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Broodmare Management – Henry & Associates

Broodmare Management – Henry & Associates

Broodmare Management Issues

Vaughn W. Henry

 The reproductive anatomy of the mare often predisposes female horses to be subfertile or even sterile. Owners and breeding farm managers should conduct a thorough pre-breeding exam in cooperation with their veterinary advisors and select out those individuals likely to cause grief. Note the scars and damage from previous foaling, look for poorly conformed labia and a forward tilt to the vulva and see if there is dried pus or other signs of infection. These mares tend to have problems conceiving due to the accumulation of fecal contamination or urine pooling in the vagina. This contamination and the associated pathogens are easily drawn into the vagina, and later into the cervix and uterus, when the mare is in heat and or when bred in less than ideal sanitary conditions. Besides physical contaminants, sometimes anatomical defects like poor labial tone or vulvo-vestibular closure causes mares to be “wind-suckers” and they will have a condition called pneumovagina. This condition of excessive air in the tract irritates the vagina and cervix, and sets up the mare for infections. A veterinary surgical procedure, a Caslick’s, often corrects this condition but the mare is somewhat harder to breed and the opening must be modified with an episiotomy prior to foaling or excessive tearing may occur during the foal’s birth. Generally, once a mare has had the procedure, it must be repeated every year.

On the accompanying illustration (taken from the Anatomy of Domestic Animals – 4th Edition by Sisson and Grossman, W. B. Saunders Co.) note the location of the kidney (#13), the supporting broad ligament (#6), left ovary (#1), oviduct or Fallopian tube (#2), left uterine horn (#3), uterine body (#5), vagina (#7), labia (#8), bladder (#15), and the surrounding bony pelvic structure (#d, e, f). A thorough understanding of the mare’s anatomy allows the breeder more opportunity to overcome problems and raise healthy foals consistently.

Maintaining uterine health is important for continued fertility, as the subfertile mare lacks the resources to prevent opportunistic organisms from infecting her tract. Good management practices are essential for success.

Suggested Management

  • Identify potential problem mares early, as it often takes six months or more to treat successfully. Use the autumn and winter as a period to isolate, medicate and improve the success rates of your barren mare herd.
  • Eliminate parasite problems, adjust the mare’s plane of nutrition so she is neither carrying excessive weight nor extremely thin. Many managers like for mares to come out of the winter season in a weight gaining state to encourage improved cycling and fertility. This is called “flushing” and is a common technique in other farm species.
  • The use of increased lighting regimes to simulate the approach of breeding season will accelerate the transition period in mares’ estrous cycles when they are exposed to 12 to 16 hours of light per day over a four to six week period in the early part of the season. There are sophisticated light meters which can measure the amount of effective light stimulating the mare’s pineal gland, but a good test in the field is the ability to read newspaper print in the stall or loafing shed. If it’s too dark to easily read the type, then there’s probably not enough light to adequately stimulate the mare’s reproductive system.
  • If necessary, have a microbial culture of the cervix and uterine lining (endometrium) performed. A culture may be able to identify if a pathogen is causing problems and the results may suggest which antibiotic treatments, if any will be most effective. Some clinicians use a direct swab of the uterine lining, looking for the presence of excessive white blood cells. These cells, neutrophils, are the response to infectious agents in the tracts and can give the managers immediate feedback on whether or not the mare is infected.
  • An endometrial biopsy (samples of the uterine lining microscopically examined) may be helpful in determining the extent of damage and likelihood of breeding success.
  • Mares with poor conformation and a tendency to re-infect themselves may benefit from a Caslick’s procedure or a more involved episioplasty and reconstruction of the vulva.
  • Pre-breeding sanitation, of both the mare’s and stallion’s genitals, is important if recontamination is to be avoided. Artificial insemination may reduce the number of organisms introduced into the tract by incorporating antibiotics in the semen extenders and reducing the trauma of breeding naturally.
  • Artificial insemination and improved stallion management play an important part in this plan; so don’t neglect the stallion.
image

Older mares with a history of several foals often have broad ligaments(or see view #2 that have stretched excessively. The forward pull of the uterus over the brim of the pelvic floor and loss of uterine tone causes some mares to “pool” fluids and may contribute to poor uterine health.

“no one loves a barren mare” – horse owner lament

 The close cooperation among the breeding farm staff, veterinary consultants and owners is required if these marginally fertile mares with their compromised defense mechanisms are expected to breed, stay pregnant and deliver a healthy foal successfully. The alternative is to keep barren mares, pay the economic expense and for those mares that against all odds do become pregnant, produce healthy foals only rarely and sickly foals often.

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Bad Trustees and Bad Decisions

Bad Trustees and Bad Decisions

Avoid Trustees Who Don’t Understand the Rules or Risks

Crash and burn management of a CRT injures clients.

 

Charitable remainder trusts are powerful tools for charitably inclined donors who find themselves asset rich, but income poor.  Because of the complexity, trust-makers and trustees occasionally make mistakes that threaten the tax-exempt nature of a charitable trust, but sometimes they do dumb things and damage beneficiaries too. 

 

Often marketed by sales professionals, a CRT is first and foremost a philanthropic gift; it is neither a tax dodge nor a means to evade capital gains taxes.  While there are legitimate tax advantages with the use of a CRT, the tax tail should not wag the dog.  Instead, income tax deductions should be viewed as an additional benefit, not the principal reason for creating a CRT.  Too often, sales representatives, trained by someone who attended a three hour course on advanced planning, tout the benefits of the charitable remainder trust and try to sell it as a product.  This lack of understanding leads clients, charities, and (eventually) their advisors into disenchantment (and liability exposure) with the CRT because it was used for the wrong reasons, and/or was improperly designed.

