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Red File Checklist

Notebook or other centralized source of information that will aid an executor in navigating the waters of estate administration and will make a person’s wishes very clear in the event he or she becomes incapacitated.

Typically a spouse, child, or other loved one takes on the role of executor with only part of the instructions they need. They may know who is to receive mom’s assets, but what exactly did mom own? How many bank accounts did she use? What insurance policies did she have? Was there a safety deposit box? What bills did she owe? Are there magazine subscriptions to cancel? How do I access her email or shut down her social media accounts?

In Section 1, create a centralized file of personal information.
In Section 2, gather the information the family will need for any businesses managed.
In Section 3, create a plan in case of incapacity, including guidance for future care, preferences, and a clear expression of financial intentions. Many individuals assume a family member will take care of them in the event of incapacity, but few appreciate the number of decisions a guardian or caretaker must make on behalf of an incapacitated person. From housing situations to medical treatment to simple living and eating preferences, without guidance, a family member is left to simply guess at what their loved one wanted.
In Section 4, gather information about the legacy you want to leave behind—aside from money or assets.
Section 5 is a list of some of the additional resources available.
Most importantly, once you’ve created your Red File with all of this information, be sure to tell someone where it’s kept. And, be sure to update it periodically.

SECTION 1 – CENTRALIZED FILE OF PERSONAL INFORMATION

You and Your Family
– You– Full legal name, date and place of birth, copy of birth certificate, location of original birth certificate, copy of Social Security card, location of Social Security card, copy of driver’s license, location of driver’s license
– Parents– Mother’s full name, father’s full name, date and place of mother’s birth, date and place of father’s birth
– Children– Children’s full names, dates of birth, copies of children’s birth certificates, copies of adoption paperwork
– Stepchildren– Full names, dates of birth, how related to you
– Grandchildren– Grandchildren’s full names, dates of birth, parents’ names
– Marriages– Spouses’ full names, dates and places of marriages and divorces, copies of marriage certificates, copies of pre-nuptial and post-nuptial agreements, copies of divorce decrees
– Military Service– Branch of military, enlistment and discharge dates, rank at discharge, location of military service record and discharge document (form DD214)
– Contact Information– Phone numbers and addresses for family members and close friends

Legal Documents
– Financial/Durable Power of Attorney– Copy of document, location of original document, who has copies, effective now or upon incapacity, who is named (in order)
– Medical Power of Attorney– Copy of document, location of original document, who has copies, who is named (in order)
– HIPAA Release– Copy of document, location of original document, who has copies, who is named
– Declaration of Guardianship in Event of Later Incapacity– Copy of document, location of original document, who has copies, who is named (in order)
– Directive to Physicians/Living Will– Copy of document, location of original document, who has copies
– Funeral Arrangements Directive– Copy of document, location of original document, who has copies
– Appointment of Agent to Control Disposition of Remains– Copy of document, location of original document, who has copies, who is named (in order)
– Will– Copy of document, location of original document, who has copies
– Living Trust/Revocable Trust– Copy of document, location of original document, who has copies
– Trusts For Your Benefit– Copies of trust agreements, contact information for trust officers, contact information for trustees, what trust owns
– Trusts You Created– Copies of trust agreements, contact information for trust officers, contact information for trustees, what trust owns
– Disposition of Personal Effects– Codicil, Trust Addendum, or Memorandum addressing how to distribute personal effects

Financial
– Financial Accounts– For each checking and savings account, brokerage account, retirement account, annuity: Copy of one statement, contact information for bank/institution, account number, exact name on account, beneficiary designation, signers on the account, online login information, what account is generally used for, what bills are automatically debited from account, what income is direct deposited into account
– Credit and Debit Cards– For each card: Copy of front and back of card, exact name on card, financial account card is linked to (if debit card), copy of one statement (if credit card), what bills are automatically charged to card
– Advisors– Contact information for bankers, investment advisors, financial advisors, attorneys, tax advisors
– Financial Statement– Copy of recent personal financial statement
– Tax Returns– Location of tax returns for past three years, contact information for preparer

