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This new producer flyer compares the estates of three wealthy people - Michael Jackson, Dan Duncan and George Steinbrenner - who have passed away in the past 13 months and shows just how important timing is when it comes to federal taxes! It also addresses the fact that clients who will live past 2010 may need strategies in place to avoid federal taxes.
Widespread abuse saddled life insurance premium financing with a bad reputation in recent years, however, the economic crisis purged many questionable players. Now, though credit remains tight, traditional premium financing remains a viable strategy for funding life insurance premiums for large estate and business planning needs. This Advisor Update discusses issues and risks that should be understood if considering the strategy.
Every plan in existence needs to be reviewed to see if it’s the best design for the owner.
Every business without a plan needs to explore their options. It may be costing them money not having a plan.
Establishment of a new plan must take place by December 31st for most businesses (October 1st for Safe Harbor 401k)
But what do you say to get the prospect’s attention? Click “More Info” for a simple sales talk that will work for 401(k) plans as well as pension plans. Your goal is simply to make the owner aware that there are new rules for small business retirement plans and greater opportunities now exist. All you need to obtain is a census of the employees to get started.
Dan Duncan died in March 2010. By all accounts he died one of the wealthiest people in the world; his $9 billion net worth placed him 74th on Forbes’ list. But in an odd twist in timing, his estate may escape traditional federal estate taxation as we have known it for decades. Had he died a few months earlier, he might have faced a federal estate tax of at least 45%; had he lived past January 1, 2011, his federal estate tax rate might have been even higher, at 55%.
Continue reading for a case study in estate taxation!
Citizens of all states may want to take note of recent legislation passed in Florida, highlighting the estate planning gap created by Federal inactivity. The underlying issues may impact estate and gift plans for many clients. Many wills (last will and testaments) for married couples contain formula clauses designed to distribute family estate assets in a way to help minimize or eliminate Federal estate taxes. Typical clauses provide that “my executor will identify the amount that can pass free of estate taxes under federal law in place at the time of my death and that amount will be distributed first to heirs other than the surviving spouse, the remainder is to be distributed to my surviving spouse.” Frequently, this technique involves the use of “family trusts” and “marital trusts” to receive estate assets. Commonly, we describe these as “A and B Trusts.” For example, if an estate owner had a $10 million estate and died in 2009, the first $3,500,000 (equivalent exemption amount) would be distributed to a family trust (B) and the remainder, $6,500,000, would be transferred to a marital trust (A) or to the spouse. The result would be zero estate taxes at the death of the first spouse and the removal of the estate tax equivalent amount ($3,500,000) from the survivor’s estate so it would avoid estate taxation at the death of the surviving spouse.
The Problem With Eliminating Federal Estate Taxes
When many of these “formula clause” wills were drafted, it was never taken into account the possibility that federal estate tax might be totally eliminated. And here we are, in 2010, without an estate tax. With a strict application of the terms of some of these wills, the effect is, that the whole probate estate will be distributed to the family trust and nothing would be available to distribute to the surviving spouse or marital trust.
Florida has recognized the uncertainty that may be created by Federal Estate Tax rules in 2010. To address this situation, legislation was designed to protect the surviving Florida spouse’s rights to an inheritance for deaths that occur during 2010. The new law allows a probate court to correct the potential inequity that may be created by a strict interpretation of a will whose distribution provisions rely on a Federal Estate Tax. The legislation allows an executor (or beneficiary) of the estate to petition the probate court to interpret the terms of a will and the Federal Unified Tax Credit, and address the estate distribution as if the death occurred in 2009. In most situations, the surviving spouse will not be left destitute. Most family trusts include a provision to provide income to the surviving spouse and to allow discretion to the trustee to provide for the surviving spouse’s health and welfare. In addition, many assets like life insurance, jointly held property, trust assets and other property types that provide for direct transfers to named beneficiaries are not subject to terms of the will. However, it remains possible that a surviving spouse can effectively be disinherited in 2010.
Whether clients live in Florida or any other state, the existence and use of formula clause wills may provide another opportunity to meet with and address the planning oversight that may exist.