 

John Andrews had a successful family lumberyard, operated as an S corporation, and was being solicited by a broker to sell his business for its prime real estate location. John entered into a contract for the sale of his business, and was visiting with one of his neighbors about the disadvantages of selling high priced land. Overhearing the conversation, John’s long-time insurance agent, Fred Friendly, suggested a charitable remainder annuity trust would be the perfect vehicle to avoid the unrealized taxable gain on the sale, and offered to help John set up the transaction.

 

John appointed Fred as trustee to avoid the potential self-dealing problems that sometimes occur when a donor has too much influence over the affairs of the trust.  Trustees should be wary of transactions that might create some personal financial benefits, and often a third-party trustee is used to put some distance between the donor and the sales process.  Because Fred was the local, self-proclaimed “expert”; John willingly went along since he had plenty on his agenda with all of the business transitions that were already taking up too much time.  In the meantime, Fred had John transfer the S Corporation shares into the trust’s ownership.  Fred, as newly appointed trustee, consummated the transfer of the shares with the sales agreement that was already in place, and then went looking for a product to invest the $5 million proceeds of the sale.  As an insurance agent with no securities license, Fred’s own offerings were limited to fixed and equity indexed annuities, so he decided those were the ideal investment for a CRAT.  Once Fred collected his remarkable commissions, he decided that this was such a great opportunity, he went down to the bank and borrowed money in the trust’s name, pledging its new annuity contracts as collateral,  and went out and purchased additional annuity products through his insurance agency with the borrowed funds and received another set of commissions.

 

Six months into the operation of the trust, John’s accountant asked about this “CRT thing” and gathered up some information about the transaction and planning so he could complete John’s tax return.  Without any specialized training in charitable trusts or fiduciary accounting, he consulted with a firm that specialized in design and management of these IRC §664 charitable trusts and he learned the following ten problems were very real and potentially catastrophic.

 

  1. A CRT is not a Qualified Subchapter S Trust.  As an entity that can not own S corporation stock and maintain its S election, the CRT converts the corporation to a regular corporation and this involuntary conversion may trigger income tax liabilities.
  2. Naming a friend or trusted advisor as trustee is a perfectly acceptable procedure, but there should be provisions in place to use a trust protector to remove an inept or uncooperative trustee or a means of replacing the trustee should he/she become unable to manage the affairs of the trust.
  3. The trustee sold the business through an existing sales agreement.  Once the sales contract was signed, and a commitment made to sell the business, it was too late to introduce a CRT into the transaction.  A CRT does not avoid favorable capital gains treatment if there is an assignment of income or a pre-existing agreement is already in place.  The IRS looks at step-transactions and may impose taxes and penalties for improper management of the trust when the sale has gone too far down the path and both parties are obligated to act.
  4. Placing all of the clients’ assets into an irrevocable trust may not be the most prudent approach in the planning process.  Advisors should not put clients into inflexible arrangements without full disclosure and a complete understanding of the risks.
  5. Since it was an S corporation that actually owned the valuable real estate,the corporation itself might have been the better trustmaker, rather than John.  By contributing the land to a term of years trust (not to exceed 20), the corporation could have taken advantage of a more flexible tax planning situation and passed the resulting trust income pro-rata out to the shareholders.
  6. A trustee has a fiduciary responsibility to properly invest the funds of the trust.  In many states, the Prudent Investor statutes stipulate the parameters of appropriate assets, allocation, and management considerations.  The IRS also has private foundation regulations and laws, under which charitable trusts operate (see §4944), that restrict trustees from imprudently managing assets or acquiring assets that jeopardize the trust’s security and tax-exempt status.
  7. A CRT trustee should not borrow funds.  Assets with debt or a mortgage may create debt-financed income and trigger unrelated business taxable income (UBTI).  The presence of UBTI means the CRT loses its income tax-exempt status, and to do that the first year of the trust’s operation, when a major sale of appreciated assets occurs, means the capital gains tax is not avoided
  8. Third party trustees should not be selling product to a CRT over which they have management responsibilities; there are too many opportunities for self-dealing and conflict of interest problems.
  9. Borrowing funds to buy investment products is unwise for a trust, and purchasing only fixed and indexed annuities for either a standard CRUT or a CRAT is inappropriate.  These products do not offer tax-advantages inside an already tax-exempt trust unless there is a “net-income” feature to the CRUT and the income beneficiaries desire some deferral.  Even with both of these conditions in a unitrust design, proper diversification should still be the hallmark of a prudent investor.  Additionally, the income beneficiary of a NICRUT OR NIMCRUT has to agree to defer income for at least seven to ten years in order to be comfortable with the performance of these contracts inside an already complicated trust structure. Neither a CRAT nor standard CRUT offers income deferral features, and this needs to be understood from the outset.
  10. Contributing an active trade or business to a CRT has to be carefully considered because of the potential for UBTI.  Normally, contributing stock of a C corporation, even of a closely-held corporation, works if the rules are followed, but trust makers must be very careful with other entities or sole proprietorships.

