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Income and Estate Tax Planning Toolkit

This is a sample Income and Estate Tax Planning Toolkit. It is intended to demonstrate the type of analysis that can be created for you. This

should not be construed as a recommendation for any specific product or service. An actual Income and Estate Tax Planning Toolkit would be

based on your individual financial considerations, needs, objectives, and risk tolerance. It would therefore differ from this sample Income and

Estate Tax Planning Toolkit .

2

Agenda

Gifting Early

Irrevocable Life Insurance Trust (ILIT)

Marital Credit Shelter Trust (CST)

Grantor Retained Annuity Trust (GRAT)

Sale/Loan to Irrevocable Grantor Trust (IDGT)

Qualified Personal Residence Trust (QPRT)

Charitable Lead Trust (CLT)

Charitable Remainder Trust (CRT)

Charitable Tax Deduction

Appendix & Disclosure

Overview

4

Executive Summary

• The goal of Income and Estate Tax Planning Toolkit is to help clients develop a general understanding of the tax and estate planning techniques. The presentation dedicates one chapter to each technique. Each chapter comprises three complementary sections: summary of considerations, graphic illustration, and custom example.

• This presentation was designed to illustrate the financial impact of a particular planning decision. The slides herein do not constitute a recommendation. Caution: many estate techniques share the common risk of the loss of control of the assets once the gift of the assets is complete.

NOTE: The strategies set forth herein are shown for educational purposes only, are not tailored to any specific client, and do not constitute a recommendation to employ any strategy identified. To that end, they do not capture all possible outcomes but are based on limited set of assumptions. If the assumptions upon which they are based are not realized, the efficacy of the strategy may be materially different from that which is reflected in the illustration. Additionally, the current government is suggesting changes to the estate tax laws which if ultimately enacted could materially change the efficacy of the strategies described herein. Accordingly, clients must consult their tax advisor when considering the utility and appropriateness of any strategies identified herein. Please see the additional Important Disclosures at the end of this presentation

Important: The projections regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Please see Important Disclosures at the end of the presentation

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Basic and Advanced Income and Estate Tax Planning



Basic Estate Planning Income Tax Planning Advanced Estate Planning

Gifting Early

Irrevocable

Life Insurance

Trust (ILIT)

Marital Credit Shelter Trust

(CST)

Qualified Personal

Residence Trust

(QPRT)

Grantor Retained

Annuity Trust (GRAT)

Sale/Loan to Irrevocable

Grantor Trust

(IDGT)

Charitable

Tax Deduction

Charitable Remainder

Trust (CRT)

Charitable Lead Trust

(CLT)

Please see Important Disclosures at the end of the presentation

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Techniques by Wealth Level

INCOME TAX PLANNING INCOME TAX AND ESTATE PLANNING ESTATE PLANNING

INCOME TAX PLANNING SPLIT INTEREST GIFTS PHILANTHROPY WEALTH TRANSFER

All Wealth Levels • Long Term Capital Gains • Qualified Dividends • Options • Charitable Tax Deduction • Tax-advantaged Investment

Vehicles

• Donor Advised Fund

(DAF) • Public Foundation

• Wills • Health Care Documents • Financial Powers of Attorney • Annual Exclusion • Gifting

$5MM+ • Charitable Remainder Trusts (CRT)

• Credit Shelter Trust (within will) (CST) • ILIT

$15MM+ • Charitable Lead Trusts (CLT) • Private Foundation • Leveraged Gifting – Grantor Retained Annuity Trusts

(GRAT) – Sale to Irrevocable Grantor Trusts

(IDGT) – Qualified Personal Residence Trusts

(QPRT)

$25MM+ • Lifetime Exemption • Irrevocable Trusts • Dynasty Trusts


Individuals and estates may want to consider life insurance and lending for liquidity for estate tax purposes and spending to maintain lifestyle.

Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors and Private Wealth Advisors do not provide tax or legal advice. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning, charitable giving, philanthropic planning and other legal matters.

7

Basic Estate Planning

NOTE: The strategies set forth herein are shown for educational purposes only, are not tailored to any specific client, and do not constitute a recommendation to employ any strategy identified. To that end, they do not capture all possible outcomes but are based on limited set of assumptions. If the assumptions upon which they are based are not realized, the efficacy of the strategy may be materially different from that which is reflected in the illustration. Additionally, the current government is suggesting changes to the estate tax laws which if ultimately enacted could materially change the efficacy of the strategies described herein. Accordingly, clients must consult their tax advisor when considering the utility and appropriateness of any strategies identified herein. Please see the additional Important Disclosures at the end of this presentation.



Gifting Early

Irrevocable

Life Insurance

Trust (ILIT)


(CST)

Qualified Personal

Residence Trust

(QPRT)

Grantor Retained



Grantor Trust

(IDGT)

Charitable

Tax Deduction


Trust (CRT)


(CLT)


Gifting Early

SECTION 1


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Gifting Early

Gift Tax

• Generally, all transfers prior to death (except those to charity or a U.S. citizen spouse) are subject to gift tax. Excluded from gift tax are the $14,000 “annual exclusion” gifts per recipient. Of note, there may be as many recipients as desired. Direct payments of certain medical and educational expenses on anyone’s behalf are also excluded from gift tax.

• Under the American Taxpayer Relief Act of 2012 (“the Act”), the inflation-adjusted $5MM gift tax credit was made permanent, and this amount is adjusted for inflation. When taxable gifts total the available exemption ($5.49MM in 2017) the credit is fully used and the gift tax is assessed on any additional gifts. The maximum rate of the federal gift tax for any gifts in excess of the exemption amount is 40%. A limited number of states also impose a gift tax in addition to the federal gift tax. To the extent an individual wants to transfer asset free of tax beyond available credits or exclusions, more advanced gifting strategies need to be employed.