Assets
– Real Estate– Copies of deeds and mortgages, location of original deeds, mortgage information (payment amount, contact information for bank, financial account payment is automatically debited from), information on time shares, contact information for property management companies of rental properties
– Business Interests– List of business interests owned, how owner name is styled, contact information for business manager and/or partners, location of documents (corporate documents, buy-sell agreements, stock purchase agreements, appraisals), copies of promissory notes, what
happens to business interests at death
– Consolidated List of All Income Sources– Include source, frequency, amount for all retirement benefits, Social Security, IRAs, annuities, investment dividends, income from rental properties, business income, mineral royalties, trust distributions, disability benefits
– Vehicles (Including Boats, Recreational Vehicles, Trailers)– List of all owned (including make, model, year), location of original title, exact owner name on title, information on loans (including payment amount, contact information for bank, financial account payment is automatically debited from)
– Jewelry, Art and Collectibles– List of valuable items including location of each, copies of appraisals
– Bonds– List of bonds and where kept
– Safe Deposit Boxes, Safes, Storage, Locked Areas– For each: Location, location of your key or combination, who else has key or combination, list of contents
– Hidden Assets– Location of any assets hidden within the home your heirs should be aware of including location of any firearms, money hidden in the mattress, etc.

Home Utilities and Maintenance
– Electricity, Gas, Water, Telephone, Cable Television, Internet, Alarm Monitoring– For each: Copy of one statement, account number, contact information for provider
– House Cleaning, Lawn Care, Landscaping, Pool Maintenance, Pest Control– For each: Contact information for provider, copy of contract
– Home Repair Contacts– For each: Contact information and services used
– Community Association– Contact information, when fees are due and amount

Insurance
– Homeowner’s Insurance– Copy of policy, policy number, contact information for carrier and agent/broker, coverage information, deductible
– Auto Insurance– Copy of policy, policy number, contact information for carrier and agent/broker, coverage information, deductible
– Insurance on Valuables– For policies on jewelry, art, or other collectibles: Copy of policy, policy number, contact information for carrier and agent/broker, coverage information
– Business Insurance– For each worker’s compensation insurance, property insurance, general liability insurance, umbrella policy: Copy of policy, policy number, contact information for carrier and agent/broker, coverage information, deductible
– Health Insurance– For each coverage: Copies of policy and insurance card, contact information for insurance company, member/group number, coverage information, deductible/co-pay information
– Long-Term Care Insurance– Copies of policy and insurance card, contact information for insurance company, member/group number, coverage information
– Disability Insurance– Copies of policy and insurance card, contact information for insurance company, member/group number, coverage information
– Dental Insurance– Copies of policy and insurance card, contact information for insurance company, member/group number, coverage information
– Vision Insurance– Copies of policy and insurance card, contact information for insurance company, member/group number, coverage information
– Prescription Drug Coverage– Copies of policy and insurance card, contact information for insurance company, member/group number, coverage information, deductible/co-pay information
– Medicare/Medicaid– Copy of card, coverage information
– Life Insurance on Your Life– For each policy: Copy of policy and beneficiary designation, policy number, contact information for carrier and agent/broker
– Life Insurance Owned on Someone Else’s Life– Copies of policy and beneficiary designation, policy number, contact information for carrier and agent/broker
– Veteran’s Benefits– Copy of Veteran’s Health Identification Card, information on any benefits currently receiving (pension, disability compensation, medical), information on additional benefits available (life insurance, health care, long-term care, rehabilitation, nursing and residential care, burial and memorial benefits), contact information for closest Veterans Affairs regional office

Medical
– Current Medical Issues– List of current health issues
– Current Health Care Providers– For each: Name, phone number, area of practice
– Medications– List of current medications including dosage and prescribing physician
– Supplements and Vitamins– List of all supplements and vitamins currently taking
– Allergies– List of all allergies including food and drug allergies
– Dietary Restrictions– List of dietary restrictions that need to be adhered to
– Pharmacy– Phone number and address of pharmacy where prescriptions are filled
– Medical Supply Company– Phone number and address for provider of any medical equipment or supplies used
– Medical History– Detailed medical history including vaccines received, surgeries, hospital stays
– Family Medical History– Information on ancestors’ medical health that would be good for future generations to know about in dealing with their own health issues
– Past Medical Records– Contact information for locations of past hospital stays or surgeries, contact information for former physicians

Funeral and Burial
– Legal Documents– Indicate if a Funeral Arrangements Directive or Appointment of Agent to Control Disposition of Remains is included with legal documents
– Grave Plots Owned– Location of plots, copy of deed
– Funeral Expenses Prepaid– Contact information for funeral home
– Funeral Plans– If no Funeral Arrangements Directive, indicate burial or cremation preference, religious considerations, any music preference, any scriptures or prayers to include
– Notifications– Contact information for anyone to notify when you die
– Obituary– Information you’d like included in your obituary
– Photos– Digital copies of lifetime photos you’d like shown at your memorial service

