The Congressional ‘Joint Select Committee’ May Return The Gift Tax Exemption to 2009 ($1 million) Levels by Year End

As a result of this generous gift tax exemption, individuals who can afford to have been aggressively giving away the available exemption in cash, marketable securities, commercial real estate, residences, closely held business interests, family partnerships, LLCs, etc. In addition, they have been using estate planning leveraging techniques such as (1) GRATs and (2) sales to Intentionally Defective Grantor Trusts (IDGTs) to transfer multiples of the $10 million exemption without the imposition of any gift tax (these have been discussed in prior email blasts). It is important to note that while many states such as New York and New Jersey have very onerous estate taxes, these states do not have a gift tax. As a result, the importance of gifting becomes significantly amplified.

Recently, a 12 member congressional committee (the “Joint Select Committee”) was formed to reduce the deficit. The recommendations of the Joint Select Committee will be sent to Congress no later than November 23, 2011. An “up or down” vote must take place by December 23, 2011. If either the Joint Select Committee fails to make the required recommendations or Congress fails to accept those recommendations, then the automatic spending reductions mandated by the Budget Control Act of 2011 will be triggered (including huge cuts to the defense budget).

There have been members of the Joint Select Committee that have indicated a willingness to consider changes to certain gift and estate planning techniques that benefit wealthy individuals. The changes being considered include a reversion as of January 1, 2012 to the gift and estate tax exemptions that existed in 2009. In 2009, the lifetime gift tax exemption was only $1 million (as opposed to the current $5 million gift tax exemption) and the top gift and estate tax bracket was 45% (as opposed to the current 35% rate). In addition, some members are considering changes to available estate planning techniques such as GRATs and discounts for intra-family transfers. Given the severity of our budget crisis, it is impossible to predict what will happen. Without agreement of the committee, Congress and the President, there will be unprecedented cuts in our defense budget. Since very few members of Congress would be happy with the scheduled cuts in defense, some compromise will have to be reached.

If you have been delaying your estate planning on the assumption you have until the end of 2012 to take advantage of these tremendous opportunities, DON’T. Now is the time to act. Let us answer any questions you may have.

The information in this e-mail message may be privileged, confidential, and protected from disclosure. If you are not the intended recipient, any dissemination, distribution or copying is strictly prohibited. If you think that you have received this e-mail message in error, please e-mail the sender and delete all copies. Thank you.

As required by new U.S. Treasury rules, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this email, including attachments, is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.

1. Reduce the lifetime gift tax exemption from $ 5,120,000 to $1,000,000.
2. Reduce the estate tax exemption from $ 5,120,000 to $ 3,500,000.
3. Increase the top federal gift and estate tax bracket from 35% to 45%.
4. Eliminate valuation discounts for Intra-Family transfers. Thus discounts for minority interest and lack of marketability will not be available.
5. Require GRATs be a minimum of 10 years.
6. Eliminate perpetual dynasty trusts.
7. Eliminate the estate planning benefits of the Grantor Trust rules.

Even if these proposals are not enacted, the transfer tax rules for 2012 will “sunset” on December 31, 2012. Thus, the gift and estate tax exemptions will drop to only $1,000,000 and the top bracket will increase to 55%.

There is only 10 months left to take advantage of the 2012 rules.

Under current tax law, there are very few allowable deductions. However, a very important deduction is the deduction for qualified retirement plans including a defined benefit plan. A defined benefit plan is a qualified retirement plan under the Internal Revenue Code that in many circumstances can generate above the line annual income tax deductions in the hundreds of thousands of dollars and significant retirement assets for the self-employed and small business owner. All contributions into a qualified defined benefit plan are 100% tax deductible. These plans generate “above the line” income tax deductions and are therefore the perfect means to reduce current income tax liability for federal, state and city purposes while saving for retirement. For example, a taxpayer earning $1 million dollars per year with a defined benefit plan contribution of $200,000 would only have $800,000 in adjusted gross income potentially saving $100,000 in current income tax liabilities!