Estate Tax

• The amount that can be passed at death free of estate tax increased in 2017 to $5,490,000. The maximum federal estate tax rate on any estate in excess of $5.49 million is 40%. Certain states also impose an estate tax in addition to the federal estate tax. The cost basis of asset included in a decedent’s gross estate will generally be adjusted to fair market value on the date of the decedent’s death, which is referred to as a “step up” on basis when the asset has appreciated in value. Asset can also receive a “step down” in basis depending on the value.

Gifting Early

• Individuals anticipating an estate in excess of the federal estate tax exemption amount often consider making gifts because a lifetime gift removes the asset and any of its future appreciation from the total estate. This potentially reduces the total estate and gift tax.

• Individuals may enhance the potential benefit of gifting early by creating an irrevocable grantor trust. If a trust is structured as a grantor trust, the grantor of the trust is treated as the owner of the trust asset for income tax purposes. By paying taxes incurred in the trust, the grantor effectively makes an indirect gift to the trust, which is not subject to gift tax.

• If the asset gifted represent a non-managing membership of a Family Limited Partnership (FLP) or Limited Liability Company (LLC), an appraisal of the asset may reflect a potential liquidity discount and/or a potential lack of control discount. Gifting with valuation discounts may further enhance the wealth transfer.



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Gifting Early


Donor Beneficiary Donor makes gifts to the beneficiary.

If the gifts are made to an irrevocable grantor trust, of which the donor is the grantor, the donor pays taxes incurred in the trust, thus making an indirect gift that is not subject to gift tax.

Potential future appreciation of the gift is removed from the estate.

Valuation Discount Gifting with valuation discounts (i.e. liquidity discount, lack of control discount) may further enhance the wealth transfer.

Irrevocable Grantor Trust


11

Gifting Early


Gifting to An Irrevocable Grantor Trust

• The following is an illustration of a hypothetical scenario, where parents gift $5,000,000 today to an irrevocable grantor trust for the benefit of their two children. They also make four annual exclusion gifts (from each parent to each child) to the trust per year.

• In this hypothetical illustration, if the estate transfer occurs in Year 10, the heirs receive an additional amount of $3,553,621 as a result of early

Impact of Early Gifting

$22 $26

$7 $4

$0

$10

$20

$30

$40

No Gifting Gifting

Mill

ions

Net to Heirs Hypothetical Estate Tax

ASSUMPTIONS:

Current Total Asset (In Estate) $20,000,000

Lifetime Exemption $10,980,000

Upfront Gifts $5,000,000

Annual Gifts $56,000

Time Horizon (year) 10

Effective Investment Tax Rate 20.0%

Hypothetical example is for illustrative purposes only. Not representative of any specific investment.

AFTER 10 YEARS NO GIFTING GIFTING DIFFERENCE

Total Asset $29,604,886 $29,604,886 $0

Asset outside the Estate $0 $8,884,053

Asset in the Estate $29,604,886 $20,720,832

Hypothetical Estate Tax $7,449,954 $3,896,333

Net to Heirs $22,154,931 $25,708,553 $3,553,621



SECTION 2


13


Life insurance can be used to help protect one’s family by replacing lost future earnings or to help provide liquidity to pay estate taxes or other expenses. However, the proceeds of a life insurance policy owned or controlled by the insured will generally be included in his or her gross estate for estate tax purposes. A life insurance policy can be excluded from an insured’s gross estate if an irrevocable trust (rather than the insured himself or herself) purchases the insurance. • Creating an Irrevocable Life Insurance Trust (ILIT): An ILIT is set up during the insured’s lifetime in order to purchase a life insurance policy.

Upon the death of the insured, the proceeds are paid to the ILIT generally free of estate tax. If an insured transfers an existing insurance policy to the ILIT, the proceeds will still be subject to estate tax in his or her estate unless he or she survives the transfer by three years (the “three-year contemplation of death rule”).

• Paying Premiums: In order to fund the policy, the insured typically makes gifts to the trust so that the trustee may pay the premiums on the life insurance. Gifts made to a trust will qualify for the annual gift tax exclusion if the beneficiaries are given certain rights of withdrawal over the gifts contributed to the trust (“Crummey powers”). If the ILIT contains Crummey powers and a notification is sent to each beneficiary, the gifts will be allocated to the annual exclusion gifts. If the gifts exceed the annual exclusions, then they will count toward the grantor’s lifetime exemption (currently $5,490,000). When the gifts exceed both the annual exclusion and lifetime exemption available, a gift tax would be payable on the excess amount.

• Payment of Death Benefit: The proceeds of a life insurance policy paid to an ILIT upon the death of the insured are generally received income tax free and estate tax free. Once received by the trustee, the proceeds are administered according to the terms of the trust agreement. When drafted properly, the asset held in an ILIT is exempt from claim of the beneficiary's creditors.

• Selecting a trustee: The insured cannot be the trustee of an ILIT. However, when the trust is drafted to provide distributions of income and/or principal to the beneficiary according to a standard known as HEMS (health, education, maintenance, and support), the insured’s spouse and/or children can be a trustee. Alternatively, a corporate fiduciary can be selected as the trustee due to the ongoing administration and responsibilities once the proceeds are paid.



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Insured ILIT

Beneficiary

Insurance Premium Gifts

Insurance Company

Death Benefit

Proceeds are generally not subject to income or estate taxes.


15



Rate of Return on Fixed Death Benefit with Survivorship Coverage

• The following hypothetical illustration outlines the rate of return on a $10,000,000 death benefit. This sample pricing is on a healthy male and a healthy female, both age 60, with survivorship coverage.

