estate planning in 2013 and beyond prepared by: julius h. giarmarco, j.d., ll.m. giarmarco, mullins...

Estate Planning in 2013 and Beyond

Prepared by:

Julius H. Giarmarco, J.D., LL.M.Giarmarco, Mullins & Horton, P.C.

101 W. Big Beaver Road, 10th FloorTroy, Michigan 48084

(248) 457-7200jhg@disinherit-irs.comwww.disinherit-irs.com

1

Income Tax Rates for 2013

Taxable Income Medicare Tax

$200,000+ (AGI)

$250,000+ (AGI)

33%

15%

3.80% 3.80%

$250,000+ (AGI)

$300,000+ (AGI)**

$398,350+ $398,350+ 35%

$400,000+ $450,000+ $11,950 39.60% 20%

2

Single Joint TrustsOrdinary Income

Capital Gains and Dividends

Earned Income*

Investment Income

*Earned income Medicare tax includes 1.45% employer portion**Phaseout of personal exemptions and itemized deductions begins

Federal Estate, Gift and GST Tax Exemptions and Rates

2012

2013,

had Congress failed to act 2013+ after fiscal cliff rescue

Exemption Rate Exemption Top Rate Exemption* Rate

Estate Tax $5,120,000 35% $1,000,000 55% $5,250,000 40%

Gift Tax $5,120,000 35% $1,000,000 55% $5,250,000 40%

GST Tax $5,120,000 35% $1,430,000 55% $5,250,000 40%

*Adjusted annually for inflation.

3

Administration’s Proposals that Didn’t Make it into the 2012 Act

Eliminate a trust’s GST exemption on the trust’s 90th anniversary.

Eliminate valuation discounts on family-controlled entities.

Require a minimum 10-year term for GRATs.

4

Administration’s Proposals that Didn’t Make it into the 2012 Act

Modify the treatment of “grantor trusts” so that:• Trust assets would be subject to estate tax.• Distributions to a beneficiary during the

grantor’s lifetime would be subject to a gift tax.• Trust assets would be subject to gift tax if the

trust ceases to be a grantor trust during the grantor’s lifetime.

5

Administration’s Proposals that Didn’t Make it into the 2012 Act

Caution: Most ILITs are grantor trusts!• The power to use trust income to benefit the

grantor’s spouse (IRC 677(a)(1)); • The power to use income to pay premiums on

policies insuring the grantor (IRC 677(a)(3)); or • The grantor’s non-fiduciary power to substitute

trust assets for assets of an equivalent value (IRC 675(4)(C) and Rev. Rul. 2011-28).

6

Planning for Married Couples under $5.25 Million

GRAT

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8

Planning for Married Couples under $5.25 Million

Transfer taxes generally irrelevant. Should an estate tax return (Form 706) be

filed at first death to make portability election?

Planning for Married Couples under $5.25 Million

Wills, Living Trusts, General Powers of Attorney and Patient Advocate Designations will continue to be needed to: • Set forth the couple’s dispositive wishes.

• Name guardians for minor children.• Avoid the costs, delays and publicity associated

with probate.• Make end-of-life decisions.

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10

Planning for Married Couples under $5.25 Million

Preserve step-up in basis at death of each spouse by:

• Leaving assets outright to surviving spouse by joint ownership, beneficiary designation or a simple will.

• Giving surviving spouse a testamentary general power of appointment over assets held in trust.

• Taking steps to cause assets in an irrevocable trust to be included in the Settlor’s (or Settlor’s spouse’s) gross estate.

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Planning for Married Couples under $5.25 Million

Trusts will continue to be popular:• For surviving spouses not capable of managing

assets;• In second marriages with blended families;• Where the parties fear the surviving spouse may

remarry;• For beneficiaries with disabilities (Special Needs

Trusts); and/or• For asset protection.

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Planning for Married Couples under $5.25 Million

Dealing with the highest income tax rates (39.6% and 3.8%) that apply to trusts with undistributed income of more than $11,950 (in 2013).

• Invest for growth instead of income.• Make distributions to move the tax to the

beneficiary’s bracket.• Invest trust property in muni-bonds, annuities and/or

life insurance.

13

Planning for Married Couples under $5.25 Million

Focus shifts to maintaining standard of living.• Not outliving one’s assets.• Stretch IRAs.• Elder Law / Medicaid Planning.

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Planning for Married Couples under $5.25 Million

Rethinking traditional planning.• Portability over credit-shelter trusts.• Personally-owned life insurance over ILITs.

Planning for Married Couples in $5- $10 Million Range

GRAT

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Planning for Married Couples in $5- $10 Million Range

In addition to the planning issues for married couples under $5 million, couples in this range must decide on whether to rely on portability or to use credit shelter trusts.

Portability:• Now permanent.• A surviving spouse can use the unused estate tax

exemption of his/her last spouse.• Eliminates the need of a credit shelter trust to take

advantage of both spouse’s exemptions.

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Planning for Married Couples in $5- $10 Million Range

Situations favoring portability:• Couples who are more interested in two basis step-

ups than removing future appreciation out of their estate.