- A buy-sell agreement obligates one party to purchase a deceased business owner’s interest at a certain price, and another party , typically the deceased owner’s estate or heirs – to sell the interest at that price.
- The agreement gives business owners assurance about who will purchase a deceased owner’s interest, what the price will be, when the sale will take place, and where the funds will come from.
This sample proposal helps you explain the cross-purchase buy-sell concept to clients. We can prepare customized proposals like this for your cases - just call (800) 936 - 0339 option 1 today.
2010 May Provide A Limited Time Opportunity to Avoid The Generation Skipping Transfer (GST) Tax
With all the discussion and focus on the elimination of estate taxes for 2010, in some planning circles, the repeal of the 2010 generation skipping tax (GST) has gone unnoticed. Due to this repeal, there are some unique planning opportunities. Congress’ failure to act this year may prove a great savings opportunity for multi-generation planning. With greater after tax gift values available there remains a larger source of premiums to support the overall estate plan.
Background
Estate and GST taxes have been repealed through December 31, 2010. While gift taxes apply in 2010, they are at a maximum federal tax rate of 35%. This is 10% less than the maximum rate in 2009 and 20% less than the maximum rate scheduled to be in place in 2011. The provisions of EGTRRA provide that in 2011, the estate and GST taxes are to be reinstated with a $1 million exemption(1) and a 55% top federal rate(2). The gift tax will also return to pre-2001 levels in 2011(3)
What Are The Planning Opportunities?
For 2010, gifts directly distributed to grandchildren are a viable option. Although they remain subject to gift taxes, they should avoid GST . One consideration is that clients who make large gifts that would be subject to taxation should do so this year , when the gift tax rate at 35%. They can avoid GST and pay a lower gift tax than may be available at a future date. In addition, this may be a good time to make a gift of assets which have depressed fair market values due to market conditions.
Another opportunity involves the timing of distributions from existing trusts. Trust distributions may be subject to the GST tax when:
The trust makes a distribution to beneficiaries two or more generations below the original donor or
The trust terminates and assets pass to beneficiaries two or more generations below the original donor
These trusts may not have to deal with GST tax in 2010. If the trust allows, distributions may be made early or the termination may be triggered to occur in 2010.
A planning opportunity exists with a surviving spouse that is a beneficiary of a marital trust that will be taxed at death. A trustee can make a distribution to them and then make gifts to children or grandchildren now. This would allow them to take advantage of the 35% gift tax rate and the ability to make such gifts in long-term trusts that may escape GST tax.
Lastly, an opportunity may exist for clients who are considering funding grantor retained annuity trusts (GRATs), but who wish to have the remainder after the GRAT period continue in a trust for grandchildren. Generally, they must allocate the GST exemption after the estate tax inclusion period (ETIP), usually at the termination of the GRAT . Some practitioners believe that there is the possibility that a GRAT created in 2010, before the estate tax and the GST tax are reinstated, will not be subject to the GST tax. If this position is accurate, the GRAT and any trust into which the GRAT assets pass should not be subject to the GST tax.
With all these techniques, remember that there remains an outside risk that the GST tax may be re-enacted retroactive to January 1, 2010 and the GST tax might apply to transfers made in 2010. There may be ways for certain transfers to be made which allow them to be “undone” should this possibility become a reality. Before implementing any of these techniques, your client should first seek tax and/or legal advice.
(1) The GST exemption is $1 million, indexed for inflation
(2) With an additional 5% surtax for certain large estates
(3) $1 million exemption, 55% top rate
Do You Have Clients That Look Like This?
• Have a need for life insurance
• Have high net worth
• Desire flexibility
• Face high life insurance premiums
• Need to minimize their gift taxes
• Are illiquid and/or desire to preserve assets for other purposes
• Wish to minimize the out-of-pocket assets pledged as collateral, or minimize the cost of the letter of credit as part of financing
Athena Indexed Universal LifeSM with the Cash Value Plus (CVPlus) Rider has potential for cash value growth in both early and later years. This cash value can provide much-needed flexibility in a commercial premium financing arrangement:
• Help Minimize Collateral – The opportunity for high cash value relative to the premiums paid reduces the need for additional collateral.