For those that qualify, defined benefit plans also allow significantly larger contributions than a typical 401(k), profit sharing or money purchase plan. Individuals who are 50 years of age or older could potentially contribute in excess of $300.000 per year. The goal of this type of planning is to maximize owner contributions while minimizing employee cost. Any plan must of course comply with all IRS requirements. The contributions are actuarially calculated based on the employee’s age, income, assumed retirement age and the plan’s assumed and actual investment performance. Under current law, a defined benefit payment can be designed to pay at the participant’s retirement age as much as $200,000 per year for life. If someone retires at age 62, many millions of dollars would have to be accumulated in the plan in order to receive $200,000 per year for life. Since, the size of the contribution (and the deduction) is essentially based on the age of the business owner, the number of years until retirement, life expectancy and the presumed rate of return, the largest contribution will be enjoyed by taxpayers who have a shorter number of years until retirement. For example, an owner/sole proprietor with 10 years of plan participation could retire at age 62 with a lump sum of $2,480,000 given the right salary, coverage and effective investment guidance. This amount could increase to $3.7 million if the plan adjusts pay-outs for cost of living increases. In addition, an equivalent amount can be set aside for the owner’s spouse if the spouse is an employee in the business and the spouse earns at least $250,000 per year. These benefits clearly cannot be achieved with a simple 401(k) or profit sharing plan where contributions are limited to only $50,000 per year.

While a defined benefit plan has several advantages, it is somewhat more expensive to maintain than some other qualified plans, but it should be considered by any business owner who is looking to maximize his or her assets at retirement and substantially reduce current income tax obligations. Given the rising tax environment, now is the time to take action.

If any of the above information is a concern to either your clients or yourself, please contact Maurice Kassimir at 212-944-1377 or mkassimir@mkpclaw.com to see how you can plan today for a substantially better tomorrow.

The following is a summary of the provisions of the new law that relate to estate and gift taxation and a brief summary of important estate planning techniques that are still available:

1. The estate, gift and generation-skipping transfer tax exemptions are retained and indexed for inflation so that the 2013 exemptions are $5,250,000.
2. The minimum estate, gift and generation-skipping transfer tax rate is increased from 35% to 40%. The 40% rate is reached at a taxable estate or cumulative lifetime gifts of $1,000,000. The combined federal and state estate tax rate for New York and New Jersey residents approaches 50%. Therefore, sophisticated estate planning for taxable estates above the exemption is extremely important.
3. Unrelated to the new tax law, the annual exclusion has increased to $14,000 per donee or $28,000 for a married couple who elect to gift split.
4. Portability of any unused estate tax exemption between spouses is now permanent. This outcome means the unused estate tax exemption of a decedent can be transferred over to a surviving spouse. As a result, all wills and living trusts should be reviewed to make sure the documents are sufficiently flexible to allow for a full deferral of New York or New Jersey estate taxes until the death of the surviving spouse.

The new law removes much of the uncertainty we have been dealing with in the past decade due to the threat of a reversion to pre-2001 tax laws. Those who made significant gifts in 2011 and 2012 have succeeded in removing assets and future appreciation on those assets for multiple generations. For those who did not make substantial gifts last year, there is now more time to assess the advantages of doing so in light of personal goals and objectives.

It is worth noting that no changes were made to the Grantor Retained Annuity Trusts (GRATs) rules, and no limitations were placed on valuation discounts for intra-family transactions or the fantastic benefits of intentionally defective grantor trusts. It is entirely possible that these planning techniques will be revisited at some point in the future when additional tax reform is considered. Also, neither New York State nor New Jersey has a gift tax (though they both have onerous estate taxes). In an effort to raise revenue, those rules could change. It is therefore much less costly to make taxable gifts than to pay estate taxes.

Interest rates remain at all time historical lows. Therefore, it is an opportune time to implement strategies that involve giving away assets with future appreciation potential. For example, the hurdle rate for making a GRAT successful is now only 1%. The minimum interest rates for installment sales to intentionally defective grantor trusts on intra-family loans are only .21% (short term), .87% (mid-term) and 2.31% (long term). These low rates offer a compelling opportunity to transfer future appreciation while maintaining principal assets for the current generation.

All estate plans NEED to be reviewed to determine whether changes to your will should be made and whether additional planning is warranted. We recognize that estate planning only benefits the next generation and beyond and not the planner. However, not only it is important to have one’s affairs in order, most clients prefer that their heirs be the primary beneficiaries of their estate. Without planning, the government is often the primary beneficiary. Trusts are essential to ensure that wealth transfer can be accomplished without transferring control while creating asset protection strategies.