 

Advanced estate planning tools are often seen as a terrific way to preserve assets, protect dignity, and control the distribution and timing of assets acquired over a lifetime of hard work.  For that reason, seek competent legal and tax counsel from advisors truly experienced in the tools of the trade.  Learn about the choices offered and understand the costs, benefits, and risks associated with each of the tools proposed in any financial or estate plan.

© Henry & Associates 2006

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Case Studies and Articles

Cleaning Up Loose Ends — A Tale of Two Farmers – Henry & Associates

Cleaning Up Loose Ends — a Tale of Two Farmers

 

imageJeannie Evans inherited farm ground from her father, and she was exceptionally proud of its status as a centennial farm, one that had been under the same family’s management for over 100 years.  With no heirs other than a few nieces and nephews, Ms. Evans decided to leave her farm to the local university.  Not that giving farmland is a bad idea, but when Jeannie invited the alumni and development officers from the university out to see the farm, they indicated that it was foundation policy was to sell farmland if it did not fit into their management scheme.  After the development officers headed down the road to their next appointment, Ms. Evans hurried over to her lawyer’s office to redraft her will.  The new will’s provisions? 

§   The university cannot sell the land, even though the farm is too far from the research unit on the campus to be practical, and the acreage is too small to devote resources or staff to manage it.

§   The university has to continue using Jeannie’s long time tenant farmer and give him preferential lease rates, although the university had a professional farm manager and staff experienced in maximizing production. 

§   She leaves her nieces and nephews her portfolio of government savings bonds.  Unfortunately, the problem with inheriting bonds is that all of the accrued interest usually has an income tax liability that passes to the heirs.

 

In this case, Ms. Evans would be more tax efficient in her tax planning if she leaves the farmland, which steps up in basis at death, to her family and the taxable bonds to the tax-exempt university, which prefers cash for scholarships and endowment.  This solution allows her heirs the option of selling the farm without a capital gains tax, and the university receives the cash from the bonds without paying tax on what would otherwise be an IRD (income in respect of a decedent) asset.  Even with the gift in place and booked as a bequest, the university foundation should reconsider this gift.  With Jeannie’s new provisions, the university will be better off disclaiming a gift that has so many restrictions and avoid the grief of working with an uncooperative tenant farmer and an underperforming real estate asset.

 

The Right Stuff

Dave Janssen owns and operates an irrigated corn, soybean and wheat farm, and like many farmers, he lives poor, but is quite likely to die rich.  Dave is active on the town council, serves on the local school board, and would like to make a significant gift to the new school foundation.  Not comfortable with making a sizeable gift while he is still actively farming, a bequest in Dave’s estate plan seems to be the best solution.  In Dave’s role as a communitarian, this bequest would endow scholarships for students planning to return to the community as a teacher, health care provider or serve in a public service capacity. 

 

After reviewing the Janssen balance sheet and cash flow projections, the choice comes down to a gift of farmland or a gift of equipment and grain.  Whichimagemakes more sense?  In this case, the grain would be an IRD asset taxed at 35% in his estate, and the depreciated equipment is not something his non-farming heirs would be able to use or easily market.  His heirs would be better off if they inherited the land that steps up in basis at death, and then they can choose whether to sell it tax-free or operate it as a leased farm until other opportunities present themselves.  The tax-exempt foundation can take possession of the grain stored in the bins and have it sold through the local co-op elevator at market value without paying any income tax, and the equipment auctioned at a farm sale with the proceeds reinvested in the scholarship fund.

 

Achieve tax efficiency in charitable bequests more easily by inserting language in the will that specifies how to make gifts, and where to go in the estate to find the best assets.  Consider using something like the following as a guide.  “I instruct that all charitable gifts, bequests, and devises should be made, to the extent possible, from assets that constitute income in respect of a decedent, as that term is defined in the Internal Revenue Code.”

 

©2003 — Vaughn W. Henry

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PhilanthroCalc for the WebCONTACT US FOR A FREE PRELIMINARY CASE STUDY FOR 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 it 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 is a CRUT 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. Why? 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.

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Business Succession Planning

Will Your Family Business Survive to the Next Generation?

 

imageThe wealth of theUnited Statesis often concentrated in family businesses, not the stock market, despite the occasional dire media warnings on slow news days.  The IRS now reports that there are nearly a million more S corporation (more often used in smaller businesses) tax returns filed than regular corporate returns, and the gap continues to widen annually.  Factor in the partnerships and sole proprietorships, and you find numerous entrepreneurs cranking out products and services that keep the economy rolling along.  Unfortunately, few closely held or family businesses have done any succession or disaster planning.  Vernon Rudolph, founder of the well-known Krispy Kreme doughnut franchise, died in 1973, but had no estate plan for his family.  As a result, Krispy Kreme had to be sold and Beatrice Foods eventually acquired the company in 1976, and its family influence was lost.  Even though Rudolph established his business inWinston-Salemin 1937, far from the stresses of big city concerns, he failed to create a plan that would preserve and protect his business interests for his family.

 

Why Do Family Businesses Fail?

 

Despite the posturing by politicians advocating “tax relief” and the elimination of the death tax, the reality is that by changing the rules and moving the goal posts so frequently, Congress has created a tax environment that results in taxpayer paralysis  Estate planning should be a thoughtful process designed to work over many years, but a sense of impermanence and capriciousness in tax laws fosters inaction.  While business owners acknowledge the risks of neglecting their transition problems, they doom their business to failure because they will not take the necessary steps to minimize the “easiest tax to avoid” with just a little planning.  Even if there is no federal estate tax concern, there will still be taxes on income and capital gains, and newly imposed state inheritance taxes to deal with.  However, the tax tail must not wag the dog.  Once the tax issues are addressed, it may be more important to find a way to pass down a value system and maintain continuity.  These are critical steps in the planning process, but too many advisors are not helping matters by ignoring the non-tax conflicts in their hurry to complete an estate plan and push their clients out the door with cookie cutter plans.  