• Potential Exit Strategy – Cash value can provide funds to help reduce and in some cases repay the premium financing loan in the future.
• Opportunity for Favorable Arbitrage – Upside potential of cash value can provide a very good hedge against a lender’s loan interest rate.
• Potential source of funds – Can pay loan interest.
Continue reading for a case study. For fast help with your tough life cases, contact one of our advanced markets experts at (800) 936-0339 option 1. Continue reading Commercial Premium Financing…
159 Lookout Place
Suite 101
Maitland, FL 32751
407-647-PLAN (7526)
Our firm was founded by Charles D. Wilder and grew by merger with Rubino & Associates. The attorneys are: Chuck Wilder, Nick Rubino, Mark Hammond and Mike Dunn. We specialize in Wills,Trusts, Probate, Asset Protection, Trust and Probate Administration, Guardianships, Medicaid Planning and Special Needs Trusts. Visit our website, www.epllc-plc.com.
A new 3.8% surtax on certain investment income starts January 1, 2013, as part of the health care reform act. While that’s a couple of years away, it is not too early to start planning for it, because there are steps clients can take this year that will help reduce or even eliminate it.
In this issue of The Wealth Counselor, we present an overview of this surtax, explore what taxpayers it will affect, and give some planning ideas you can use now with your clients.
Understanding the Tax
The 3.8% investment income surtax, also called the health care surtax or the Medicare tax, applies to tax years ending after December 31, 2012. The surtax is:
For individuals, 3.8% of the lesser of:
net investment income for such taxable year, or
the excess, if any, of
the modified adjusted gross income for the year, over
the threshold amount.
For trusts and estates, 3.8% of the lesser of:
the undistributed net investment income for the year, or
the excess, if any, of
the adjusted gross income (as defined in Code Section 67(e)) for the year, over
the dollar amount at which the highest tax bracket in Code Section 1(e) begins for the year ($11,200 in 2010).
Three Key Numbers
There are three numbers that determine how this surtax will affect a client.
1. Net Investment Income
This is the sum of gross investment income over allocable investment expenses. For purposes of this surtax, investment income includes interest, dividends, capital gains, annuities, rents, royalties and passive activity income.
Investment income does not include active trade and/or business income; any of the income sources listed above (e.g., interest, dividends, capital gains, etc.) to the extent it is derived in active trade and/or business; distributions from IRAs and other qualified retirement plans; or any income taken into account for self-employment tax purposes.
For the sale of an active interest in a partnership or S-corporation, gain is included as investment income only to the extent net gain that would be recognized if all of the partnership/S-corporation interests were at fair market value.
2. Modified Adjusted Gross Income (MAGI)
Here, MAGI is the sum of adjusted gross income (the number from the last line on page 1 of Form 1040) plus the net foreign income exclusion amount.
3. Threshold Amount
Married taxpayers filing jointly . . . $250,000
Married taxpayers filing separately . . . $125,000
All other individual taxpayers . . . $200,000
Trusts and estates . . . Beginning of the top bracket ($11,200 for 2010)
Who Will Pay the New Surtax?
Here’s a quick formula to determine if the 3.8% surtax will apply:
MAGI less than or equal to threshold amount = No tax
MAGI greater than threshold amount = Tax is 3.8% of the lesser of
investment income or
MAGI - threshold amount
Note that the surtax liability is determined on income BEFORE any tax deductions (page 2 of Form 1040) are considered. As a consequence, a client with lots of deductions could be in the lowest tax bracket and yet have investment income that is subject to the surtax!
Also, because the capital gain rate will increase for high-income taxpayers to 20% in 2011, with the 3.8% surtax the total tax on capital gains can be 23.8% in 2013 and beyond.
Let’s look at some examples:
Individuals Example: Evan, single, has $100,000 of salary and $50,000 of net investment income. Result: The 3.8% surtax would not apply because MAGI is less than $200,000.