First, you may consider the creation of one or more Delaware limited liability companies to hold your homes, any businesses and commercial real estate you may own (if they are not already held in limited liability entities), and centralize the investment management of your liquid asset portfolio. Delaware is a debtor-friendly state with a long history of statutes and case law favorable to persons who form Delaware entities to protect their assets prior to experiencing creditor issues. The most a creditor could hope to obtain from your Delaware LLC would be a charging order requiring you to turn over any distributions made to you until your debt is paid. However, if such a charging order were in effect, you would cease any distributions frustrating the creditors who might be encouraged to settle the claim for cents on the dollar. An additional advantage is that Delaware law does not allow creditors to participate in the management of a Delaware LLC, so no distributions can be forced if your LLC’s operating agreement is properly drafted; nor can your creditors demand that the LLC be dissolved.

We would advise that your Delaware LLCs be multi-member and not be single member LLCs. In other words, give your spouse, your child or a non-grantor trust, a small membership interest in each LLC (any gift tax issues would have to be addressed). Without a second member, the LLC would be considered a disregarded entity for income tax purposes and may be considered a disregarded entity for creditor protection purposes, as well. Because the asset protection laws of Delaware are designed to protect members of an LLC against charging orders obtained by creditors of one of the members, you will need a multi-member LLC to take advantage of that protection. In short, a single member LLC might cause you to lose the asset protection benefits as you and your entity would be too closely identified with one another. You may also consider allowing your spouse or child to act as the Manager of any non-operating business LLCs to put more legal distance between yourself and your assets which would be advantageous in any litigation. Contributing your assets to a multi-member Delaware LLC in this manner will provide you with a very healthy level of asset protection. Your creditors would need to obtain a charging order in a Delaware court to prevail against your LLC-protected assets. This structure is a very effective deterrent to litigation.

After the formation of the LLC(s), deeds would be prepared to transfer your homes and any additional real estate to the LLCs. You would contribute your liquid assets to the LLC by re-titling your bank and stock accounts. The more LLCs that are created will likely improve the asset protection results. If you decide to go no further, you will already have done quite a bit to protect yourself from future creditor claims.

Should you wish to engage in additional planning to protect your assets, a Delaware LLC may be created in conjunction with an Alaska trust. The trust would have to have an Alaska trustee (typically a trust company). The trust company would only act in an administrative capacity and family members, friends or advisors acting as the trustees would be responsible to handle investments and distributions. Alaska, like Delaware, has laws which strongly favor the protection of persons who contribute their assets to Alaska trusts prior to having any creditor issues. Your Delaware LLC membership interests can be transferred to an Alaska trust in a manner which does not result in a current gift for gift tax purposes. It would be extremely difficult for a creditor to obtain a charging order against a Delaware LLC making a distribution to an Alaska trust. A potential creditor would be required to bring suit in both Delaware and Alaska and contest the formidable asset protection laws of both jurisdictions to reach the assets held in the trust.

During your lifetime, you, your spouse and your descendants can be beneficiaries of your Alaska trust, as long as you have no power to distribute assets to yourself. After the death of you and your spouse, lifetime asset protection trusts could be created for the benefit of your descendants for as long as you have descendants, as Alaska is a jurisdiction which allows for the creation of perpetual trusts. To the extent your assets are held through an Alaska trust, its provisions will effectively act as a Will in directing the distribution of those assets at your death.

Call us to talk about these exciting opportunities to protect what your hard work has built for you and your family.

Under current tax law, there are very few allowable deductions. However, a very important deduction is the deduction for qualified retirement plans, including a defined benefit plan. A defined benefit plan is a qualified retirement plan under the Internal Revenue Code that in many circumstances can generate above the line annual income tax deductions in the many hundreds of thousands of dollars as well as significant retirement assets for the self-employed and small business owner. All contributions into a qualified defined benefit plan are 100% tax deductible. Since these plans generate “above the line” income tax deductions they are the perfect way to reduce current income tax liability for federal, state and city purposes while saving for retirement. For example, a taxpayer earning $1 million dollars per year with a defined benefit plan contribution of $200,000 would only have $800,000 in adjusted gross income potentially saving $100,000 in current income tax liabilities!