• The earlier death occurs, the higher the internal rate of return (IRR) will be to the beneficiary. Life insurance proceeds are generally free of income taxes (and potentially estate taxes if structured properly).

• The last row in the table below reflects the normal life expectancy of the second deceased.

The above hypothetical table is for illustrative purposes only.

YEAR AGE ANNUAL PREMIUM CUMULATIVE PREMIUMS PAID DEATH BENEFIT IRR ON THE DEATH BENEFIT

5 65 100,000 500,000 10,000,000 124.0%

10 70 100,000 1,000,000 10,000,000 40.4%

15 75 100,000 1,500,000 10,000,000 21.6%

20 80 100,000 2,000,000 10,000,000 13.7%

25 85 100,000 2,500,000 10,000,000 9.5%

30 90 100,000 3,000,000 10,000,000 6.9%

32 92 100,000 3,200,000 10,000,000 6.2%

The above table serves as a high-level illustration, assuming an annual premium of $100,000 and a death benefit of $10,000,000. In this hypothetical example, should the death occur in Year 30 (at age 90), the corresponding internal rate of return on the death benefit is 6.9%. As the example illustrates, the later the death, the lower the internal rate of return on the death benefit.

The type of insurance product selected effects the outcome. Not all policies are guaranteed. Clients and their financial advisors should pay particularly close attention to guarantees when electing this type of estate planning technique. Please see Important Disclosures at the end of the presentation


SECTION 3


17


U.S. citizen spouses have unlimited marital deduction from the federal gift and estate tax; thus, they may transfer asset to each other free of such taxes. This allows any estate tax to be deferred until the death of the surviving spouse.

• Any portion of the exemption amount ($5,490,000 as of 2017) that remains unused on the death of the first spouse may be “portable” to the

surviving spouse.

– If the deceased spouse made $3,490,000 worth of gifts during their life and the portability election is made on their estate tax return, their

surviving spouse will be able to shelter $5,490,000 using their own exemption amount plus another $2,000,000 using the unused portion of

their deceased spouse’s exemption amount.

• Asset owned by the deceased spouse can be used to take advantage of the estate tax exemption amount. Such asset would pass pursuant to

the decedent’s will and an amount equal to the estate tax exemption amount could be set aside in a “credit shelter” trust which could benefit

beneficiaries (even including the surviving spouse). Whatever remains in the credit shelter trust will not be subject to estate tax on the death of

the surviving spouse.

• A good reason to use a Credit Shelter Trust – oppose to rely solely on the “portability” of the exemption – is the future growth of asset.

‒ Since the predeceased spouse’s exemption is frozen at the amount of their unused estate tax exemption amount, this is all that will be

available to the surviving spouse in addition to the survivor’s own inflation-adjusted exemption amount.

‒ If, however, the predeceased spouse placed lifetime exemption asset into a Credit Shelter Trust upon their death for the benefit of the

survivor and children, these asset, and whatever it grows to over the remaining lifetime of the survivor, will be estate tax free.

‒ Moreover, asset placed in a Credit Shelter Trust can be held for more than a single generation, thus estate tax savings.



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Total Estate

Credit Shelter Trust

Beneficiary

Asset continues to grow outside the surviving’s spouse’s estate.

Estate Tax Estate tax applied on excess of the Survivor’s Estate over the Survivor’s exemption.

Survivor’s Estate

Lifetime exemption eliminates estate tax on the trust.


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Funding a Marital Credit Shelter Trust

• The following is an illustration of a $5.49MM marital credit shelter trust funded upon the death of the first spouse. The credit shelter trust is not subject to estate tax on the death of the surviving spouse.

• In this hypothetical scenario, the Credit Shelter technique generates $1,054,616 of estate tax savings.

ASSUMPTIONS: Credit Shelter Amount $5,490,000 Estate Tax Rate 40.0% Annual Investment Gross Return 5.0% Effective Investment Tax Rate 20.0%

Marital Share/QTIP $20,000,000


Estate Taxes $0

Estate Taxes $7,449,954

Net to Beneficiary

$22,154,932



Estate Taxes $0

Estate Taxes $6,395,338

Net to Beneficiary

$23,209,548


$5,490,000


$8,126,541

Transfer $1,054,616 more to beneficiary

With Credit Shelter Without Credit Shelter

Year 0 First to Die

Year 10 Second to Die


Current Estate $20,000,000

20

Advanced Estate Planning




Gifting Early

Irrevocable

Life Insurance

Trust (ILIT)


(CST)

Qualified Personal

Residence Trust

(QPRT)

Grantor Retained



Grantor Trust

(IDGT)

Charitable

Tax Deduction


Trust (CRT)


(CLT)



SECTION 4


22


One type of leveraged gifting technique, a grantor retained annuity trust (GRAT), allows an individual to transfer asset to a trust, retain an annuity stream for a term of years such that the present value of the annuity stream is equal in value to the transferred asset. A GRAT transfers future appreciation (if any) above the IRS 7520 rate to the named beneficiaries free of gift and estate tax.

• The donor irrevocably transfers asset to a trust for a term of years and selects beneficiaries to receive any remaining trust asset at the end of the term of the trust.

• The donor retains the right to receive a fixed dollar amount of the asset each year. If the value of the asset transferred is greater than the present value of the annuity he or she retains, the difference is considered an upfront taxable gift.

• The annuity is generally calculated to result in a nominal gift, i.e., the GRAT is “zeroed out” so there is virtually no gift tax cost to funding the GRAT.

– The annuity is valued using an IRS 7520 rate.

– A GRAT may be structured so that annuity payments increase annually to allow for greater compounding in the trust.