Example: Jill, single, has $225,000 of net investment income and no other income. Result: The 3.8% surtax would apply to $25,000 of income (excess of $225,000 MAGI over $200,000 threshold amount).
Example: George and Eve, married filing jointly, have $300,000 of salaries and no other income. Result: The 3.8% surtax would not apply (no investment income).
Example: Frank and Lily, married filing jointly, have $400,000 of salaries and $50,000 of net investment income. Result: The 3.8% surtax would apply to $50,000 of net investment income (lesser of rule).
Estates and Trusts Example: The Pat Jones Trust has investment income of $51,000 and no distributions. Result: $39,800 of income ($51,000 - $11,200 top bracket amount) will be subject to the 3.8% surtax.
Example: The Estate of Sue Jones earned $111,200 of dividends and made no distributions. Result: $100,000 ($111,200 - $11,200 top bracket amount) will be subject to the 3.8% surtax.
Example: The Estate of Jim Jones earned $111,200 of interest and distributes 100% of income. Result: The income will be reported by the heirs. That income will go into their individual surtax determinations, but the Jim Jones Estate will pay no 3.8% surtax.
Planning Tip: Start adjusting trust and estate investments now to reduce income in 2013 and beyond.
Planning Considerations
For taxpayers who could be hit by the surtax, look for ways to reduce investment income and MAGI:
* The 3.8% surtax does not directly apply to distributions from IRAs and other qualified retirement plans, and contributions to these plans provide tax-deferred growth. Therefore, taxpayers may wish to increase contributions to IRAs and 401(k), 403(b) and 457 plans. However, required minimum distributions will increase MAGI as they are considered ordinary income.
* The 3.8% surtax does not apply to distributions from Roth IRAs, but Roth conversion income will count toward MAGI. Thus 2010-2012 Roth conversions can help to avoid the surtax by reducing post-2012 MAGI from required minimum and other plan distributions in 2013 and beyond.
* Because income from tax-exempt and tax-deferred vehicles like municipal bonds, tax-deferred nonqualified annuities, life insurance and nonqualified deferred compensation are not included in investment income, investments in these vehicles should become more favorable.
* Charitable remainder trusts should become more appealing because they permit taxpayers to defer income over a period of time, enabling them to stay under the threshold amount.
* Charitable lead trusts will become more popular to shift investment income to a CLT which in turn will be offset by the “above the line” charitable deduction.
* Installment sales will be popular to smooth income.
* Oil and gas (with up to 95% initial investment deduction, 15% depletion allowance and IDC deduction on passive oil and gas) will continue to be attractive investments.
* For eligible estates and electing trusts, select the proper year to reduce the surtax. Example: Frieda dies in January 2012. Her estate elects a November 30, 2012 year end. Result: The surtax will not apply to her estate until the year beginning December 1, 2013, providing 11 additional months without the surtax.
Roth IRA Conversions Today Reduce Future MAGI
As stated earlier, required minimum distributions from Traditional IRAs are exempt from the surtax but they increase MAGI. This can effectively create a 43.4% effective tax on IRA distributions (39.6% income tax plus 3.8% surtax on investment income made surtaxable by the IRA distribution).
Planning Tip: Converting to a Roth prior to 2013 can reduce MAGI in 2013 and beyond and thereby reduce or eliminate surtax exposure.
Example: Robert and Anna, age 69, have pension income of $130,000 and net investment income of $115,000 for a total MAGI of $245,000, just below the threshold amount. In 2013, their RMDs from their IRAs will be $50,000, which will bring their MAGI to $295,000. Result: MAGI is $45,000 above the threshold amount ($295,000 less $250,000) so the surtax will be imposed on $45,000 of their net investment income. Making Roth conversions in 2010, 2011 and 2012 to eliminate the RMD in 2013 would eliminate the surtax.
Planning Tip: Using outside/taxable funds to pay the income tax on a Roth conversion can be advantageous in lowering future MAGI.