Other
– Subscriptions– List of all club memberships (including country club, gym, Sam’s Club, Costco), airline rewards programs, toll tag accounts, magazine subscriptions and newspaper subscriptions including membership numbers, renewal dates, and contact information for organization
– Post Office Box or Offsite Mailbox– Location, location of your key or combination, who else has key or combination
– Online Accounts– Website, username, and password for all online accounts including email accounts, online banking accounts, social media accounts, online shopping accounts, online entertainment accounts
– Computer Logins– Usernames and passwords to log onto each computer
– Mobile Device Locks– PIN lock for each device

SECTION 2 – BUSINESS CONTINUITY PLAN

For Each Business Managed With a Succession Plan in Place
– Contact Information– Whom family should contact for information on the succession plan
– Company Documents– Location of any buy-sell agreements or stock purchase agreements
– Ownership– How the company’s ownership will be structured
– Management– How the company’s management will be handled

For Each Business Managed Without a Succession Plan
– Contact Information– Contact information for all business partners, employees, advisors
– Emergency Instructions– Any information that will be immediately needed
– Company Documents– Location of all company documents including buy-sell agreements, stock purchase agreements, appraisals, promissory notes
– Management– Who should fill which roles in the company

SECTION 3 – PLAN FOR INCAPACITY

Care Provider
– Do you prefer to live at home with home health care attendants or with a family member? If with a family member, who?
– Is there an adult day care program available that you would be okay going to?
– If you can’t be cared for in a home environment, which long-term care facilities do you prefer?
– If the above-named facilities cannot be used, would you prefer that facilities with a particular affiliation or close to a particular person be given preference?
– If you don’t have children who can guide your care, who will implement your wishes for care during your remaining lifetime?

Personal Preferences
– Spiritual or Religious Advisors– Contact information for any spiritual or religious advisors you would like to continue to minister to you to the extent possible
– Spiritual Preferences– Any faith traditions or religious observances you want to continue
– Favorite Things– List of favorite foods, music, books, movies, television programs, activities, sports, colors
– Friends to Update– List of any people you would like kept informed as to your wellbeing including contact information, list of anyone you expressly want to not have access to you
– Palliative Care & Hospice– Your wishes regarding quality-of-life issues that occur during the course of a serious illness (see Section 5, item B)

Expression of Financial Intentions
– If you prefer to live at home with a family member, do you want a portion of your assets to be used to remodel the home (enlarge doorways to accommodate a wheelchair, handrails in the restroom, ramps instead of stairs, a bedroom that could accommodate a hospital bed) or to purchase a larger home? If so, how much? Will this be considered a gift or an advance against a future inheritance?
– Do you want to provide financial support to a family member or close friend who takes on the role
of caregiver? If so, will this be considered compensation or a gift?

SECTION 4 – LEGACY PLAN

Philanthropy and Gifting
– Do you have any outstanding charitable pledges?
– Are there any causes you support that you would like to continue to be supported?
– Do you have any ongoing gifting plans?

Family History and Culture
– Ancestors– History of family including names and hometowns of ancestors
– Accomplishments– List of family accomplishments
– Traditions– Traditions you want future generations to continue
– Values– Family’s core values and mission statement
– Legacy Letter– (Also known as an ethical will) written to future generations to communicate what you value most in life, your best memories and fondest moments, what you want for your descendants’ lives, wisdom you want to share

SECTION 5 – ADDITIONAL RESOURCES

A) Marvin Blum authored the article “Filling in the Gaps: Create a ‘Red File’ for Clients to Cover Issues Beyond Traditional Estate Planning” in the February 2017 edition of Trusts & Estates magazine. It’s available at www.theblumfirm.com/2017/Filling-in-the-Gaps.pdf
B) A great article about end-of-life planning was published in the October 2017 edition of D Magazine about Dr. Robert Fine, the head of palliative care for Baylor Scott & White. It’s titled “This Man Wants to Help You Die Better” and is available at www.dmagazine.com/publications/dmagazine/2017/october/palliative-care-baylor-robert-fine
C) Debbie Pearson authored a workbook which walks you through the decisions to make, the discussions to have, and the information to gather. The Blueprint to Age Your Way (Family Night Press, 2017).
D) There are consultants who can assist with planning for possible incapacity—aging life care professionals (also called geriatric care managers). These consultants know, for example, the going rate for in-home care, the physical obstacles to look for in a home environment, and which walker would be best. One national association of such consultants is the Aging Life Care Association. The ALCA website provides a resource to search for a list of aging life care experts near you.