• The term of the trust must be carefully considered because the trust asset generally will be included in the donor’s estate if the donor dies during the trust term.

• Where the GRAT’s total return (income and appreciation) exceeds the IRS 7520 rate used in valuing the annuity (and the donor outlives the trust term), the excess will pass transfer tax free at the termination of the trust.

• A GRAT is typically structured as a grantor such that the donor is treated as the owner of the trust asset for income tax purposes (making it a “grantor trust”), thus further enhancing the wealth transfer to the beneficiaries.



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Donor GRAT

Beneficiary

Donor receives annuity payment each year for the term of the trust.

At end of term, asset in excess of the required annuity payments will pass estate tax free to beneficiary either in trust or outright.

Donor funds the trust with asset.

Remainder

Donor pays taxes incurred by the trust.


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“Zeroed-Out” Flat Annuity GRAT

• The following is an illustration of a “zeroed-out” flat annuity GRAT funded with $1,000,000 marketable securities.

• In this hypothetical scenario, the donor receives an annuity worth $349,460 per year for 3 years and the remainder beneficiaries receive (outright or in continuing trust) asset worth $55,953.

ASSUMPTIONS:

Term of Trust 3

Principal $1,000,000

7520 Rate 2.4%

Annual Investment Return 5.0%


YEAR BEGINNING PRINCIPAL GROWTH ANNUITY PAYMENT REMAINDER

1 $1,000,000 $50,000 $349,460 $700,540

2 $700,540 $35,027 $349,460 $386,107

3 $386,107 $19,305 $349,460 $55,953

KEY OUTPUTS:

Annuity to Donor (%) 34.9%

Annuity to Donor ($) $349,460

Remainder $55,953


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Zeroed-Out” Growing Annuity GRAT

• The following example is the same as the “zeroed-out” flat annuity GRAT except the annuity grows 20% per year. There is still no taxable gift on funding the trust (i.e., the value of the annuity stream is still roughly equal to the principal contributed to the trust).

• However, the amount of asset passing to the beneficiaries at the end of the term may increase reflecting the potential benefit of having asset stay in the trust longer and generate compounded returns for the beneficiaries. In this hypothetical scenario, the remainder beneficiaries receive asset worth $59,296 , or $3,343 more compared to the flat annuity scenario.

ASSUMPTIONS:

Term of Trust 3


7520 Rate 2.4%


Annuity Growth 20.0%


KEY OUTPUTS:

Remainder (Growing Annuity) $59,296

Remainder (Flat Annuity) $55,953

Difference $3,343

YEAR BEGINNING PRINCIPAL GROWTH ANNUITY PAYMENT REMAINDER

1 $1,000,000 $50,000 $288,844 $761,156

2 $761,156 $38,058 $346,613 $452,601

3 $452,601 $22,630 $415,935 $59,296


26



Rolling GRATs

• Relative to a standard GRAT, so-called “Rolling GRATs” may provide greater opportunity for compounding returns while reducing mortality risk through the creation of a series of sequential short-term GRATs with each subsequent GRAT being funded with an annuity payment from an earlier-created GRAT. The potential compounding benefit results from Rolling GRATs keeping all principal (and interest, in some cases) “at work” over a longer period of time.

• The following is an illustration of two sequential two-year rolling GRATs. In this hypothetical scenario, the remainder beneficiaries receive asset worth $63,435 , or $7,482 more than they would with one three-year GRAT.

ASSUMPTIONS:

Rolling Period 3


7520 Rate 2.4%



KEY OUTPUTS:

"Remainder Trust" Ending Principal $63,435

3-Year Flat GRAT Remainder $55,953

Difference $7,482

YEAR PRINCIPAL GROWTH ANNUITY REMAINDER

1 $1,000,000 $50,000 $518,071 $531,929

2 $531,929 $26,596 $518,071 $40,454

Rolling GRATs

YEAR PRINCIPAL GROWTH ANNUITY REMAINDER

2 $518,071 $25,904 $268,398 $275,577

3 $275,577 $13,779 $268,398 $20,958

YEAR BEGINNING PRINCIPAL GROWTH ANNUITY ENDING PRINCIPAL

1 $0 $0 $0 $0

2 $0 $0 $40,454 $40,454

3 $40,454 $2,023 $20,958 $63,435

Remainder Trust


Sale/Loan to Irrevocable Grantor Trust

SECTION 5


28


A donor can set up a trust that he or she is considered to own for income tax purposes and sell asset to the trust in exchange for an interest bearing promissory note. • A donor can establish a trust and the donor (or his or her spouse) can retain certain powers with respect to the trust which cause the donor to be

treated as the owner of the trust asset for income tax purposes (making it a “grantor trust”), but not for estate or gift tax purposes.

– By paying taxes on trust income, the donor, in effect, makes additional transfers to the beneficiaries of the trust, but those additional transfers are not subject to gift tax.

• The donor can sell asset to the trust in exchange for an interest-bearing promissory note.

‒ The interest rate will be based on the Applicable Federal Rate (AFR), which is often lower than the 7520 rate used with a GRAT.

‒ The note may be structured as an amortizing loan or an interest-only balloon loan.

• Because the trust is a grantor trust, no gain or loss is recognized by the donor on the sale to the trust and payment of the interest pursuant to the promissory note has no income tax consequences to the donor or the trust.

• The sale may produce estate and gift tax savings if the trust asset produces an annual return in excess of the interest rate on the note over the term of its repayment.

‒ The sale in exchange for a note may produce greater transfer tax savings than a GRAT because of the lower interest rate and because the note repayment structure can allow more of the payments from the trust to be deferred allowing more asset to compound for the benefit of the trust beneficiaries.

• If the donor dies before the note is paid off, the donor’s death may trigger a gain for income tax purposes up to the amount of gain outstanding in connection with the note.