 

The estate planning process can be confusing and highly technical, contributing to the 66% of family business that fail to make it to the second generation.  Try to pass the business on to the third generation and fewer than 14% make the grade.  (Keeping the Family Business Healthy,  John L. Ward, 1987).  Among many of the other reasons for such high failure rates is the “founder’s syndrome”, or the inability to let go.  For some owners with unhappy marriages, they have taken refuge in the business, while other owners dislike dealing with personally traumatic issues like mortality or disability.  All of this contributes to a revolving door of quasi-retirement for the founder who has little else in life other than work, and who keeps showing up at the office without relinquishing control of the reins. 

 

Many of the founder’s business interests are closely intertwined with their driven personalities.  This determination to succeed is the foundation for their many achievements, and the source of future conflicts.  Since control concerns are such a major part of their life’s work, acknowledging any loss of mental acuity or mortality is a real struggle.  Additionally, many founders have made some bad decisions along the way and they worry about disrupting family relationships in the process of getting the situation back under control.  How so?  They may have ignored some family members by favoring just a few select heirs, or minimized the advice from non-family key employees.  Too often, business founders put heirs on the payroll with no-show jobs or with limited responsibilities.  By setting family members up in executive roles for which they have little training or aptitude, the founder creates unrealistic expectations for heirs.  Add to the mix an heir who really works in the business and there will often be a festering sense of inequity where one heir is working and the other heirs are not; yet all draw a paycheck.

 

In the classic estate planning process, owners pass value down to heirs in the form of stock in corporations or partnership units in family entities.  The problem is that owners will not voluntarily give up control of a business in which they have invested a good part of their lives, and such workaholics will not accept the concept of a life in retirement or the need for a family forum in which a fair and open exchange of information is necessary.  For retirement to succeed, the energies and priorities of the founder have to be channeled into something other than work, but that is very hard when the founder fears becoming irrelevant and unappreciated by succeeding heirs.

 

Since the principals constantly interact with each other outside the business, family entities are often in turmoil because problems are brought home and the management stresses are not easily set aside. When children marry and have families of their own, the in-laws and third generation all want input.  Getting all the players to focus on problems and achieve a unified management system is a lot like herding cats, not an easy situation under the best of circumstances.  Besides conflicting goals, intergenerational conflict, and sibling rivalry, tension in the office is a foregone conclusion. Add to that volatile mix a history of poor communication and a failure to enact meaningful changes in management and frustration will build.  Thus, it should be no surprise that few businesses maintain operations far beyond the founder’s life. In addition, it should shock no one that the founder may be the worst teacher for heirs as he tries to integrate them into the family business—he has spent his life fixated on control, not on sharing information or techniques. Sometimes a non-family key employee or mentor can be a buffer and may be a better choice to interface between the generations to make sure everyone is prepared to assume his or her rightful place in the business.

 

Not all is lost.  Some families manage to make the business work down through the years.  The best example in theU.S.is the Zildjian Cymbal Co. of Norwell,Massachusetts  Founded in 1623 by an alchemist named Avedis I in Constantinople, and relocated to the Quincy, MA in 1929, this family business holds the U.S. record for continuity.  The founder discovered a metal alloy that created cymbals possessing special clarity.  The business continues 14 generations later under the direction of two of his female heirs, Craigie and Debbie, after almost 400 years of continuous operation focused on supplying their niche product to musicians around the world.

 

The Plan

 

Generally, for a succession plan to work, the main concerns about death, disability and retirement must be addressed early and often.  In the post 9/11 world, it would be terribly imprudent to ignore the potential for catastrophic loss of principal family members.  Therefore, create a plan that addresses these questions:

  • How can institutional memory be enhanced and senior family members achieve a sense of validation.
  • Who is going to own the business, and in what format?
  • What steps must be taken to ensure continuity, and which advisors need to be brought into the transition team to make sure it happens? 
  • Who is going to operate the business, make day-to-day decisions, pay bills, sign checks?
  • Has the business buy-sell agreement been updated, and are realistic valuation techniques in place?
  • Will there be adequate liquidity to continue to operate the business when the founder steps out of the picture and still provide for an equitable distribution of ownership interests?
  • Will non-operating heirs be satisfied with reinvesting the profits back into the business to expand?  If not, managers face a shortsighted process of carving out value for income.  Or will heirs take the first good offer for the business and head to warm and gentle climates?
  • Can the operating heirs buy out the others in a fair exchange of value for control? 
  • Can all of this planning be done in a tax efficient manner without disrupting the business?
  • If there is a family heir anointed as successor, does this person have a grasp on the business operation, its employees, suppliers, credit worthiness, and customers? 
  • Do the heirs have the capacity and training to make decisions and keep the company moving forward with the full confidence of the other family members?  Alternatively, is there a key employee or outside manager available to hold the business together?

 

Most companies fail within a short time of their inception.  Family owned business have a tradition of being more durable, but it takes special care and a lot of extra effort to overcome these hurdles and succeed for the next generation.  Start the process early and preserve a lifetime of family work for the future.

