Tag Archives: Gift Tax

5 Reasons Parents Should Discuss Their Estate Plans with Children

Gift to Grandchildren“What should I tell my children?,” is a common question I hear after clients execute their estate plans.  Few people enjoy discussing their own mortality.  And few parents speak openly to children about what will unfold financially after the parents die.  Parents may fear that by speaking about their estate planning it could ignite a family fight over who will receive what.  Further, many of my clients worry that children may become entitled and lose motivation to be financially responsible.

However, open communication can benefit both generations.  The parents can explain their decisions and the children can better plan their lives.  Further, children can provide feedback about their needs or lack thereof.  Also, parents and children can discuss tax considerations and develop more efficient plans.

Here are five reasons to tell children what is included in your estate plan before you die:

1. You can calm angered heirs.

Resentment among related heirs runs rampant after discovering Dad and Mom’s final wishes for the distribution of their estate.  Talking over the rationale for making unequal distributions can smooth ruffled feathers.  I have seen clients give more to children who have more children of their own as opposed to a child with no offspring.  I have clients who leave a greater share of their estate to a financially irresponsible child in trust so the child will not deplete the assets but they task a responsible child with making the distributions. Such an arrangement can be doubly painful for the financially prudent child. I have also seen heirs who resent their parents for leaving significant bequests to charities.  Parents can explain these decisions during their lifetimes, in their own words, to alleviate angry or bitter feelings.

2.  You can save hassles and prevent mistakes.

Children will be emotionally spent following the death of a parent.  If they have to search far and wide for estate planning documents and assets, they will be psychologically, physically and financially spent too.  Parents should let children know where to locate estate planning documents and what to expect within those documents.  If children are surprised by the deceased’s wishes, they may not execute those wishes properly.

3.  You may benefit your children’s lives now.

Parents should devote time to listening to and learning from their children about their financial wherewithal and work ethic.  Holding regular meetings or open dialogues would provide a golden opportunity for the parent to share their plans with the children.  Parents may withhold assets from children during financial struggles as part of a “tough love” approach. Yet, this approach can be viewed as stingy and cause children to question why Mom and Dad chose to withhold assets during the child’s difficulties.

4. Children might give you a better idea

Many of my clients hold significant wealth in a home or business.  I have had numerous clients wrongfully assume that their children want to keep the valuable home or operate the business.  I have come to expect that parent business owners do not discuss with their children whether the children want to keep the business.  Placing stipulations on the continued operation of a business or keeping a valuable real property in trust may not be the desire of the heirs.  Recently, I dissuaded a client out from keeping a family cabin in the Sierra Nevada mountains in trust for his children’s lifetimes.  One child resides in another county and the other child works as a very busy professional in another state and has not been to the cabin in six years.  Seek your heirs input.

5. You may save children taxes

You should consider whether children need additional assets.  Also, be mindful of the type of asset you are passing down to a child.  Consider the difference between an IRA account in which future distributions will be taxed and a rental real estate property with an existing mortgage.  A beneficiary working as a school teacher will likely appreciate the additional income from the IRA much more than a beneficiary working as a highly-paid physician.  For even greater tax savings, you may be able to make asset transfers directly to grandchildren and skip the children altogether.

Facebook Billionaires Avoid Taxes with GRATs

Forbes recently highlighted how Facebook co-founders Mark Zuckerberg and Dustin Moskovitz established grantor retained annuity trusts (GRATs) to transfer significant amounts of wealth tax-free.  In 2008, Zuckerberg and Moskovitz established GRATs which will enable the Facebook executives to transfer as much as $185 million to future offspring or others without paying any gift tax.  Most wealthy individuals recognize that this year offers a golden opportunity to transfer $5.12 million in assets without incurring any gift tax. However, the Facebook executives followed a similar tax strategy to the Walmart founders, the Walton family, by funding their GRATs with their rapidly appreciating Facebook shares.

ImageGRATs function by allowing a grantor (Zuckerberg and Moskovitz) to place shares or other assets into an ­irrevocable trust and retain the right to ­receive an annual payment back from the trust for a period of time.  Typically, to avoid the risk of premature death, advisors select a shorter time period of 2 to 4 years. If the grantor survives that period, any property left in the trust when the annual payments end passes to family members, other beneficiaries, or another trust.

A crucial aspect is determining the value of the remainder interest in the annuity. In calculating how much value will be left at the end of the annuity term (the remainder) — and thus how big a gift the grantor is making — the IRS does look at the performance of the actual stock (or any other asset) in the trust. Instead, the IRS assumes the trust assets are earning a meager government-determined interest rate. With a zeroed-out, or “Walton” GRAT, the grantor receives an annuity that leaves nothing for heirs if assets grow only at the IRS’ lowly interest rate. If the assets grow faster, the excess goes to the heirs gift tax free. If assets or stock under-perform or decrease in value, there is no downside for the grantor because the annuity can be paid by returning some shares each year to the grantor.