• Note: Some commentators argue that the trust must have asset other than the asset sold or else the donor may be deemed to have retained an interest in the trust, which can cause inclusion of the trust asset in his or her estate on death.



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Donor Irrevocable Grantor Trust

Beneficiary

Donor pays taxes incurred by the trust.

Trust asset, net of installment note and interest, passes to beneficiary free of gift and estate taxes.

Donor sells asset to Irrevocable Grantor Trust for note.

Installment Note


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Balloon Payment

• The following illustrates a sale of $1,000,000 asset to a grantor trust in exchange for a $1,000,000 promissory note bearing interest at the rate of 2.05% per year for a 9 year term.

• In this hypothetical Illustration, the donor receives interest payments of $20,500 per year and the $1,000,000 loan principal at the end of the term. After repayment of the note, the trust has $325,284 asset remaining.

ASSUMPTIONS:

Term of Trust 9

Sale Price $1,000,000

AFR Rate 2.05%



KEY OUTPUTS:

Ending Value $325,284

YEAR BEGINNING PRINCIPAL GROWTH

ANNUITY PAYMENT

ENDING PRINCIPAL

1 $1,000,000 $50,000 $20,500 $1,029,500

2 $1,029,500 $51,475 $20,500 $1,060,475

3 $1,060,475 $53,024 $20,500 $1,092,999

4 $1,092,999 $54,650 $20,500 $1,127,149

5 $1,127,149 $56,357 $20,500 $1,163,006

6 $1,163,006 $58,150 $20,500 $1,200,656

7 $1,200,656 $60,033 $20,500 $1,240,189

8 $1,240,189 $62,009 $20,500 $1,281,699

9 $1,281,699 $64,085 $1,020,500 $325,284


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Balloon Payment with Seeding Gift

• The following example is the same as the balloon payment except the promissory note has a $500,000 principal instead. The difference of $500,000 is a taxable gift upon funding the trust.

• In this hypothetical Illustration, the donor receives interest payments of $10,250 per year and the $500,000 loan principal at the end of the term. After repayment of the note, the trust has $938,306 asset remaining, or $613,022 more compared to the scenario with no seeding gift.

ASSUMPTIONS:

Term of Trust 9


Seed $500,000

AFR Rate 2.05%



KEY OUTPUTS:

Ending Value (Seeding Gift) $938,306

Ending Value (No Seeding Gift) $325,284

Difference $613,022


ANNUITY PAYMENT

ENDING PRINCIPAL

1 $1,000,000 $50,000 $10,250 $1,039,750

2 $1,039,750 $51,988 $10,250 $1,081,488

3 $1,081,488 $54,074 $10,250 $1,125,312

4 $1,125,312 $56,266 $10,250 $1,171,327

5 $1,171,327 $58,566 $10,250 $1,219,644

6 $1,219,644 $60,982 $10,250 $1,270,376

7 $1,270,376 $63,519 $10,250 $1,323,645

8 $1,323,645 $66,182 $10,250 $1,379,577

9 $1,379,577 $68,979 $510,250 $938,306


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Amortized Payment

• The following example is the same as the balloon payment except the $1,000,000 promissory note is amortized over time.

• In this hypothetical Illustration, the donor receives $122,808 of interest and principal payments per year. At the end of the term, the trust has $197,178 asset remaining, or $128,105 less compared to the balloon payment scenario.

ASSUMPTIONS:

Term of Trust 9


AFR Rate 2.05%



KEY OUTPUTS:

Ending Principal (Amortizing) $197,178

Ending Principal (Interest-Only) $325,284

Difference -$128,105


ANNUITY PAYMENT

ENDING PRINCIPAL

1 $1,000,000 $50,000 $122,808 $927,192

2 $927,192 $46,360 $122,808 $850,744

3 $850,744 $42,537 $122,808 $770,473

4 $770,473 $38,524 $122,808 $686,189

5 $686,189 $34,309 $122,808 $597,690

6 $597,690 $29,884 $122,808 $504,767

7 $504,767 $25,238 $122,808 $407,197

8 $407,197 $20,360 $122,808 $304,749

9 $304,749 $15,237 $122,808 $197,178



SECTION 6


34


A A QPRT gives an individual the opportunity to retain the use of a principal residence and/or vacation home for a term of years and potentially freeze the value of the residence at the time the trust is created for estate tax purposes. • The donor irrevocably transfers a residence to a trust for a term of years, retains use of the residence for a term and selects a beneficiary or

beneficiaries to receive the residence at the end of the term of the trust. QPRT beneficiaries are typically children (but not grandchildren).

• The donor may transfer a primary residence or another personal residence, such as a vacation home, or a partial interest in either to the QPRT.

• By retaining the use of the residence for a term of years, the donor retains an interest in the residence. Thus, although the transfer of property to an irrevocable trust is taxable for gift purposes, only a portion of the property value is considered a taxable gift. The taxable gift, or remainder interest, is the difference between the property value at the time of transfer and the value of the interest retained by the donor. The retained interest is determined using the IRS 7520 rate.

• Generally, the higher the interest rate and/or longer the trust term, the lower the discounted value of the gift. However, the longer the trust term, the greater the mortality risk. See the following slide for an illustration.

• The term of the trust must be carefully considered because the trust asset will be included in the donor’s estate if the donor dies during the trust term.

• When the term of the trust ends, the asset passes to the remaindermen (or a trust for their benefit) free of additional transfer taxes.

• The donor can continue to use the residence by renting back the asset (from the trust or the beneficiaries) at fair market rent.