Example: In 2010, Paul converts a $1 million IRA to a Roth IRA, incurring $450,000 of state and federal income tax. Paul pays the income taxes from his outside/taxable investment funds. Result: Future investment income from the outside funds will no longer exist and will avoid the 3.8% surtax. Distributions from the Roth IRA are neither investment income nor included in MAGI.
Planning Tip: Anyone can now convert to a Roth IRA, regardless of income. If the conversion occurs in 2010, half of the conversion amount can be claimed as income in 2011 and half in 2012. After 2010, conversions must be claimed as income for the year in which the conversion is made.
Conclusion
Even though the 3.8% health care surtax will not go into effect until 2013, taxpayers who will be exposed to it should begin planning in 2010, especially if a Roth conversion is desirable. Now is the time to get organized and run the projections so you will be able to incorporate any changes in year-end planning for your clients.
Commentary regarding the estate tax exemption for 2011: It is looking more and more like the exemption will be $1 million in 2011. However, there is still a possibility that it will be $3.5 million. It is recommended that you start assessing your clients now to see which ones will be over the $3.5 million exemption and start their planning now. You can also start a “second-tier list” of those who will have net estates of between $1 million and $3.5 million so that, in the event the exemption is $1 million, you will already know which of your clients will need additional planning.
To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax adviser based on the taxpayer’s particular circumstances.
Tax exemption trusts provide readily available funds that can be leveraged to transfer more wealth efficiently.
Leverage At Death
A Credit Shelter Trust (CST), also referred to as a B-Trust, is funded at death to shelter a certain amount from estate taxes (for 2011, the amount is $1,000,000). The trust can be leveraged with life insurance on a surviving spouse to transfer more wealth to heirs.
Leverage During Lifeftime
A Lifetime Exemption Trust can be funded during lifetime with up to $1,000,000 of assets that can be sheltered from gift taxes. It can be leveraged with life insurance.
Better to Give Now (2010) vs. Making Charitable Contributions Later (2011)
Call me a law nerd if you want, but I spend a lot of time thinking about legal strategies. I know my clients will thank me for it.
Here’s something advisors need to consider: Taken from a tax standpoint, would your high-net-worth clients be better off making large charitable contributions in 2010 or 2011?
Two Good Reasons to Do It Now
First, income tax rates in 2011 are set to top out at 39.6%, compared to a top rate of 35 percent in 2010.
Second, the capital gains tax will increase from 15% to 20%. This may be limited to folks with incomes over $250,000, but that depends on future legislation.
Usually, taxpayers save more from charitable contributions when tax rates are high. However, that may not be the case after 2010.
Employees and business owners alike face the challenge of accumulating sufficient assets to provide for their needs in retirement. They often turn to qualified retirement plans (or “Qualified Plans”) as a tax efficient means of providing retirement benefits. But employees and business owners face another problem: What happens to their families if they die before reaching retirement age? Death benefit coverage provides for family members what retirement savings give to employees and owners. And so employees and business owners often ask: Would it be more efficient to provide death benefit protection using the same dollars being used to provide retirement benefits? If so, can money which is contributed to Qualified Plans be used to purchase life insurance? Qualified pensions and profit-sharing plans were created by Congress to help employees accumulate assets for retirement and provide certain tax advantages for contributions made by employers. Qualified Plans are subject to significant rules and regulations under the Internal Revenue Code (“IRC”) as well as to all of the complexities of the Employee Retirement Income Security Act of 1974 (“ERISA”).
For example, Qualified Plans are subject to reporting and disclosure requirements, vesting and participation requirements, funding requirements, fiduciary responsibilities, and administration and enforcement requirements.
Thus, when considering what investments to use in a Qualified Plan, employers and plan participants should seek advice from tax or legal counsel, or seek the services of a third-party administrator (“TPA”).
Those considering the purchase of life insurance within a Qualified Plan must understand the “incidental benefit” limitations for various types of plan designs, ERISA and labor law limitations for purchasing life insurance in Qualified Plans, the tax treatment of life insurance protection while participating in a plan, the tax treatment of death benefits when paid out, and the options for continuing life insurance coverage at retirement.
159 Lookout Place