Red File Checklist Read More »

Planning in a Perfect Stormfor Business Owners

Investing involves risk including possible loss of principal. Information is current as of the date of this material.

Any opinions expressed herein are from a third party and are given in good faith, are subjects to change without notice, and are considered correct as of the stated date of their issue.

Merrill Lynch, Pierce, Fenner & Smith Incorporated is not a tax or legal advisor. Clients should consult a personal tax or legal advisor prior to making any tax or legal related investment decisions.

Bank of America Corporation (“Bank of AMerica”) is a financial holding company that, through its subsidiaries and affiliated companies, provides banking and investment products and other fainancial services.

Merrill Lynch, Pierce, Fenner & Smith Incorporated (also referred to as “MLPF&S” or “Merrill”) makes available certain investment products sponsored, managed, distributed or provided by companies that are affiliates of Bank of America Corporation (“BofA Corp.”). MLPF&S is a registered broker-dealer, registered investment adviser, Member SIPC and a wholly owned subsidiary of BofA Corp. Merrill Lynch Life Agency Inc. (“MLLA”) is a licensed insurance agency and a wholly owned subsidiary of BofA Corp.

This material does not take into account a client’s particular investment objectives, financial situations, or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security or investment strategy. Merrill offers a broad range of brokerage, investment advisory (including financial planning) and other services. There are important differences between brokerage and investment advisory services, including the type of advice and assistance provided, the fees charged, and the rights and obligations of the parties. It is important to understand the differences, particularly when determining which service or servies to select. For more information about these services and their differences, speak with your Merrill financial advisor.

Nothing discussed or suggested in these materials should be construced as permission to supersede or circumvent any Bank of America, Merrill Lynch, Piierce, Fenner & Smith Incorporated polices, procedures, rules, and guidelines.

Investment products offered through MLPF&S and insurance and annuity products offered through Merrill Lynch Life Agency Inc.:

Are Not FDIC InsuredMay Lose ValueAre Not Bank Guaranteed
Are Not Insured by Any Federal Government AgencyAre Not DespositsAre Not a Condition to Any Banking Service or Activity

Why is Now the “Perfect Storm” for Planning?

  • $12,060,000 Gift Tax Exemption
  • Low Interest Rates
  • Valuation Discounts
  • Defective” Grantor Trust (DGT) Rules
  • “Squeeze & Freeze”

Ideas for Business Owners to Harvest and Leverage Gift Tax Exemption

1. Outright Gifts to Heirs
2. Gifts to Trusts for Benefit of Heirs
3. Estate Freeze Sale to DGT
4. Estate Freeze Sale to “678 Trust”
5. Gift to Spousal Lifetime Access Trust (SLAT)
6. Gift of Undivided Interest in Real Estate or Real Estate Partnership
7. Irrevocable Life Insurance Trust (ILIT)

1. Outright Gifts of Business Interests to Heirs

  • Gift $12.06 million outright to descendants
  • Drawbacks:
  • Assets subject to descendants’ creditors
  • Estate and GST tax exemptions not preserved for future generations
  • Fails to take advantage of leveraging and perhaps the use of discounts

2. Gifts to Trusts for the Benefit of Heirs

  • Traditional, non-grantor trust
  • Defective Grantor Trust (DGT)
  • Gift is “supercharged” by Grantor’s payment of income tax on trust income
  • Can toggle off Grantor Trust status later, if desired

3. Estate Freeze Sale of Business Interest to DGT

  • Sell assets to DGT in exchange for 25-year promissory note (long-term AFR for June is 3.11%)
  • Freezes client’s estate at value of the note
  • All post-sale appreciation is in the DGT

4. Estate Freeze Sale to “678 Trust”

  • Client’s parent establishes 678 Trust with $5,000 gift; Client sells business to 678 Trust in exchange for promissory note
  • Benefits:
  • Assets owned by 678 Trust not subject to estate or GST taxes for generations
  • Assets owned by 678 Trust not subject to creditors
  • Client continues to have access, control, and flexibility over assets in 678 Trust