• If the residence in the QPRT is sold, the proceeds must, in general, be rolled over to another residence. If the cost of the new residence is less than that of the old, a certain amount of property must be distributed back to the grantor (based on how much the property has appreciated or depreciated since the transfer) or converted to a grantor retained annuity trust (GRAT).

• If the donor outlives the term interest, the property will pass to the remainder beneficiaries. The donor will have removed the value of the residence from his or her estate with a relatively small gift. The estate and gift tax savings are enhanced if the residence appreciates over the term. Fractional interests in a residence gifted to the trust can be discounted.



35



Donor QPRT

IRS Beneficiary

Donor transfers residence to trust and retains use of residence for the term of the trust.

The difference between the property value at the time of transfer and the value of the interest retained by the donor is considered a taxable gift. Gift tax may be due.

At end of term, asset will pass tax free to children or a trust for their benefit.


36



Funding a QPRT

• The following assumes that a QPRT is set up with property interest worth $5,000,000.

• The taxable gift amount is calculated for multiple scenarios with various combinations of term and IRS 7520 rate. The scenario comparison shows that the longer the term and/or the higher the IRS discount rate, the smaller the gift.

• The donor’s survival of the term is necessary for any transfer tax savings. Appreciation of the asset enhances the benefits of the technique. QPRTs tend to not be attractive in low interest rate environments absent meaningful depreciation in the personal residences’ value.

TERM 7520 RATE RESIDENCE VALUE RETAINED INTEREST TAXABLE GIFT

10 2.0% 5,000,000 898,259 4,101,741

15 2.0% 5,000,000 1,284,926 3,715,074

20 2.0% 5,000,000 1,635,143 3,364,857

Different Terms, Same 7520 Rate

TERM 7520 RATE RESIDENCE VALUE RETAINED INTEREST TAXABLE GIFT

15 2.0% 5,000,000 1,284,926 3,715,074

15 3.0% 5,000,000 1,790,690 3,209,310

15 4.0% 5,000,000 2,223,677 2,776,323

Same Terms, Different 7520 Rates


37

Income Tax Planning




Gifting Early

Irrevocable

Life Insurance

Trust (ILIT)


(CST)

Qualified Personal

Residence Trust

(QPRT)

Grantor Retained



Grantor Trust

(IDGT)

Charitable

Tax Deduction


Trust (CRT)


(CLT)



SECTION 7

Income and Estate Tax Planning

39

Charitable Lead Trust (CLT) (1), (2)

A A CLT allows a donor to transfer asset to a trust that makes annual payments to charity and remove future appreciation (if any) above an IRS 7520 rate from the donor’s estate. • A CLAT provides one or more charities with an annuity for a period of years. When the period ends, the remaining trust asset is paid to one or

more designated non-charitable beneficiaries. ‒ The value of the charity’s annuity interest is calculated using an IRS 7520 rate. The difference between the initial value of the asset

contributed to the trust and the present value of the charity’s annuity interest is a taxable gift to the remainder beneficiaries. ‒ The annuity can be structured to result in no taxable gift, i.e., the CLT is “zeroed out” so there is no tax cost to funding the CLT.

• A CLT may also be structured as a CLUT (unitrust), where the charity receives a set percentage of the fair market value of the trust’s asset, as predetermined annually. These structures are not commonly used because any appreciation is shared with the charity, thus reducing the remainder.

• If the total return (income and appreciation) exceeds the IRS 7520 rate used in valuing the periodic payments, the excess passes to the remainder beneficiaries (typically, children and/or grandchildren) at the termination of the trust free of gift and estate taxes.

• The donor may or may not be treated as the owner and thus subject to tax on all of the trust’s income during the charitable term: ‒ Grantor Trust: where the donor is treated as the owner of the trust, he or she is entitled to a charitable income tax deduction equal to the

actuarial value of the charity’s interest in the trust. The benefit of that income tax deduction may be recaptured over the trust’s term because the donor is taxed on all of the trust’s income.

‒ Non-Grantor Trust: where the donor is not treated as the owner of the trust, he or she does not receive a charitable income tax deduction on the creation of the trust. The trust is a separate taxable entity which receives a charitable income deduction for the payments made to charity each year.

• If structured carefully, the donor’s own private foundation can receive the periodic payments to charity. • Certain prohibitions associated with private foundations may also apply to a CLT (regardless of the identity of the charitable beneficiary).


1. A CLT may also be structured as a unitrust (a CLUT), where the charity receives a set percentage of the fair market value of the trust’s asset, as predetermined annually. These structures are not commonly used because any appreciation is shared with the charity, thus reducing the remainder

2. Please see Important Disclosures at the end of the presentation

40



Donor CLT

Charitable Deduction

Beneficiary

Grantor Trust: Donor receives an upfront income tax deduction. Non-Grantor Trust: Trust receives an income deduction for the annuity paid.

Donor makes a gift to the trust.

At end of term, asset will pass tax free to beneficiary or a trust for their benefit.

Remainder Charity

Charity receives periodic payments each year for the term of the trust.


41



Funding a “Zeroed-Out” Grantor Clat

• The following is an illustration of a “zeroed-out” grantor CLAT funded with $1,00,000.

• In this hypothetical illustration, a charity receives an annuity of $113,670 per year for 10 years and the remainder beneficiaries receive (outright or in continuing trust) $199,166 free of gift and estate taxes.