 

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Terminating a CRT – Henry & Associates

Many of the charitable remainder trusts created during the high-flying 1990’s, especially those created prior to the imposition of the 10% remainder rule, have cratered along with the market decline.  For those with net income type trusts, the inability to find suitable income investments means that most of those trusts are now seriously underperforming.  What options exist for trustees and income beneficiaries with their trusts?  Depending on state law, the controlling language of the trust document, and the trustmaker’s charitable inclinations, there may be a few options.

 

1. Some charitable remainder trusts are created with a charitable organization as one of the income beneficiaries.  In this unusual case, this option to share the wealth exists as long as there is at least one tax paying entity receiving an income interest too.

 

2. For the trustee who no longer wants to deal with the hassle of a charitable trust, it may be possible to assign the income interest to charity, or terminate the trust entirely and accelerate the trust principal to charity now.  This gift generates another income tax deduction based on the present value of the income interests given away.  However, there may be state specific laws or spendthrift language in the trust document that would prevent the assignment of the beneficiaries’ income interest.

 

3. Make principal distributions from the charitable trust.  While there is no additional charitable income tax deduction, for the charitable client who wants to tap assets for current gifts, this may work if the document allows its use.  Otherwise, a letter ruling from the IRS may be necessary.

 

image4. Seek court ordered termination of the trust and split the CRT into two portions, an actuarially calculated interest passing to the income beneficiary, and the remainder interest passing to charity.  There is no added income tax deduction, and the income beneficiary receives a zero basis capital asset to reinvest and use as needed. 

 

For example, Garth Books, 65 years old, created a NIMCRUT several years ago, but with declining bond rates, his trust produces less income than anticipated.  However, the stocks inside the trust have appreciated, so Garth finds himself with a more valuable trust, but is unable to distribute enough income.  His 8.5% income interest would not be prudent in today’s environment, but he selected the higher payout anticipating continued double-digit interest rates.  By cashing out the trust, Garth can reinvest the proceeds and use them to maintain his lifestyle.

 

5. Carrying the “split the blanket” philosophy one-step further, Private Letter Ruling 200152018 offers some insight into the IRS mindset about the sale of a CRT income interest in exchange for a more stable income through a charitable gift annuity.  While splitting the two interests will not generate a tax deduction, the subsequent exchange of a gift annuity for the income interest will generate a deduction, as would the purchase of any CGA.  The problem with basing any planning decisions on a private letter ruling is that it was issued to one taxpayer based on a specific fact pattern, and the IRS is under no obligation to act consistently.  You cannot rely on it as a precedent.  If you are contemplating doing something similar, seek your own letter ruling and be safe.

 

Charitable remainder trusts are irrevocable, but with suitable language tremendous flexibility in design and management is possible, and this is one significant reason to use a custom drafted document rather than an IRS prototype.  Consider the advantages of setting up the trust properly:

§   Donor and/or Trustmaker may serve as trustee for the CRT

§   Modify trustee or use a special independent trustee

§   Revoke or modify charitable remainder interests

§   Use revocable, multiple, or non-spousal income interests

§   Distribute of principal to charity before the trust terminates

§   Use multiple charitable remainder interests

§   Define “income” for fiduciary accounting purposes

§   Accept closely-held or illiquid assets

§   Accept testamentary contributions

§   Distribute assets in kind

§   Unbundle the trustee, investment, and administrative functions

§   Modify investment objectives to improve tax efficiency

  

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Too Many Irons in the Fire – Malpractice XIII – Vaughn W. Henry

Too Many Irons in the Fire – Malpractice XIII – Vaughn W. Henry

Too Many Irons in the Fire – Malpractice XIII

Trustees should be independent and remember their fiduciary duties.

 

Tim and Julia Brennan, both 66 years old, created a standard charitable unitrust and sold some highly appreciated bank shares through it three years ago.  It made great sense as a way to minimize their capital gains liabilities, and passing the remainder to a charity was an acceptable cost, even though neither was particularly charitably oriented.  Their financial advisor on the transaction convinced them that the “perfect investment” tool inside their CRT should be a deferred variable annuity.  While using a deferred annuity is frequently a legitimate planning tactic inside a NIMCRUT that operates as a “spigot” trust, it is generally not the best tool inside a traditional CRUT. Why not?  Because there is no need for the trustee to accept the compromise of highly taxed ordinary income payments instead of more tax efficient tier two capital gains.  Using a deferred annuity turns a capital asset into an ordinary income stream, and since the top rate for tax on ordinary income is nearly twice that of capital gains, there is an unacceptable penalty for the use of this product.  If this was a net income trust there would be a need to control distributable net income, but a commercial deferred annuity usually does not work that way inside a SCRUT or CRAT.  While there may be reasonable differences of opinion about the best funding mechanisms, in the Brennan case, their financial advisor seemed to have motives that put his needs ahead of his clients’

 

Where did this train wreck fall off the rails?  Prior to helping the Brennans set up their charitable remainder trust, the life insurance agent had no experience with CRT management issues or the obscure rules associated with §664 trusts, but he knew there were opportunities to provide wealth replacement in the form of a life insurance contract.  The agent attended an advanced marketing program and learned that in addition to the insurance, a variable annuity was touted as the “perfect investment” inside a CRT.  Unfortunately, the marketing staff was more interested in pushing product instead of solving problems, and they neglected to disclose the down side of using an annuity inside the charitable remainder trust. 

 

What down side?