5. Spousal Lifetime Access Trusts (SLATs)

  • Husband creates trust for Wife, and Wife creates trust for Husband; trusts must be substantially different
  • Benefits:
  • Harvests both spouses’ gift tax exemptions (“Use It or Lose It”)
  • Assets owned by SLATs not subject to estate or GST taxes for generations
  • Assets owned by SLATs not subject to creditors
  • Spouses continue to have access to assets in SLATs

6. Gift of Undivided Interest in Real Estate

  • Example:
  • Client owns real estate under business worth $5,000,000.
  • Client deeds an undivided 1/16 to Son and Daughter. The value of each gift is $156,250 minus a 20% discount, which is $125,000.
  • When Client dies and the real estate is still worth $5,000,000, Client’s 15/16 interest is reduced by a 20% discount ($4,687,500 minus $937,500 equals $3,750,000).
  • That single deed removed $1,250,000 from Client’s estate.

7. Irrevocable Life Insurance Trust (ILIT)

  • Client gifts money to ILIT to pay for premiums
  • Trustee uses money to purchase policy and stay current on premiums
  • Upon Client’s death, life insurance proceeds are paid to ILIT
  • Client saves approximately $400,000 in estate tax for every $1 million of insurance by removing policy from Client’s estate

Considerations for Gift-Giving

  • Loss of basis step-up when gifting low basis assets
  • Many ways to qualify for discounts
  • Benefits of trusts over outright gifts
  • Use Caution with hard-to-value assets:
    • Leave a cushion
    • Obtain a qualified appraisal
    • Report the gift adequately on gift tax return
    • Use a Wandry adjustment clause

Planning in a Perfect Stormfor Business Owners Read More »

I DO, ROUND TWO:SECOND MARRIAGE ESTATE PLANNING

Families don’t remain stagnant—they change and grow, and estate planners must be prepared to help with the growing pains. Divorce and second (or third or fourth…) marriages are an inevitable aspect of preparing an estate plan. It’s estimated that more than half of Americans either have been or will be included in a blended family in their lifetime.

Approximately 75% of people who divorce choose to marry again. As a result, almost half of all marriages today are at least the second marriage for at least one spouse. And, approximately 65% of remarriages involve children from a prior marriage.
With multiple marriages comes the opportunity for stepsiblings to have different economic circumstances and face different inheritances. These divergent situations can often cause friction within a blended family. Adding an age disparity or wealth disparity between the spouses puts fuel on the fire. In general, the greater the wealth disparity between spouses, the more potential there is for animosity between the less wealthy spouse and his or her stepchildren.
Without proper planning, children from multiple relationships may not be treated as intended and the interests of surviving spouses may be in direct conflict with those children, detrimentally affecting the family dynamic.

Prenups, Postnups, and Prenup Alternatives

Situation #1 – Best Practices for Prenup or Postnup Agreements

Future-husband and Future-wife both have successful careers, and each has their own income.
They plan to continue to keep their bank accounts separate. Neither has any desire for spousal support from the other in the event of divorce. So, they don’t believe there is any need for a prenuptial or postnuptial agreement (a “prenup” or “postnup”).
Solution: They couldn’t be more wrong. With the grim statistic that about 60% of remarriages end in divorce, prenups for second marriages are even more important than for first marriages.
Individuals entering into second marriages (or third or…) have often had several years to establish a career and accumulate personal assets and thus have more to lose financially in the event of divorce.
And, a prenup serves to clearly identify the separate property assets each party brings into the marriage, which can be especially critical if either spouse comes into the marriage with children.
The prenup can help reduce the risk of later disputes between those children and a surviving spouse.

All assets benefitting a Texas married person fall into one of two categories: marital property and non-marital property.
Within the category of marital property, there are two sub-categories: community property and separate property.

  • Separate property consists of assets owned before marriage or acquired during marriage by inheritance or gift.
  • All of a spouse’s other assets, including income received from separate property, are community property. There is a presumption that all assets are community property, barring clear and convincing evidence that an asset is separate property.