For those that qualify, defined benefit plans also allow significantly larger contributions than a typical 401(k), profit sharing or money purchase plan. Individuals who are 50 years of age or older could potentially contribute in excess of $300,000 per year. The goal of this type of planning is to maximize owner contributions while minimizing employee cost. Any plan must of course comply with all IRS requirements. The contributions are actuarially calculated based on the employee’s age, income, assumed retirement age and the plan’s assumed and actual investment performance. Under current law, a defined benefit payment can be designed to pay at the participant’s retirement age as much as $205,000 per year for life. If someone retires at age 62, many millions of dollars would have to be accumulated in the plan in order to receive $200,000 per year for life. Since, the size of the contribution (and the deduction) is calculated using a compounded present value calculation, the largest contribution (and deduction) will be enjoyed by taxpayers who have a shorter number of years until retirement. For example, an owner/sole proprietor with 10 years of plan participation could retire at age 62 with a lump sum of $2,480,000 given the right salary, coverage and effective investment guidance. This amount could increase to $3.7 million if the plan adjusts pay-outs for cost of living increases. In addition, an equivalent amount can be set aside for the owner’s spouse if the spouse is an employee in the business and the spouse earns at least $250,000 per year. These benefits clearly cannot be achieved with a simple 401(k) or profit sharing plan where contributions are limited to only $50,000 per year.

While a defined benefit plan is somewhat more expensive to maintain than some other qualified plans, it should be considered by any business owner who is looking to maximize his or her assets at retirement and substantially reduce current income tax obligations. Given the rising tax environment, now is the time to take action.

In addition to generating very large income tax deductions, in many cases, a portion or “incidental” portion of the retirement plan can be used to pay for life insurance that may be desirable or necessary for your estate planning. Pre-tax money would be used to pay the premium. If the plan and life insurance are structured properly, a vast portion of the life insurance proceeds can escape estate taxation even though pre-tax money was used to pay the premium.

If you wish to discuss the information described above for yourself or for your clients, please contact Maurice Kassimir at 212-944-1377 or mkassimir@mkpclaw.com to see how you can plan today for a substantially better tomorrow.

UAs you may be aware, the current Federal gift/estate tax exemption is $5,340,000 (inflation adjusted from the $5 million base) while the NY estate tax exemption is only $1 million. In addition, lifetime gifts are currently not taxable by NY and will effectively reduce any NY estate taxes. Therefore, a NY decedent with a taxable estate of $5 million would not pay Federal estate taxes (as the taxable estate is less than the Federal exemption of $5,340,000) but would be subject to a NY estate tax of $391,600 (as the taxable estate exceeds the NY exemption of $1 million). However, since lifetime gifts are only partially included in the NY estate tax calculation, it is currently possible for a NY resident to make lifetime gifts to reduce the NY estate tax liability. As an example, if the same decedent had made lifetime gifts of $4,900,000, his Federal taxable estate would remain at $5 million with $0 Federal tax (since lifetime gifts are fully included in the Federal taxable estate) but his NY taxable estate would be reduced to $100,000 with $0 NY tax, thereby eliminating the $391,600 of NY tax previously mentioned.

The Governor’s budget proposals would greatly reduce (and in some cases completely eliminate) that benefit as they would instead include lifetime gifts made after April 1, 2014 in the NY taxable estate. Therefore, a NY decedent would not receive any reduction in NY estate taxes for such lifetime gifts. If a NY resident has an estate in excess of $5.34 million dollars, consideration should be given to gifting the lifetime exemption prior to April 1st.

It should be noted that included among the budget proposals is an increase in the NY estate tax exemption from the current $1 million to $5,250,000 over the next few years (increasing to $2,065,500 on April 1st and then $3,125,00, $4,187,500 and $5,250,000 on April 1 of years 2015-2017, respectively, with inflation increases after January 1, 2019). In addition, the top estate tax rate bracket will reduce from 16% to 10% by April 2017. While this will help offset the lifetime gift addback, there will still be a NY estate tax effect while the Federal and NY exemptions remain unequal.