As a result, a GRAT is an ideal instrument to shift assets you expect to suddenly increase in value.  Hence, rapidly appreciating stock of technology giants (Facebook) or growing retails empires (Walmart) have proven to be the perfect assets to utilize within a GRAT.  President Obama and Democrat legislators have targeted zeroed-out GRATs as tax loopholes of the wealthy and have proposed legislation which would eliminate their use.  Until that time, the GRAT remains a valuable wealth transfer tool.

Choose Lawyers Instead of the Internet

The Internet has changed numerous industries including the legal market.  Despite the many advantages of online services, there are considerable drawbacks when comparing the use of web-based estate planning forms versus hiring a competent attorney. The following list comes from a North Carolina attorney. Rather than relying on the bare information fed into a computer, a skilled lawyer can:

  1. Listen to your goals and desires and incorporate them into your plan.
  2. Offer advice, not just words on paper.
  3. Help with referrals to other trusted professionals.
  4. Make sure that the documents are properly executed.
  5. Make sure that any trusts are properly funded.
  6. Make sure that beneficiary designations are properly completed.
  7. Make sure that accounts and real estate are  properly titled.
  8. Help with managing assets of incapacitated family members.
  9. Help with probate and trust administration.
  10. Help with income, gift and estate tax matters.
  11. Help ensure governmental benefits for disabled or incapacitated family members.
  12. Serve as an advocate in dealing with financial institution and governmental bodies.
  13. Care about you and your family.

Of course, there is a sinister view that attorneys embrace computer-based estate planning programs because such planning generally leads to a much more costly probate proceeding.  To avoid the added cost and delay involved in a probate,  and enjoy the benefits listed above, consult with an estate planning specialist today.

Sloppy Gifting of Real Estate Leads to IRS Mess

The idiom “pigs get fat, hogs get slaughtered,” is directly relevant to the current, generous gift tax exemption.  During 2011 and 2012, donors may gift up to $5 million in assets without paying any federal gift tax.  The limited window of opportunity, depressed real estate prices, and liberal exemption amount are enticing factors for donors to transfer highly appreciated and/or highly valuable real estate.   Typically, the giver transfers the real estate to one or more family members.

Despite the fact that gift tax is not owed on many of these real estate transfers, the giver must report any gift in excess of $13,000 to the Internal Revenue Service (“IRS”).  The donor must file Form 709 to report U.S. gift taxes to the IRS.  Irrespective of whether tax is due and payable or the transfer is made to a family member, Form 709 must be filed for gifts in excess of the annual exclusion amount.

A recent Wall Street Journal article noted that the IRS is scrutinizing gifts of real estate to family members.  The IRS has obtained real property transfer information from 16 states.  The small sample size revealed noncompliance rates  in excess of 50% which will likely spur on additional IRS examinations of real property.   While this is a favorable time to make gifts of real estate, seek assistance from trusted counsel to properly transfer real estate.

by: Jason C. Morris, Esq.

Ideal Time for Business Succession Planning

This article appeared in the February 21, 2011 edition of Northern Nevada Business Weekly:

One of the chief concerns of family business owners is how to pass the business to the next generation and/or key employees.  Although various provisions of the federal estate tax laws are intended to ease the tax burden on the transition of small businesses upon an owner’s death, these provisions are very limited in their scope and benefit.  However, the recently enacted Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “Act”) provides business owners with some meaningful tax-free opportunities to move their businesses to the next generation.

As widely publicized, the Act extends the Bush-era individual income, capital-gains and dividend tax cuts for all taxpayers for two years (2011 and 2012).  Most people also know that the Act temporarily increased the federal estate tax exclusion (i.e., the amount that may be passed to heirs free of federal estate tax) from $1 million to $5 million and reduces the federal estate tax rate to a single tax bracket of 35%.  For the first time ever the Act also provides for “portability” of the estate tax exclusion between spouses.  Portability means that any unused portion of a person’s estate tax exemption is transferable to his or her surviving spouse to be used upon the surviving spouse’s death.  So, if one spouse died in 2011 or 2012 and did not use any of his or her gift or estate tax exclusion, the surviving spouse will have an available estate tax exclusion of $10 million, and only the value of assets in excess of that sum would be subject to the 35% federal estate tax.