When separate and community properties are commingled, the commingling generally results in the assets becoming community.
When a family court divides community property, it doesn’t necessarily divide it 50/50. The court can make a “just and right” division and award more than one-half to a spouse, taking into consideration equitable factors. One of the factors that a court can weigh is whether one of the spouses has more separate property than the other.
Even though separate property cannot be awarded to the other spouse, it is still on the table for consideration and can impact the way a court divides the community property. On the other hand, non-marital property is not on the table for consideration in a divorce settlement.
Assets owned by a carefully drafted irrevocable trust are non-marital property. Furthermore, assets owned inside an entity, including income earned but undistributed, aren’t divisible upon divorce. Although a spouse’s outside ownership interest in the entity is marital property, assets inside the entity are not.
Our Future-husband and Future-wife can enter into a prenup to declare that income earned on separate property will be separate. They can also agree that wages earned by a spouse are that spouse’s separate property. In effect, they can create a “community-free” marriage.
When entering into a prenup, certain practices should be followed for the agreement to have a greater likelihood of enforceability.

  • Start the prenup process early, long before the wedding day, and complete the process well
    in advance of the wedding.
  • Each party is well-advised by his or her own attorney.
  • Let the lawyers do as much of the talking directly with each other as possible.
  • Provide a full disclosure of each party’s finances and comprehensive plan for handling finances going forward, including the following:
    o Identify assets each brings into the marriage.
    o How income from each party’s separate property will be characterized.
    o How wages, salary, or other compensation will be characterized.
    o The disposition of retirement plans, especially those that are separate property prior to marriage but which may be funded with community property wages during marriage.
    o The treatment of debts—those existing prior to marriage and any incurred during the marriage.
    o The filing of income tax returns.
    o The division of assets upon death or divorce and the issue of spousal support upon divorce.
  • A comprehensive and forward-thinking agreement could also assign certain financial responsibilities like housing costs or schooling expenditures or even address non-financial matters that are important to the relationship such as childrearing, the religious upbringing of future children, and even the division of household and other tasks.

Situation #2 – Prenup Alternatives

Future-husband has substantial separate property assets but would rather not start down the road of discussing a prenup.
Solution A: Much of the goal of protecting family assets can be achieved outside of a prenup agreement through a “prenup alternative,” such as a carefully drafted irrevocable trust. Assets owned by an irrevocable trust prior to marriage are non-marital property.
Single adults who have already accumulated assets in their own name can transfer assets to certain “self-settled” non-Texas trusts or can sell assets to a 678 Trust. When assets are transferred to a self-settled non-Texas trust or sold to a 678 Trust before marriage, the assets in the trust will continue to be non-marital property, even as they grow. If the assets were sold for a promissory note, the note will be separate property. However, the note will be frozen in value and is the type of asset not susceptible to being commingled.
For those wishing to take an extra measure of precaution, there are additional steps estate planners can take in drafting irrevocable trusts. First, consider avoiding the use of ascertainable standards and instead provide for a trust protector (or special trustee) to have authority to amend the trust and direct or veto distributions. Second, give a special power of appointment (“SPOA”)—or the power to create an SPOA—to a third party who can move assets to another trust with similar (but more appealing) provisions. Finally, in some cases, it may be prudent to include a forfeiture provision that requires a beneficiary’s interest to terminate in the event such beneficiary is named as a defendant in a lawsuit or is a party to a divorce proceeding.
It’s important to note that a trust should be created and funded as far in advance of the wedding date as possible. Irrevocable trusts are far less likely than prenups to be subjected to legal challenge. Legal precedent tends to favor respecting the integrity of the trust.
Furthermore, the future spouse plays no role with the trust and needn’t sign anything with respect to the trust.
Solution B: Another prenup alternative is to contribute assets to an entity, such as a limited liability company or limited partnership, before marriage. In Texas, the growth of assets owned in a partnership, as well as income earned on such assets but undistributed, aren’t divisible upon divorce. Contrast this with income earned on separate property that was not contributed to an entity. Income earned on a Texas spouse’s separate property is community, whereas income accumulated in the entity is non-marital property.

Situation #3 – What Prenup Alternatives Can’t Do 

Future-husband has read about prenup alternatives and thinks everything can be accomplished without a prenup. He resists his attorney’s advice to enter into a prenup.
Solution: There are certain protections that still require a prenup, but perhaps it could be a scaled-back prenup.
Those entering into second marriages may need to address obligations to former spouses. A child from a prior relationship requires special planning to diminish the risk of later friction between the child and stepparent.
If a spouse is in a high-liability-risk profession, a prenup can provide an added layer of protection for the other spouse’s property.
A prenup can also specify how assets will be divided when a marriage ends, whether by divorce or by a spouse’s death, which cannot fully be achieved with only a prenup alternative.
In addition, if assets were transferred before marriage to an entity, distributions from the entity are generally treated as community property. A prenup can override that treatment and characterize those distributions as separate property.
If the primary goal is to only protect certain family legacy assets, sufficient protection can often be achieved by prenup alternatives. However, many couples do both a prenup and a prenup alternative (sort of a belt and suspenders approach).

