tax deduction. If a donor funds a gift annuity with long-term capital gain property like appreciated stock, the donor will report only some of the gain, and may be able to report it in installments over many years.  Income from a gift annuity may be deferred for a period of years and these are often set up by younger donors to supplement retirement income.

Pooled Income Fund — The name describes this planned gift as a charity accepts gifts from many donors into a common fund and distributes the income of the fund to each donor or recipient of the donor’s choosing.  Income recipients receive income in proportion to their share of the fund.  A gift to a pooled fund provides a charitable income tax deduction and the donor will not have to pay capital gains tax if the gift is of appreciated property.  When an income beneficiary dies, the charity receives the donor’s portion of the fund.

Retained Life Estate — A donor may make a gift of a farm or residence to charity and retain the right to live in the house for the remainder of the donor’s life. The donor receives an immediate income tax deduction for the gift. At the donor’s death, the property goes to charity.

While many of these split interest gifts and techniques are used for donors with estate tax liabilities, they still work when the donor has a modest estate.  A good advisor should be able to suggest tools to help a donor preserve personal financial security and still fulfill any charitable goals.

CONTACT US FOR A FREE PRELIMINARY CASE STUDY FOR YOUR OWN CRT SCENARIO

Charitable Trust Planning – Vaughn Henry & Associates

Charitable Trust & Estate Planning

Case studies, workshops and professional planned giving resources.

Individuals considering a charitable remainder or lead trust need to understand that their financial goals can be met without interfering with their family’s security. Heirs can be protected and families united as they redirect their social capital. Develop your potential for economic citizenship.

• Minimize Estate and Capital Gains Taxes, Reduce Income Taxes
• Use a charitable remainder trust (CRT) as a Discretionary Pension Plan
• Control Retirement Income with a NIMCRUT or Spigot Trust
• Real Estate, Stock Portfolios, Business Assets Repositioned Tax-Free (Lifetime Control of More Capital) through a CRUT
• Business Exit Strategies for Family Business Owners
• Coordinate the Control of Your Social Capital with a CRT and Family Foundation or Donor Advised Funds by Giving Away the IRS’ Money.
• Families with Donative Intent Can Meet Their Financial Goals Within an Integrated Financial and Estate Plan
• Professional Development for NPO Gift Planners and Commercial Advisors
• Host Workshops and Private Seminars for Not-for-Profits and Family Groups

Professional Resources and BooksNow booking workshops, briefings and seminars for 2006 and 2007 … Association of Advisors in Philanthropy – Conference Philanthropy … Public Link to PGDC – CRT Advisors’ Liability and … New estate and gift tax rates in place now, but what effect will sunset have?

CONTACT US FOR A FREE PRELIMINARY CASE STUDYFOR YOUR OWN CRT SCENARIO or try your own at Donor Direct

Please note — there’s much more to estate and charitable planning than simply running software calculations, but this service does give you a chance to see how the calculations affect some of the design considerations.

This is not “do it yourself brain surgery”.

When might a CRUT be superior to a CRAT? Which type of CRT is best used with which assets? Although it may be counter-intuitive, sometimes a lower payout CRUT makes more sense and pays more total income to beneficiaries. Learn why and when to use a CLUT vs. CLAT and the traps in each lead trust. Which tools work best in which planning scenarios? Check with our office for solutions to this alphabet soup of planned giving tools.