• A competent spouse who can manage assets.• A first marriage or no children from prior marriages.• A desire to avoid increased income tax applicable to

trusts.• A desire not to retitle assets into living trusts and for

administrative simplicity.

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Planning for Married Couples in $5- $10 Million Range

Situations favoring portability:• Qualified plans and IRAs are the predominant asset

in the estate.• Creditor protection for surviving spouse is not a

concern.• A desire of the surviving spouse to use the

deceased spouse’s exemption to create an intentionally-defective grantor trust for the benefit of children (and more remote descendants).

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Planning for Married Couples in $5- $10 Million Range

Situations favoring credit shelter trusts:• A desire to remove future appreciation from the

estate.• Blended families.• A desire for professional management, for restricting

the surviving spouse’s access to funds and/or for creditor protection.

• A desire to start the statute of limitations on hard-to-value assets used to fund the credit shelter trust. May be a low audit risk at first spouse’s death.

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Planning for Married Couples in $5- $10 Million Range

Advantages of credit shelter trusts:• No portability of deceased spouse’s GST exemption.• The deceased spouse’s unused exemption is lost if

the surviving spouse remarries and predeceases his/her next spouse.

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Optional Credit Shelter Trust – Disclaimer Trust

Living Trust

Heirs

First Spouse’s Death

Surviving Spouse’s Death

Everything is left to surviving spouse outright, except what he/she disclaims.

Surviving spouse can receive income and principal for health, education, maintenance and support; plus a 5% annual withdrawal right.

After second death, all trust assets pass to the couple’s heirs.

Planning for Married Couples above $10 Million

GRAT

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Planning for Married Couples above $10 Million

ILITs. Dynasty Trusts. Spousal Lifetime Access Trusts (SLATs). Grantor Retained Annuity Trusts (GRATs). Intentionally-Defective Grantor Trusts

(IDGTs). Qualified Personal Residence Trusts

(QPRTs).

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ILITs

Grantor/Insured

Dynasty/ILIT

Insurance Company

Children and More

Remote Descendants

Crummey Gifts Premium Payments

Allocate GST Exemption Death Benefit

Net Proceeds

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Switching ILITs

Sale of policy from old ILIT to new ILIT for cash or promissory note.• If purchase price is at fair market value, then

three-year rule of IRC Sec. 2503 does not apply.• No transfer-for-value if new ILIT is grantor trust.

Rev. Rul. 2007-13.• No gain on sale if old ILIT is a grantor trust (or if

no gain in policy).

Dynasty Trusts

Dynasty Trust

Discretionary Distributionsto Children for Life

Discretionary Distributions to Grandchildren for Life

Discretionary Distributionsto Great-Grandchildren

for Life

Future Generations

Grantor

Advantages•Creditor protection•Divorce protection•Estate tax protection•Dispositive plan protection•Spendthrift protection•Consolidation of capital

Gift should take advantage of any remaining lifetime gift exclusion and lifetime GST exclusion

No transfer tax paid.

No transfer tax paid.

No transfer tax paid.

No transfer tax paid.

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Dynasty Trusts

$1 MillionAfter-Tax Growth

Value of Dynasty Trust After 90 Years

Value of Property if No Trust

5.00% $80,730,365 $29,062,927

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SLATs

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Grantor SLATAssets

Spouse and children

Spouse is trustee; and spouse and children have access to income and principal; spouse is primary beneficiary

Remainder to children and more remote

descendants

At spouse’s death

Non-Reciprocal SLATs

If Husband and Wife set up trusts for each other that are similar, then the two trusts may be “uncrossed” and treated for estate tax purposes as if each spouse had created a trust for himself / herself. United States v Grace, 395 US 316 1969.

Gift splitting is generally unavailable with SLATs.

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Non-Reciprocal SLATs

Different provisions for distribution of income and principal.• Sprinkling of income.• 5% / $5,000 withdrawal power.• Different limited powers of appointment.

Different assets and amounts. Different trustees. Different funding dates.

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Non-Reciprocal SLATs

If the richer spouse transfers assets to the poorer spouse so that the poorer spouse can establish a SLAT, this might trigger the step-transaction doctrine.

In Holman, 130 T.C. No. 12 and Gross, T.C. Memo 2008-21 2008, gifts of partnership interests 6 days and 11 days, respectively, after the formation of the partnership were ruled not to be step transactions.

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GRATs

Grantor(Age 70)

GRAT

______________________End of Year 1

______________________End of Year 2

______________________GRAT Remainder

$117,672

Beneficiaries

$1 million of Securities

$520,156 of Securities

$520,156 of Securities

$117,672 of Securities

Actual Asset Transfer $1,000,000Annuity Payments (Projected) $1,040,312Remainder (Projected) $117,672Taxable Gift $0.09Assumed 10% growthAssumed Section 7520 rate: 1%

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IDGT Authorities

Sale to a grantor trust is disregarded for income tax purposes. Rev. Rul. 85-13.

Grantor’s payment of trust’s income taxes is not a gift. Rev. Rul. 2004-64.