Planning to Avoid Painful Situations Common with Blended Families

Situation #4 – Waiting on Stepparent to Die Before Receiving Inheritance

Husband’s estate plan provides for the creation of a trust to benefit Wife for her life with the remainder beneficiaries being his children from a prior marriage.
After Husband’s death, his children from the prior marriage have to wait for their stepmother to die in order to receive their inheritance.
This is particularly problematic if the surviving spouse is significantly younger than the predeceasing spouse. This waiting period may stretch into decades.
Solution A: Consider “carving out” a portion of Husband’s estate for Wife sufficient to ensure she will be able to maintain her lifestyle (or appropriately supplement a lifestyle afforded by her own estate). If this amount goes to a QTIP trust for Wife, the advantage is that the undistributed portion remaining at Wife’s death passes to Husband’s children. The disadvantage is that Husband’s children may be looking over Wife’s shoulder scrutinizing what she spends from the QTIP trust.
Consider instead an outright bequest to Wife. When Husband dies, there will have to be a determination of what is Husband’s Separate Property, what is Wife’s Separate Property, and what is their Community Property. The only assets passing from Husband are his Separate Property and his half of their Community Property as the rest is already owned by Wife. Unless Husband’s entire estate passes to Wife, there could be challenges to the characterization of assets, leading to a burdensome tracing of assets. It is critical to provide clarity on asset characterization in either a marital property agreement and/or thorough, careful record keeping.
Solution B: Utilize life insurance to provide an inheritance for Husband’s children from his prior marriage. If life insurance is used for the children’s entire inheritance, Husband’s entire estate can pass to Wife outright. If instead Husband’s estate passes in trust for Wife with the remainder to Husband’s children at Wife’s death, the life insurance provides some upfront inheritance so the children don’t have to wait until their stepmother dies to receive something.

Situation #5 – My Stepmother is Draining My Inheritance

Husband has children from a prior marriage.
At Husband’s death, his estate plan provides for the creation of a traditional bypass trust to benefit Wife for her lifetime and his children from a prior marriage as remainder beneficiaries. Wife is entitled to discretionary distributions of income and principal from the bypass trust under a Health, Education, Maintenance, and Support (“HEMS”) standard.
Husband’s children from his prior marriage, as remainder beneficiaries, constantly challenge Wife’s entitlement to distributions from the bypass trust. They want the highest amount possible of trust assets to be remaining in the trust when Wife dies.
Solution A: Carve out a portion of the estate for Wife and a separate portion (and/or life insurance) for the children from the first marriage, as discussed above.
Solution B: Utilize an independent trustee for the bypass trust rather than the surviving spouse.
Also consider giving the independent trustee the ability to make distributions in addition to those under a HEMS standard in order to avoid having to demonstrate a “need” each time a distribution is made. As a result, Wife will still be entitled to distributions under a HEMS standard, but the independent trustee will not have to justify “close call” distributions since it will have broad discretion to make distributions for any reason.
Solution C: Rather than using a discretionary distribution standard for distributions of income, consider making annual income distributions mandatory. Principal distributions will still be discretionary. Having an independent trustee make investment decisions would insulate Wife from attacks that she is weighting investments to income-producing assets in order to pump up the amount of income.

Situation #6 – My Spouse Would Never Cut Out My Kids (Or Would She?)