ASSUMPTIONS:

Term of Trust 10


7520 Rate 2.4%

Annuity (% of Funding Amount) 11.4%

Annual Investment Gross Return 5.0%


KEY OUTPUTS:

Marginal Tax Rate 39.6%

Tax Savings from Deduction $396,000

Taxable Gift $0

Remainder $199,166


ANNUITY PAYMENT REMAINDER

1 $1,000,000 $50,000 $113,670 $936,330

2 $936,330 $46,817 $113,670 $869,477

3 $869,477 $43,474 $113,670 $799,280

4 $799,280 $39,964 $113,670 $725,574

5 $725,574 $36,279 $113,670 $648,183

6 $648,183 $32,409 $113,670 $566,922

7 $566,922 $28,346 $113,670 $481,598

8 $481,598 $24,080 $113,670 $392,008

9 $392,008 $19,600 $113,670 $297,939

10 $297,939 $14,897 $113,670 $199,166



SECTION 8

Income Tax Planning

43


A CRT allows an individual to retain an income interest in asset, diversify a low-basis position without an immediate capital gains tax and give the remainder to charity.

• With a CRT, the donor transfers asset to a trust that makes annual distributions to the donor for a period of time. asset remaining in trust at the expiration of the term is paid to charity.

• Generally speaking, there are two types of CRTs:

– Charitable Remainder Annuity Trust (CRAT): A CRAT pays the income beneficiary a fixed dollar amount each year. The amount must be at least 5% (but not more than 50%) of the market value of the asset at the time the trust is established.

– Charitable Remainder Unitrust (CRUT): A CRUT pays the income beneficiary at least 5% (but not more than 50%) of the fair market value of the trust’s asset, as redetermined annually.

• The donor’s income interest may last for one life; two or more lives; a term not to exceed 20 years; or the shorter (but not the longer) of one or more lives and a term of years.

• The value of the charity’s remainder interest must be at least 10% of the initial value of the trust asset when the trust is created.

– If a CRT fails the 10% test, it does not qualify as a charitable trust and loses all the favorable tax treatment of a qualified CRT.

– Subject to certain limitations, the donor is allowed to deduct for income tax purposes the fair market value of the charity’s remainder interest.

• The remainder beneficiary can be a public charity and/or a private foundation. The donor may retain the right to change the charitable beneficiary or beneficiaries named or name one or more charitable beneficiaries in the future.

– The classification of the charitable remainder beneficiary (as well as the type of asset contributed to the CRT) impacts the charitable tax deduction available to the donor upon funding the trust.



44


• CRTs are generally not themselves subject to income tax.

– The annuity or unitrust amount distributed is, in general, taxable to the donor and the character of the income is based on the character of the income earned by the trust.

• Tiering rules generally force the “worst” income to the non-charitable beneficiary first. Distributions from the CRT are deemed to occur in the following order: ordinary

income (interest, dividends not qualified for a reduced rate and then qualified dividends), short-term then long-term capital gains, tax-exempt income and, finally,

principal of the trust.

– However, a CRT that has any Unrelated Business Taxable Income (UBTI) is taxed at the rate of 100% on all of its UBTI for that year.

• The IRS defines UBTI as the net income from an activity that is a regularly carried on trade or business not substantially related to furthering the exempt purpose of the

CRT. UBTI also includes income generated by the use of borrowed funds.

• Certain of the private foundation rules apply to CRTs.

• Use of a CRT allows diversification and reinvestment of 100% of the proceeds of sale of any (low basis) asset contributed to the trust on a tax-deferred basis.

– Compared to a taxable sale of an appreciated asset, the net effect of the use of a CRT includes:

• The tax deferral benefit associated with the donor paying capital gains taxes on the realized appreciation over time.

• The charitable income tax deduction available to the donor upon funding the CRT.

– However, whether or not the donor is “better off” just selling the asset and reinvesting the after-tax proceeds depends on the applicable tax rates and the assumptions made

about how asset would be invested inside or outside of the CRT.



45



Donor CRT

Charity

Donor receives distributions each year for the term of the trust and pays taxes on the income and gains embedded in the distributions.

Donor funds a CRT with appreciated asset.

At end of term, the remainder passes to charity.

Donor receives a charitable deduction.


Charitable Deduction

46



Funding A Crut With Appreciated Asset

• The following is an illustration of a Charitable Remainder Unitrust (CRUT) funded with $1,000,000 appreciated asset (zero cost basis). The trust has a 5-year term and a 10% charitable deduction. The donor’s personal account collects the unitrust distributions from the CRT.

• In this hypothetical illustration, the charity receives a remainder of $136,391 at the end of the term, whereas the personal account has an ending value of $899,237.

CRT

Gross Principal $1,000,000

Cost Basis $0

7520 Rate 2.6%

Term of Trust 5

Unitrust Rate 37.9%


CRUT Remainder $136,391


Personal Account (initial value reflects tax savings from charitable deduction)

YEAR BEGINNING PRINCIPAL GROWTH TOTAL UNITRUST

AMOUNT REMAINDER

1 $1,000,000 $50,000 $1,050,000 $378,638 $671,362

2 $671,362 $33,568 $704,930 $254,203 $450,727

3 $450,727 $22,536 $473,264 $170,662 $302,601

4 $302,601 $15,130 $317,731 $114,576 $203,155

5 $203,155 $10,158 $213,313 $76,922 $136,391


CRT

Charitable Deduction $100,000

Marginal Tax Rate 39.6%

Potential Tax Savings $39,600

Investment Period 5

Effective Investment Tax Rate 20.0%


Ending Portfolio Value $899,237

YEAR PERSONAL ACCOUNT

NET UNITRUST PAYMENT

AFTER TAX GROWTH TOTAL

1 $39,600 $290,422 $1,584 $331,606

2 $331,606 $194,978 $13,264 $539,849

3 $539,849 $130,901 $21,594 $692,344

4 $692,344 $87,882 $27,694 $807,919

5 $807,919 $59,001 $32,317 $899,237

Charitable tax deduction

SECTION 9

Income Tax Planning

48

Charitable Tax Deduction (3)