Power of substitution does not result in adverse estate tax consequences. IRC Sec. 675(4)(c) and Rev. Rul. 2008-22.

Power of substitution over life insurance not an incident of ownership. Rev. Rul. 2011-28.

Sale / Loan to IDGT

Grantor/Insured

IDGTLife Insurance

Company

1. Gifts $1M

2. Sells/Loans $9M

5. Excess Cash Flow/Premiums

6. Death Proceeds (Income and Estate Tax Free/Leverages GST Exemption)3. $9M Note to Grantor

Balloon Payment in 9 Years

4. $78,300 annual interest (Interest Rate 0.87%)

Advantages:

Value of loan proceeds frozen at 0.87% for nine years (January 2013 mid-term AFR).

Grantor’s estate further reduced by the income taxes paid on behalf of the trust.

The trust property escapes estate taxation for as long as permitted under state law.

Possible valuation discounts for promissory note in Grantor’s estate. 34

Grantor Trust vs. Non-Grantor Trust

NON-GRANTOR TRUST GRANTOR TRUST

YearBeginning Balance

Taxable Income

7%

Less: Taxes at

40%Ending Balance Year

Beginning Balance

Taxable Income

7%

Less: Taxes at

40%Ending Balance

1 $10,000,000 $700,000 $(280,000) $10,420,000 1 $10,000,000 $700,000 $ - $10,700,000

2 10,420,000 729,400 (291,760) 10,857,640 2 10,700,000 749,000 - 11,449,000

3 10,857,640 760,035 (304,014) 11,313,661 3 11,449,000 801,430 - 12,250,430

4 11,313,661 791,956 (316,783) 11,788,835 4 12,250,430 857,530 - 13,107,960

5 11,788,835 825,218 (330,087) 12,283,966 5 13,107,960 917,557 - 14,025,517

6 12,283,966 859,878 (343,951) 12,799,892 6 14,025,517 981,786 - 15,007,304

7 12,799,892 895,992 (358,397) 13,337,488 7 15,007,304 1,050,511 - 16,057,815

8 13,337,488 933,624 (373,450) 13,897,662 8 16,057,815 1,124,047 - 17,181,862

9 13,897,662 972,836 (389,135) 14,481,364 9 17,181,862 1,202,730 - 18,384,592

10 14,481,364 1,013,695 (405,478) 15,089,581 10 18,384,592 1,286,921 - 19,671,514

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IDGT vs. GRAT

With IDGT:• No mortality risk.• Can allocate GST exemption to seed gift.• Mid-term AFR is less than Section 7520 rate.• Back-loading (i.e., interest only with balloon

payment vs. level annuity payment).• Not a statutory technique.• Possibility of unintended gift tax, which may be

mitigated by using a “defined value” clause.

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Grantor QPRT

Residence

Rent-Free Right of Use of Residence for 15 Years

Childrenor ILIT

After Expiration of Selected

Term of YearsGrantor’s Age 70FMV of Residence $2,000,000FMV in 15 years at 5% growth $4,157,856Term of QPRT 15 Years

Initial Gift $793,960FET Savings (40%) $1,345,558§7520 Rate for Jan. ‘13 1%

Qualified Personal Residence Trusts

ASSUMPTIONS:

RESULTS:Grantor

Pays

Rent

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Impact of New Tax Act on Life Insurance

GRAT

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Impact of New Tax Act on Life Insurance

Tax-deferred investments will become increasing popular.

• Permanent life insurance not only provides tax deferral and tax-free access to cash values (via policy loans and withdrawals up to basis), it also provides an income tax free death benefit.

• For conservative investors, the internal rate of return on life insurance is generally quite competitive.

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Impact of New Tax Act on Life Insurance

Charitably-inclined individuals will consider donating appreciated securities (rather than cash) to charities to avoid the 23.8% capital gains tax on the appreciation.

• The donor can then use cash to purchase life insurance, which offers tax-free growth and tax-free access to cash values.

• The charitable income tax deduction can help to offset the cost of purchasing the policy.

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Impact of New Tax Act on Life Insurance

Charitable remainder trusts will be more attractive to potential donors.

• The charitable income tax deduction can be used to fund a “wealth replacement” trust.

Non-qualified deferred compensation arrangements will be more popular.

• Life insurance remains one of the most efficient methods of “informally” funding a non-qualified deferred compensation plan.

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Impact of New Tax Act on Life Insurance

With fewer decedents being subject to estate taxes, an ILIT may be viewed as less costly and complex than the other planning acronyms (SLATs, GRATs, IDGTs, QPRTs, CLATs, etc.).

The higher gift and estate tax exemption will assist in funding ILITs without the inconvenience of having to use Crummey withdrawal powers.

43

Uses for Life Insurance in Non-Taxable Estates

Replace lost income. Wealth replacement in connection with a

CRT. Estate equalization in connection with a

family business. Creditor protection. Second marriages and blended families.

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Uses for Life Insurance in Non-Taxable Estates

Special needs children. Annuity arbitrage. As an alternative to long-term care

insurance. Charitable planning. Avoiding income taxes on traditional

retirement plans.

THE END

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THE END

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