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YOUR TAXES
Finally, a new estate tax law ... but more like a good news/bad news joke
O
n December 17, 2010, Presi- dent Obama signed the 2010 Tax Relief Act (New Law),
after cutting a deal with Congress. In a nutshell, for two years, the New Law extends: • The Bush-era income tax cuts (highest rate for all of 35%) • Retains the favorable tax rates
(15%) for long-term capital gains and qualified dividends • Includes significant estate and gift tax changes • Has a ton of other provisions be- yond the scope of this article. We are going to zero in on the most significant changes in the estate and gift tax area.
The good news Bottom line: The New Law applies
to lifetime gifts and transfers of death, only for 2011 and 2012, offer- ing an exemption (pay no tax) on the first $5 million of your wealth per person. That’s a delightful $10 mil- lion — tax-free — if you are married. Any excess over the $5 million ($10 million, if married), will be taxed at a 35% flat rate. Note: The gift tax and estate tax are
unified into one tax. You can use part or all of the $5 million/$10 million during 2011 and 2012 as a gift; any unused gift amount is tax-free for es- tate tax purposes.
The bad news makes the good news a joke The New Law has a sunset provi-
sion. After December 31, 2012, the old law will be reincarnated: a measly $1 million exemption ($2 million, if married) and a stratospheric tax rate of 55%. Outrageous! And dumb. The 2010
lame-duck Congress replaced the un- certainty we suffered with for 10 years under the old law with a two-year pe- riod of uncertainty under the New Law. Want to be safe? Better die in 2010 or 2011. Married? To get the full $10 million benefits, you both must die during those two years. Crazy. The new joke — if the kids come
to visit, better lock the bedroom door. But wait; there is some really good news, not a joke Let’s talk about the pleasant sur-
• New tax bill in effect just two years
• Maximize benefits of 2-year tax window
• Use family limited partnership (FLIP)
prise — the two-year window you have to make a $5 million ($10 mil- lion, if married) gift. Sorry, the win- dow will close on December 31, 2012. Too bad. But what about gifts that you (and your spouse) make dur- ing 2011 and 2012? The gifts are good forever. The IRS can’t take ’em back or tax you. Unquestionably, Congress made an unintended mistake. Here’s an example. Joe and Mary (married and affluent) own a closely held business. They make $10 mil- lion in gifts of various assets to their kids during 2011 and 2012. That $10 million, plus future income earned by the $10 million of assets, plus any ap- preciation of the assets will never be taxed to Joe and Mary, for as long as they live or when they die. Note: In addition, Joe and Mary
can each make annual gifts (in 2011 and 2012) of $13,000 ($26,000 total) to every one of their kids, really a continuation of the old law. So, the real question becomes, how
can we maximize the tax benefits of this two-year gift tax window? First, I should tell you the challenge my typical worried-about-the-estate tax client throws at me: “Irv, how do I get the most significant assets I own out of my estate, yet keep control of those assets?” We (my network of ad- visors and I) have been meeting this challenge for years. But Hallelujah! the New Law, concerning gifts you can make in 2011 and 2012, gives us an easy way to keep huge amounts of your wealth in the family, instead of losing it to the IRS. My network (other experienced es-
tate planning experts I work with reg- ularly) called a meeting to discuss the New Law. We all recognized that completed gifts made in 2011 and 2012 are a made-in-heaven-tax op- portunity. We spent a fun afternoon exchanging ideas and came up with 14 ways to take advantage of the gift provisions in the New Law. We have come up with more since. Following are three examples that
occur often in practice and for many of the readers of this column and will enrich your family, instead of your losing tax dollars to the IRS. • Business succession — Joe
(married to Mary) owns 100% of Success Co., which is run by his son Sam. Success Co. is profitable, grow- ing in sales, net profit and value (now worth about $12 million). Joe wants to transfer Success Co. to Sam. Here’s the simple plan: Step #1. Recapitalize Success Co. so Joe now has nonvoting stock (say
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10,000 shares) and voting stock (say 100 shares) — a tax-free transaction. Step #2. Joe gifts the nonvoting
shares to an “intentionally defective trust” (IDT) with Sam as the benefi- ciary. Note: For tax purposes, Success Co.,
because of discounts (typically, about 40%) allowed by current law, is only worth about $7.2 million (the actual gift tax amount) for tax purposes. A few significant bonuses for Joe:
Not only is Success Co. out of Joe’s estate, but the future substantial in- come will not be added to his estate. Nor is the company’s future appreci- ated value a continuing problem. Also, the IDT acts as a perfect asset protection device, protecting Joe as well as Sam, including keeping the trust assets away from Sam’s wife, should he get divorced. And, maybe
this, you will have only 22 months or less to take advantage of the New Law.
...The clock is ticking. By the time you read
best of all, Joe still controls Success Co., because he still owns all the vot- ing stock. Finally, because Joe intends to
keep working for Success Co., he can continue to take a salary and his usual fringe benefits. Also, we would put in a wage continuation plan, so Joe can keep getting a salary until the day he dies (in case he stops working and still needs income). • You own investment-type assets
— We are talking about real estate (whether income producing or not, but excluding any residence), stocks, bonds, CDs, cash and similar assets. For example, Jake owns many of the assets just listed. Here’s the strategy: Step #1. When real estate is in-
volved, we start by putting the real estate in one or more limited liability companies (LLC) as an asset protec- tion device. Step #2. Then we transfer the real
estate LLC interest and the other as- sets to a family limited partnership (FLIP). Jake (married to Sue) trans- fers $11 million of such assets to his FLIP. The discounts (about 30%) under current law make the assets transferred worth only about $7.7 million for tax purposes. Step #3. Jake and Sue give the
limited partnership units (cannot vote), which own 99% of the FLIP,
BY IRVING L. BLACKMAN Tax/succession specialist
to their kids. Jake and Sue retain all the voting units (1%) of the FLIP and keep absolute control of the as- sets transferred. What if Jake needs or wants the use
of funds inside the FLIP? Easy enough; the FLIP loans the funds to Jake. He may pay back the loan, or he may die owing it, which would reduce his taxable estate dollar for dollar. Note: Instead of transferring the as-
sets to a FLIP, an IDT or other irrev- ocable trust might be used, depending on the exact facts and circumstances. • You want to create additional
wealth without risk — This strategy actually has a number of variations, all legally taking advantage of the tax law and the favorable economic pos- sibilities if you (or your spouse, or both) are insurable for life insurance. The following facts apply to many Americans, from the little guy to the affluent. For example, Jim and his wife
Jane (both 70 years old) have a large portfolio of conservative cash-like as- sets (stocks, bonds, municipals, CDs and the like) that they will never need to maintain their lifestyle. The port- folio grows every year. Nice! But Jim is furious when he learns that the IRS will get 35% (or more) in estate taxes when he and Jane die. Strategy #1. Jim and Jane gift $6
million to a FLIP, which purchases $21 million of second-to-die life in- surance (on Jim and Jane). The FLIP limited partnership interests are gifted to their kids (value about $4.2 million for tax purposes). Result: The $6 million is out of
their estate. When Jim and Jane go to heaven, the kids will get $21 million — tax-free (no income tax, no estate tax) and oh, yes, no market risk. Strategy #2. Same facts as above,
except that this time the $6 million gift goes to the family foundation created by Jim and Jane. The foundation pur- chases the $21 million in life insur- ance, which Jim and Jane want to go to their alma mater (where they met). Jim and Jane will save about $2.1
million (federal and state) in income taxes because of the $6 million con- tribution to their foundation. (Turn to Taxes, page 52.)
•THE WHOLESALER® —MAY 2011
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