Obviously, a business owner who dies in the next two years will be able to pass substantially more of his or her business to his or her heirs than would have been possible without the act.  However, unless the business owner dies in the next two years (which is hopefully not the case) the Act’s changes to the estate tax laws really won’t help very much.  As seen in 2010, Congress may or may not extend, modify, or otherwise alter these new laws.  If nothing is done, we will revert to the rules that would have been applicable in 2011 without the Act, i.e., a $1 million federal estate tax exclusion and a maximum estate tax rate of 55%.

The Act’s biggest benefit to business owners, however, is a 500% increase in the federal lifetime gift tax exclusion.  Since 2001 the lifetime gift tax exclusion has remained at $1 million.  Under the terms of the Act, the gift tax exception increases dramatically to $5 million and the gift tax rate is reduced to 35% for transfers in excess of $5 million.  Like the estate tax exclusion, the gift tax exclusion is an exclusion from federal transfer taxes for assets transferred to other persons except that it relates to transfers made while you are alive rather than at death.  The federal gift tax and estate tax exclusions are unified such that any gifts made during your lifetime which use a portion of your gift tax exclusion will also reduce dollar for dollar the amount of your estate tax exclusion available upon your death.

What does all of this mean for business owners?  During this brief, two-year window you have an unprecedented opportunity to pass up to $5 million (or up to $10 million for a married couple) in business interests or other assets to the next generation or generations.  The combination of this previously undreamed-of gift-tax exclusion, depressed asset and real property values, and rock-bottom interest rates has created a once-in-a-lifetime opportunity to transfer very large blocks of your business interests wealth to your children, grandchildren and beyond free of any federal gift and estate taxes.  There has not been a better time to make gifts in several decades.

Importantly, the Act does not disturb some very advantageous estate planning tools.  Valuation discounts for minority interests and illiquid assets (such as closely-held business interests) are still available and are often used with various estate planning techniques to leverage a person’s gift and estate tax exclusions to make tax-free transfers of substantially more assets than would otherwise be possible.  While it had been rumored that the new tax law might limit these valuation discounts, the Act is silent on this subject.  As a result, valuation discounts continue (at least for now) to be an effective estate planning tool, especially for business owners.  For example, assume Father and Mother own a business, including equipment, materials, and real property worth $10 million.  Father and Mother would like to transfer the business to their three children who all participate in the business.  By gifting equal 33% interests in the business to the three children, Father and Mother can take valuation discounts due to the lack of control and lack of marketability associated with those 33% interests.  After the transfers, none of the children will have a controlling interest in the company and there is no ready market or stock exchange available for them to quickly convert the business interests to cash.  Therefore, Father and Mother may be able to discount the value of the gifted business interests as much as 30% to 40%.

Assuming a 30% discount in our example, Father and Mother would utilize $7 million of their combined $10 million gift tax exclusions.  The remaining $3 million in gift tax exclusions could be utilized to transfer other assets to their children or lower generations .  Not only would Father and Mother avoid taxation resulting from the transfer of their business, but also they would maximize the amount of assets transferred by discounting the asset values.  The transfer also allows any future appreciation in the value of the business to inure directly to the benefit of the children outside of Father’s and Mother’s estates.

Some of you have already exhausted your $1 million lifetime gift-tax exclusion.  The Act provides a limited time period to make additional gifts.  You have another $4 million to gift for the next two years.  Some of you have sold business interests to irrevocable trusts for your children, in return for a low interest promissory note payable (which is still a very useful planning method).  Generally, the purpose of these transactions is to take advantage of valuation discounts and to “freeze” the value of the business interest in your estate by replacing the business interest with a very low interest promissory note.  If the business interest has not performed well or if you simply want to be free of the hassle of the ongoing note payments, then the additional $4 million of lifetime gift tax exclusion presents an opportunity to forgive the promissory note and thereby conclude the transaction and relieve your heirs of the burden of making the note payments.

Please keep in mind that other advanced planning techniques are available to leverage your lifetime exclusions to pass even more assets to your descendants or beneficiaries.  Prior legislative proposals would have instituted a minimum ten-year term for an estate planning technique known as a “Grantor Retained Annuity Trust” (“GRAT”), which would have greatly reduced the planning opportunities associated with this type of trust.  However, the Act did not address GRATs.  With a GRAT, the business owner receives fixed annuity payments for a specific term.  At the end of the term, any remaining trust property is transferred to the younger generation free of estate and gift taxes. Short-term GRATs (e.g. two years) are viable, at least in the immediate future.  GRATs can be particularly effective when interest rates are low, and with the current rates at historic lows GRATs are a very common planning tool at this time.

In terms of planning beyond the Act’s two-year horizon, we feel that the only prudent thing to do at this time is to assume that the Act will expire.  Therefore prompt action to take advantage of these planning opportunities is clearly advisable.

By Don L. Ross, Esq. and Jason C. Morris, Esq.