 

imageThe first problem that popped up was that this annuity contract had a limit on the number of distributions and the value of penalty free withdrawals.  Where this developed into a serious problem was when the equity market free-fall in 2000 through 2002 dropped the annuity value to a level that restricted the required quarterly unitrust distributions.  Once the annuity dropped in market value by over 50 percent, then the required payments triggered the insurance company’s penalty.  Because the annuity company had no experience with charitable trusts, it was issuing a 1099-R for all of the payments made to the income beneficiary, but that causes a problem because income beneficiaries should receive a K-1 from the CRT, not a 1099 from the carrier.  The second problem was that the agent who sold annuity had himself named trustee, and he convinced the Brennans that because the annuity was not liquid enough to make the required distributions, the trust would not be able to meet its obligations.  The third problem is that the trustee neglected his fiduciary responsibilities, i.e., the duty to look out for both the income beneficiary and the charitable remainder beneficiary.  By keeping the charitable trust invested in an underperforming annuity, he harmed both beneficial interests.  The trustee, as an insurance producer, knew that if the trust terminated the contract he might be required to refund the sales commission on the initial purchase and lose the ongoing trail commission, so there was an existing conflict of interest that may have influenced his decision to do nothing about dumping the annuity.  This is one reason why insurance carriers and the National Association of Securities Dealers (NASD) prohibit a registered representative from acting as a trustee for a client’s trust.

 

Even if the CRT is a properly drafted irrevocable trust, as long as it does not operate as a CRT it is not going to qualify as a tax-exempt charitable remainder trust.  It is important to understand that standard unitrusts and annuity trusts do not have discretionary authority to pay less than the appropriate amount as stipulated by the trust document.  Occasionally trustees make errors, and make incomplete distributions, but an ongoing pattern of missed or improper payments exposes the trust to grantor status and loss of its charitable remainder trust protections *

* Atkinson v. Commissioner, No 01-16536 (11th Cir.,Oct. 16, 2002), Atkinson v. Commissioner, 115 T.C. 26 (2000)

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Vaughn W. Henry

PhilanthroCalc for the WebCONTACT US FOR A FREE PRELIMINARY CASE STUDY FOR 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 it 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 is a CRUT 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. Why? 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.

Categories
Case Studies and Articles

Including a DAF or Private Foundation in Your Planning – Henry & Associates

Including a DAF or Private Foundation in Your Planning – Henry & Associates

 

Tax Treatment and Management

Public

Charity

501(c)3

Private

Foundation

Donor

Advised

Fund

Income, Gift and Estate Tax deductible contributions

Yes

Yes

Yes

Fair market value tax deduction

Usually

Sometimes

Usually

AGI limits for cash contributions

50%

30%

50%

AGI limits for contributing  publicly traded securities

30%

20%

30%

AGI limits for appreciated “hard to value assets”*

30%

Basis

30%

Tangible property** with a “related use”

FMV

Basis

Basis

Founder/Donor control or influence over grant-making

None

Significant

Some

Operating complexity for donor

None

Significant

None

Flexibility

Little

Significant

Moderate

Cost of making and distributing charitable gifts

None

Significant

Little

Easy to operate and stay in compliance

Simple

Complex

Simple

Excise tax on investments

None

2%

None

Paving over Farmland – Malpractice XII

Keep those tax notes updated.

 

John and Julia Ramirez have a citrus grove in what is turning into a rapidly growing neighborhood.  They have drawn the unwanted attention of a number of buyers seeking large tracts of agricultural land for its commercial and residential potential.  Additionally, because they possess senior water rights, a nearby city has been pressuring them to sell the rights to develop wells and add capacity to the city’s water system.  Rising property tax rates and increased suburbanization have added further pressure to sell out and move on, especially when they routinely find youngsters prowling around their equipment and getting into mischief.  These liability concerns have forced them reluctantly to accept the inevitable and sell out to commercial developers, and one of their advisors has suggested a charitable remainder annuity trust and a private foundation to minimize the tax hit on the transaction.

 

Generally, a CRT is a good idea to defer capital gains recognition, especially if the family has charitable inclinations.  However, a CRAT is a poor choice for most real estate sales because of its limitations and rigidity.  A better choice would be a custom drafted unitrust (CRUT) because it offers more flexibility.  Whether they choose a standard CRUT, “FLIP-CRUT”, or a NIMCRUT depends more on the family’s need for control, flexibility and a predictable income stream, as the income tax benefits and basic structure is the same for all three variations of the CRUT. 

 

Besides recommending the wrong charitable trust, their advisor’s assumptions about using a private foundation as a remainder charity are probably incorrect as well.  Although private foundations previously offered a fair market value income tax deduction for gifts of appreciated assets, after 1998, the rules changed and the more favorable tax treatment is now limited to just cash and appreciated qualified (publicly traded) securities.  If land is used, the income tax deduction is restricted to basis or cost when private foundations are the eventual recipients.  A better choice for tax efficient gifts with hard to value assets like farms, commercial real estate, or residential property would be a CRT with a public charity or, if ongoing family influence is desirable, a donor advised fund inside a community foundation is used instead. 