As mentioned above, this new rule would only apply to gifts made after April 1st. For those of you who have already used your full Federal exemption, you will still benefit from the current reduction in your NY taxable estate. However, for those of you who have not fully used your Federal exemption, the window of opportunity to reduce your NY taxable estate may be closing shortly and you should contact us immediately to discuss the best method of taking advantage of this planning opportunity before it expires.

MANY HIDDEN TRAPS

WATCH OUT !!

Estate Tax

The New York estate tax exemption is set to increase gradually though 2019 to eventually match the federal exemption, which is currently $5,340,000. The New York State exemption amounts are as follows:

April 1, 2014 – $2,062,500

April 1, 2015 – $3,125,000

April 1, 2016 – $4,187,500

April 1, 2017 – $5,250,000

After January 1, 2019 the exemption will be indexed for inflation

The top New York estate tax rate remains at 16%.

In spite of the higher exemption, there is an estate tax “cliff”. If a resident decedent’s taxable estate exceeds the exemption amount by more than 5%, the exemption is eliminated entirely. This means that your estate will be taxed on its full value, not just the amount over the exemption. There is also a phase out of the exemption for estates exceeding the exemption by 5% or less. The following example provided by the New York State Society of CPAs shows a 164% marginal tax rate. In 2017, a decedent with a New York taxable estate of $5,512,500 (which is 5% more than the exemption of $5.25 million), would pay a New York estate tax of $430,050, whereas there would be no tax if the estate were worth $5,250,000. In effect, there is a $430,050 tax on the extra $262,500!!!

If Governor Cuomo believes this new law will stop residents from moving to Florida or another state with lower tax rates, he is sorely mistaken. If your estate exceeds the exemption, it is very important that you consider estate planning to reduce your taxable estate below the threshold.

Portability/QTIP Election

There is no portability provision as there would be under federal law. Under federal law, the unused estate tax exemption of the first spouse to die can be transferred or “ported” to the surviving spouse. This cannot be done under New York law. Therefore, planning steps must be implemented (including having proper Wills) to make sure the New York exemption of the first spouse to die is not wasted. In addition, a separate New York QTIP election can only be made when a federal return is not “required to be filed”. So even if a federal return is filed solely for purposes of electing portability, a separate state QTIP election cannot be made. Therefore, creating an exemption trust at the death of the first spouse is still necessary to make sure the New York State exemption of that spouse is not wasted. This is a better alternative than relying on a full marital deduction on the death of the first spouse and taking advantage of portability.

Gift Tax

New York has no gift tax. Under prior law, lifetime gifts were not subject to gift tax or included in the New York gross estate. Under the new law, the gross estate of a resident decedent is increased by the amount of any taxable gifts made within 3 years of death (and while a New York resident) provided such gifts (i) were made between April 1, 2014 and December 31, 2018 and (ii) are not otherwise includible in the estate for federal estate tax purposes. This provision, which is intended to prevent deathbed gifts from escaping New York estate taxation, may force many taxpayers to consider a change in residency to a state which does not have an estate tax.

Income Taxation of Certain Non-Grantor Trusts

Incomplete gift non-grantor (ING) trusts created by New York residents will be treated as grantor trusts for New York income tax purposes and thereby subject to New York income tax. ING trusts that are liquidated before June 1, 2014 are excluded from these new provisions. This provision is effective for tax years beginning January 1, 2014. Prior to the change in the law, many New York residents created ING trusts outside of New York (e.g. in Delaware or Alaska) to avoid paying New York state/city income taxes. Now ING trusts will be treated as grantor trusts for New York purposes resulting in the inclusion of all trust income on the grantor’s New York personal income tax return.

The legislation also imposes an income tax on the undistributed net income accumulated by all other “exempt” resident trusts (i.e. completed gift non-grantor trusts created by New York residents with no New York (i) Trustees, (ii) property or (iii) source income). In tax years beginning January 1, 2014, such income will now be subject to New York income tax once distributed to New York resident beneficiaries. Such trusts will accordingly be subject to return filing requirements when they make distributions to New York resident beneficiaries.

Summary

Immediate planning is essential for New York residents that have existing incomplete gift non-grantor trusts. As you can see, estate planning has just become exceedingly more complicated. I urge you to schedule an appointment to review your existing plan. It likely needs updating to account for the new law.