A person’s charitable deduction may be less than the actual gifted amount as a result of the AGI Limitation. In addition, the Pease Limitation (2) may cause a further decrease in the total amount of tax deduction available in that calendar year. This may be interpreted as a two-step process

• As an itemized deduction, a person’s charitable tax deduction is calculated as the cost or the fair market value (FMV) of the charitable gifts subject to a limitation expressed as a percentage of the person’s AGI

• The Pease provision further limits the value of itemized deductions such that the total of all itemized deductions is reduced by the lesser of 3% of the excess of AGI over $313,800 and 80% of the total itemized deductions


A person may make gifts to certain charitable organizations and receive income, gift and/or estate tax charitable deductions. The organization may be a public charity, private foundation created by a private individual (including the donor) or a hybrid of the two. The classification is important because gifts to a public charity are treated more favorably for income tax purposes than comparable gifts to a private foundation. Federal law also restricts the activities of a private foundation and may impose excise taxes on the foundation and its managers and donors (or their family members) for violations of its rules.

In general, either the cost or the fair market value (FMV) of asset given to a U.S. charity may be deducted for income tax purposes subject to a limitation expressed as a percentage of the donor’s adjusted gross income (AGI). The amount of the deduction and the applicable limitation are a function of the type of asset given (cash vs. long-term capital gain asset) and the classification of the charitable organization as a public charity or private foundation (for this purpose). Gifts in excess of the limitations can be carried forward and used in any of the five years following the year of the gift. The following is a summary of some of the basic rules:

Public Charity Amount Of Deduction AGI Limitation Private Foundation Amount Of Deduction AGI Limitation

Cash Fair Market Value 50% Fair Market Value 30%

Short-Term Capital Gains Asset Cost 50% Cost 30%

Long-Term Capital Gains Asset Fair Market Value 30% Lower of Cost or Fair Market Value (1) 20%

1. Gifts of only certain types of long-term capital gain asset called “qualified appreciated stock” to a private foundation may be deducted at fair market value 2. The Pease limitation was first incorporated into the Omnibus Budget Reconciliation Act of 1990 and it is named after former Congressman Donald Pease. The purpose of the Pease limitation was to raise

revenue by limiting some popular and common itemized deductions among high-income earners. The numbers stated above assumes married-joint filing. 3. Please See Important Disclosures at the end of the presentation

49

Charitable Tax Deduction

• Charitable Gifts: the cost/fair market value of the gifted asset.

• Itemized Charitable Deduction: generally limited by a % of AGI, which is a function of the type of asset gifted and the classification of the charitable organization.

• Final Deduction: limited by the Pease Adjustment, which limits the value of itemized deductions such that the total of all itemized deductions is reduced by the lesser of 3% of the excess of AGI over $313,800 and 80% of the total itemized deductions.


Cost/Fair Market Value of Charitable

Gifts Itemized

Charitable Deduction Final

Deduction

Limited by % of AGI

Pease Adjustment


50

Charitable Tax Deduction Gifting Public Shares to a Private Foundation

• The following is an illustration of a individual gifting $1,000,000 of public company shares to either a private foundation or a donor advised fund (DAF). For charitable deduction purposes, public foundation rules apply to donor advised fund. The cost basis of the gifted shares is assumed to be zero. The individual has an adjusted gross income of $2,000,000 in the given year from taxable investment income in the personal account.

• The following shows the charitable deduction utilized in the given year. The amount equals the lesser of charitable gifts and itemized charitable deduction limit, minus any Pease adjustment.

• Of note, the hypothetical example assumes that the individual makes no other charitable gifts during the year. The numbers in the example could change if the individual gave a large cash gift or gifted other capital gains property during the same year.

Gifting to a Private Foundation Gifting to a Donor Advised Fund Fair Market Value of Charitable Gifts $1,000,000 Fair Market Value of Charitable Gifts $1,000,000 Adjusted Gross Income $2,000,000 Adjusted Gross Income $2,000,000 AGI Limit (Itemized Deduction) AGI Limit (Itemized Deduction) AGI Deduction Limit (%) 20% AGI Deduction Limit (%) 30% AGI Deduction Limit ($) $400,000 AGI Deduction Limit ($) $600,000 Pease Adjustment (Total Tax Deduction) Pease Adjustment (Total Tax Deduction) AGI over 313,800 $1,686,200 AGI over 313,800 $1,686,200 3% of AGI over 313,800 $50,586 3% of AGI over 313,800 $50,586 80% of Charitable Gifting $800,000 80% of Charitable Gifting $800,000 Pease Adjustment -$50,586 Pease Adjustment -$50,586 Charitable Deduction* $349,414 Charitable Deduction* $549,414 Deduction as % of Gifting Amount 34.9% Deduction as % of Gifting Amount 54.9%




SECTION 10

52


This presentation was designed to illustrate the financial impact of a particular planning decision. The slides herein do not constitute a recommendation.

Caution: many estate techniques share the common risk of the loss of control of the assets once the gift of the assets is complete.

This material has been prepared for informational purposes only and is subject to change at any time without further notice. Information contained herein is based on data from multiple sources and Morgan Stanley Smith Barney LLC makes no representation as to the accuracy or completeness of data from sources outside of Morgan Stanley Smith Barney LLC. It does not provide individually tailored investment advice. Be aware that particular legal, accounting and tax restrictions, margin requirements, commissions and transaction costs applicable to any given client may affect the consequences described, and these analyses will not be suitable to discuss with every client. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.

Tax laws are complex and subject to change. This information is based on current federal tax laws in effect at the time this was written. Morgan Stanley Smith Barney LLC, its affiliates, Financial Advisors and Private Wealth Advisors do not provide tax or legal advice. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and other legal matters.

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