 

Why would a donor advised fund be a better choice?  It is simple, easy, and less hassle.  The umbrella charity provides oversight and compliance, spreads the cost of operation over many funds, offers economical management, and still provides for a donor to make recommendations in support of his or her charitable interests.  Many legal and tax commentators routinely suggest the use of a private foundation when contributions exceed $5 million, others suggest that $10 million is more appropriate when families seek to create legacies and provide for ongoing family management.  However, when transferred assets are more modestly valued, then the donor advised fund offers the same immediate tax treatment as that of a public charity with some of the advantages and donor continuity of a private foundation.  Remember to consider all of your options; charitable planning involves irrevocable tools and for this planning to work, articulate specific philanthropic goals.  Too many planners and families allow tax deductions to drive the process instead of treating it as an ancillary benefit.

 

* closely held stock, commercial real estate, farms or ranches, life insurance policies with cash value, patents, personal residences and vacation homes, retirement plan assets (via beneficiary designation), securities, unimproved property

** art, collectibles or other tangible personal property, equipment or inventory, royalties, copyrights, ordinary income assets

 

*** Electing “step-down”, uses basis against AGI instead of FMV with 3% itemized deduction reduction rule.

 

©2003 — Vaughn W. Henry

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VWH www.gift-estate.com

Vaughn W. Henry

Henry & Associates

PhilanthroCalc for the WebCONTACT US FOR A FREE PRELIMINARY CASE STUDY FOR 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 it 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 is a CRUT 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. Why? 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.

image

Categories
Case Studies and Articles

Checklists for Older Clients – Vaughn W. Henry

Checklists for Older Clients – Vaughn W. Henry

Estate Planning Isn’t Just for the Elderly

 

You don’t need to be rich and famous to need an estate or financial plan.  While some people have the expertise and time to manage their affairs, others are more comfortable with the advice and counsel of professional consultants.  In either case, decisions need to be made ahead of time so you’re not stampeded into making bad choices when things start to go wrong.  First off, decide how comfortable you are with your current financial situation.  Then decide whether you need professional assistance to sort through your options.  One of the earliest questions you need to address is what happens if you are unable to manage your affairs competently down the road.  Besides accidents and acute emergencies, there are chronic and progressive illnesses that prevent people from being able to enforce their wishes and keep on top of their finances.  In either case, do you have a trusted family member, friend, or a professional advisor who can handle your money if you become incapacitated or ill?  Have you made any decisions, and shared them with family members, about the level of care and extraordinary treatments needed should you become seriously ill? 

 

It’s Not Always about Money

 

 

imageOften, arranging your affairs is more about preserving dignity and control.  Sometimes estate planning is a function of life planning; doing simple things like modifying your residence to accommodate your physical restrictions will make things easier.  For example, many people choose to widen doorways, lower light switches, install rails and bars in bathrooms, or to build ramps or lifts for stairs in order to make the home more comfortable.  Occasionally there are other emotional concerns about losing independence.  Distasteful as it may be, address them now, rather than later.  For example, do you still feel safe driving, even at night?  The problem is that many older drivers deny they have a problem or are so cognitively impaired they fail to recognize the cues that signal problems, e.g., forgetting to turn on headlights at dusk, getting lost in familiar neighborhoods, failing to recognize mechanical problems like low tire pressure, responding too slowly to emergencies, and so on.  Family members and advisors need to step in and offer to help structure or organize things so you can minimize danger to self and others.

 

Other difficult questions the elderly often avoid include quality of life issues.  Is there adequate health and long-term care insurance?  Is hospice or home care an option with your coverage?  Some of this preparation involves discussions with medical providers about some very personal values.  For instance, when you’re very sick, how much information do you want your physician to relate to you and your family about diagnoses, treatments, and recovery outcomes?  How involved do you want to be in decision making for your health care?  Will you authorize and insist on pain medication if circumstances dictate its need, even if it’s not part of your medical treatment?  Values planning issues involve medical, personal, emotional, and spiritual matters, so you need to discuss this with your family and physician if you expect procedures to be done according to your wishes.  Not only will you want to stipulate how you want to be treated, part of a good estate plan allows you to tell family important things they should know.  Itemize your thoughts in an “ethical will” where you not only tell heirs what you want them to receive, but why you want them to receive it and how your life developed over time.  It’s a great opportunity to leave your family a little something about yourself.

 

Have you made a list of all the important information that would be useful in case of family health emergencies?  Have you discussed your funeral arrangements?  A little preparation will save a lot of grief and expense; so make your choices now and regain control of your life planning.  There is no time like the present to get started; you’ve put it off too long.