(A Defined Benefit Plan / Captive Insurance Company)

A Defined Benefit Plan:

Qualified retirement plans generate income tax deductions under the Internal Revenue Code. A defined benefit plan is a qualified retirement plan that in many cases allow for above the line annual income tax deductions of several hundred thousand dollars for small business owners. All contributions into qualified defined benefit plans are completely tax deductible. Since these plans generate “above the line” deductions, use of a qualified defined benefit plan is a great way to reduce your current year income tax liability on the federal, state and local levels, while also increasing retirement savings. For example, a taxpayer earning $1.5 million per year with a defined benefit plan contribution of $300,000 would only have $1.2 million in adjusted gross income, potentially saving $150,000 in current income tax liabilities!

If you qualify, your defined benefit plan also allows for significantly larger contributions than typical 401(k), profit sharing and/or money purchase plans. Given the right situation and employee demographics, individuals over the age of 50 can potentially contribute more than $300,000 per year. The purpose is to maximize owner contributions while minimizing employee cost. Complying with IRS rules requires contributions to be calculated actuarially based on an employee’s age, income, expected age of retirement and the plan’s expected and actual investment performance.

Under current law, a defined benefit payment can be designed to pay as much as $210,000 to the plan participant per year for life. As discussed, since the size of the contribution (and therefore the deduction) is essentially based on the business owner’s age, the number of years until retirement, life expectancy and the presumed rate of return the largest contributions will be made by those taxpayers who have less time before retirement. For example, an owner with 10 years of plan participation could theoretically retire at age 62 with a lump sum of $2,480,000 given the right salary and coverage with effective investment guidance. This figure could increase to $3.7 million if the plan adjusts payouts for cost of living increases. In addition, an equivalent amount can be set aside for the owner’s spouse if the spouse is also an employee of the business and earns at least $260,000 per year. These benefits simply cannot be achieved with an ordinary 401(k) or profit sharing plan, where contributions are limited to only $52,000 per year.

A Captive Insurance Company (“CIC”):

Another method to generate a massive income tax deduction is through the use of a CIC. CICs are bona fide regulated insurance companies that underwrite insurance policies for under- or uninsured risks of a company that are not likely to occur (loss of licenses, reputational damage, kidnapping or terrorism for example). Almost all Fortune 500 companies make use of CICs because of their numerous advantages. Much of the cost of insurance premiums goes to making an insurance company profitable. In this case, the owner of the CIC (the business owner or a trust for the benefit of the business owner’s family) will reap the profits, which is only the tip of the iceberg.

Making insurance payments to third party insurance companies are allowed as income tax deductions, but self-insuring is not deductible. A CIC is usually funded with as little as $250,000 and must be taxed as a C Corporation (although the ownership structure may be in the form of a partnership or LLC), and as long as the risk is properly shifted and distributed, Internal Revenue Code §831(b) allows an income tax deduction of up to $1.2 million per year. So in addition to allowing the company to select which risk to insure against for a lower premium than an outside insurance company (or to insure against risks not otherwise available), the business generates an immediate deduction. In addition, the insurance payment is not considered income by the CIC. Instead, the CIC only pays income tax on investment income. This characteristic creates an incredible wealth transfer opportunity. Further, if distributions are made to the owner of the CIC (the business owner or a trust), the distributions are treated as capital gains (and not ordinary income), thereby incurring an income tax at a much lower bracket and enjoying a deferral for as long as the money was left in the CIC in the first place.

It is important that a CIC meet all regulatory procedures, such as making sure that more than 50% of its business is involved in issuing insurance (but not life insurance) or annuity contracts and paying valid claims. Also, having at least 12 subsidiaries to spread the risk (or if not, joining a pooled fund) may be necessary to make sure they are compliant with the law. As a result, there are annual compliance fees in addition to the start-up costs, but the tremendous advantages created by a CIC more than outweigh those costs.

Defined benefit plans and/or captive insurance companies may be appropriate for you, but they can be time-consuming to get started. If you want to take advantage of the massive income tax deductions these vehicles can produce in 2014, it is imperative you get to work on implementing your preferred strategy now.