Information Checklist

  1. Birth certificates, marriage certificates, passports and other important identification documents, any court documents dealing with a name change or adoption proceedings
  2. Marriage contracts (pre-nuptial and post-nuptial, divorce or separation agreements)
  3. Life insurance policies (have you checked to see if beneficiary designations current and accurate?)
  4. Identify other insurance policies (disability, affinity programs, health, property & casualty, and annuity contracts), insurance agent contact information
  5. Stock and bond holdings, consolidated investment account statements, broker contact information
  6. Powers of attorney for health care and property, living will or advance directive documents, while not helpful after death, they are extremely important if there is a disability or incompetence.
  7. Your will and codicils (have you identified guardians for minors and elderly parents?).  A list of personal items and the intended recipients, as it is often the family heirlooms that cause family rifts.  If any mementos are given away early, mark them off the list so they will not be reported missing or stolen.
  8. Trust documents and amendments (properly titled property in the name of the trust)
  9. Trustee, and successor trustee contact information if any, and contact information for your lawyer
  10. Mortgage documents, due date and amount of mortgage payment or rent, location of deeds and property titles, including cemetery plots, any lease information
  11. Contact information for service people.  Identifyautomatic debits or deposits and which accounts are involved (electric utilities, gas, pension payments, etc.), automatic deliveries or pick ups that need to be modified (trash, fuel oil or propane, mail, newspaper)
  12. Bank account information, checkbooks, passbook savings, account statements and PIN numbers, contact information for bankers or brokers, inventory of contents and location of safety deposit box and the key, credit card and ATM account numbers and their expiration dates; if there is a safe, who will have the combination
  13. Airline mileage points and phone numbers, life insurance provided by affinity groups, travel or credit card companies
  14. Partnership agreements, recent appraisals, corporate or partnership buy-sell arrangements, business continuity planning documents
  15. Pension, profit-sharing, IRA and other retirement plans (are beneficiary designations current now that new rules apply to changing required distributions), retirement plan administrator contact information.  If there’s a desire to support a charity with a bequest, these retirement plans make great, tax efficient ways to fund philanthropic interests with simple beneficiary designations.
  16. Contact information for your medical providers, current medications and dosages, Medicare claim number and Medigap policy number
  17. Employment contracts, deferred compensation or “golden parachutes/handcuffs” type agreements
  18. Any life income arrangements (commercial immediate annuities, charitable trusts, life estates)
  19. Social Security card
  20. Veteran’s benefits updated and military discharge paperwork, e.g., DD-214
  21. Organ donation instructions, funeral arrangements and burial instructions
  22. Directions for pet care
  23. Recent income and gift tax returns, contact information for your accountant, current 1099’s and W-2’s, expense and income worksheets for this tax year
  24. Inventory of capital assets (real estate, stock, investments, collectibles, etc.) with purchase price, history of acquisition, improvements and tax basis (which will be extremely important if the tax laws continue unchanged)
  25. Driver’s license number and expiration date, vehicle registration information, inventory of any items in storage and storage company phone number
  26. Text Box: © 2002, 2005 -- Vaughn W. Henry Gift and Estate Planning Services Springfield, IL 62703-5314 217.529.1958 -- 217.529.1959 fax VWHenry@aol.com www.gift-estate.comAny post office rental box, contact information for neighbors and friends, a list of names and phone numbers of those who should be notified during a serious illness or death
  27. Web site or e-mail accounts and passwords
  28. It is not too early to write an obituary while the person can contribute to it
Categories
Case Studies and Articles

How donors should take charge of their priorities

How donors should take charge of their priorities

Getting Your Advisors on Board – Why You Need Marching Orders for the Donor’s Advisors

Good stewardship starts with a clear plan and explicit directions

Despite the self-promoting press releases foundations and corporations generate with their giving programs, in most cases, the individual donor makes the real difference for a charity’s bottom line. According to Giving USA’s 2001 edition, 83.5% of charitable giving is from lifetime gifts and bequests from individuals.

As the population ages, more and more donors are looking for creative ways to arrange charitable gifts, and that brings us to planned giving. Why is that?  Planned gifts generally are made from capital assets, and not income.  Donors including philanthropy in their plans may use stock, land, or business interests very creatively instead of hard to find cash.  Besides helping out a deserving charity, there are tax benefits; the option for added income, and, best of all, donors need not be high-income wage earners to be tax efficient philanthropists.

Bequests and charitable trusts provide the bulk of new endowment funds; and exceptionally generous and motivated supporters make significant contributions possible.  However, no donor lives in a vacuum.  Most have a cadre of one or more professional advisors who provide them with tax, legal and financial advice.

Wise donors give because they are excited about a charity’s capacity to make the world a better place.  However, many early discussions about a proposed gift start with the charity’s fundraising staff rather than the donor’s trusted advisor.  Subsequent meetings with professional advisors, brought in later in the process, may steer the gift discussion off course.  Why does this happen?  Sometimes disinterested or inept advisors lack the technical background to understand the gift planning process, other times it revolves around miscommunication.  For all the good that a well-trained advisor can do for a donor, most of those who fail to follow through with a client’s charitable wishes do so because the client does not clearly and forcefully express his or her desires.  As a result, donors miss opportunities to support charities and projects that have drawn their attention or tugged at their heart.  And, it’s not just the charity that loses out; it is also the donor. Wonderfully creative gift arrangements can provide a sense of accomplishment and meet many of the donor’s goals too.

Commercial advisors often view their roles as one of protection and oversight, and too often do not understand or share their client’s interest in supporting a worthy nonprofit organization.  While various polls have reported that between 66 percent and 80 percent of all planned gifts are motivated by the professional advisors, unfortunately there are too many advisors responsible for derailing an untold number of needed and otherwise thoughtful gifts.

Last Updated: March 6, 2003

Gift & Estate Planning Services © 2003

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PhilanthroCalc for the WebCONTACT US FOR A FREE PRELIMINARY CASE STUDY FOR YOUR OWN CRT SCENARIO or try your own at Donor Direct. Please note — there’s more to estate and charitable planning than simply running calculations, but it does give you a chance to see how the calculations affect some of the design considerations. Which tools work best in which planning scenarios? Check with our office for solutions.

Categories
Case Studies and Articles

IASB November Cracker Barrel Forum

imageimageimageimage

Overcome Financial Fears
image image image image image image image image image image
Financial goals must not be jeopardized
by charitable strategies
Acknowledge and address concerns
about the donor’s financial security and
any potential turmoil from concerned
heirs before pursuing gifting programs
The majority of donors would give more
if they were in a position to do so
Show them how to afford more gifting