Husband and Wife both have children from prior marriages. They want their estates to benefit the surviving spouse for the spouse’s lifetime and then all of their children.
Husband’s and Wife’s estate plans are the same. At the first death, assets pass to a trust for the survivor. The trust gives the survivor a global special power of appointment among anyone other than the survivor or creditors. At the second death, the second-to-die’s estate will pass to all of their children, divided equally.
Husband dies first. Wife changes the estate plan to leave her estate to just her biological children and exercises the power of appointment over the trust to cut out Husband’s children.
Solution A: Either remove the special power of appointment from the trust or restrict it so it can only be exercised in a way that keeps an equal inheritance passing to all the children. Although Wife can still cut out Husband’s children from her estate, assets remaining in the trust at Wife’s death will benefit all the children.
Solution B: Husband and Wife could establish an Irrevocable Life Insurance Trust (“ILIT”) for the benefit of all of their children and provide for the ILIT to purchase a joint and survivor policy.
The children could be given Crummey withdrawal rights exercisable over Husband’s and Wife’s contributions to the ILIT (to facilitate premium payments) to minimize the use of Husband’s and Wife’s gift tax exemptions on contributions. The insurance proceeds payable at the surviving spouse’s death would be divided equally among separate dynasty trusts for the children.
To the extent Husband and Wife allocate their GST tax exemption amounts to their contributions to the ILIT, a child’s dynasty trust created thereunder (and subsequent trusts created for the next generations) would be forever exempt from transfer taxes.
The ILIT locks in an inheritance that benefits all the children equally, even if the surviving spouse disrupts the passage of the rest of the estate.

Situation #7 – Concern Child May Challenge My Capacity

Husband is considerably older than Wife. They do not have any children together. Husband has a child from a prior marriage.
Husband’s estate plan leaves most of his estate to Wife and a small portion to his child.
Husband believes that the child will be unhappy with the distribution of Husband’s estate and file suit, alleging that Husband did not have capacity at the time the estate plan was created.

Solution: Around the time that Husband signs his estate planning documents, Husband gives the child a significant gift. If the child accepts the gift and doesn’t bring up capacity, the child must believe Husband has the capacity to make decisions at that time.

Situation #8 – Naming Child as Trustee for Stepsiblings

Husband and Wife both have children from prior marriages. They die and leave their estate to trusts for the children, naming one of the children as trustee.
A stepsibling beneficiary is unhappy with the distribution decisions the stepsibling-trustee is making.
Solution: Stepsiblings may have no emotional relationship and readily bring suit against a stepsibling trustee. Estate planners should urge caution to avoid having one stepsibling act as a trustee for another. This puts the fiduciary in a difficult position. (Our firm is currently handling three litigation cases involving an unhappy beneficiary challenging the stepsibling-trustee, alleging the trustee is acting in their own best interest to the detriment of the unhappy beneficiary.) Instead of one of the children serving as the successor trustee, name a corporate trustee or other third-party independent trustee.

Situation #9 – The “Get Along Shirt” Doesn’t Work

Husband and Wife both have children from prior marriages. The two sets of children often do not get along with each other.
In an effort to “force” them to get along, Husband and Wife name the oldest child from each group as co-executors of both Husband’s and Wife’s estates.
Solution: Appointing stepsiblings who do not get along as coexecutors of an estate is a recipe for disaster. Rather than uniting the stepsiblings, it more commonly serves as a source of additional strife.
Instead, engage in activities with all the children during life to foster and grow a family bond between children groups. And, name an independent third party as executor!

Situation #10 – Choose: IRA Stretch-Out or Control of Final Disposition of Assets

Husband and Wife both have children from prior relationships. They have no children together.
Husband wants his retirement account to benefit Wife and then, at Wife’s death, pass to his children from his prior relationship.
Naming Wife as the beneficiary of the retirement plan allows Wife to do an IRA spousal rollover and take distributions over Wife’s lifetime.
But, Wife will also be able to designate a beneficiary for the account and thus could choose for the account to ultimately pass to beneficiaries other than to Husband’s children from his prior
marriage.
Solution: Name a QTIP trust as the beneficiary of the retirement plan.
The QTIP trust would benefit Wife for her lifetime and could then benefit Husband’s children from his first marriage.
The trade-off of naming the QTIP as beneficiary is that the entire IRA will have to be paid out within 10 years of Husband’s death, rather than over Wife’s life expectancy.
Husband has to decide which is more important to him:
(i) Getting the stretch-out of more than 10 years; or
(ii) Being able to definitively control who the remainder beneficiaries are.

Remember that the SECURE Act (Setting Every Community Up for Retirement Enhancement Act of 2019) changed the manner of distributions following the plan participant’s death.
For most beneficiaries, the life expectancy payout has been replaced by a 10-year payout rule, and there is no requirement of periodical distributions—just that the account balance is distributed at the end of ten years.
For “eligible designated beneficiaries,” the payout can be “stretched out” over a life expectancy period. “Eligible designated beneficiaries” are:

  • the surviving spouse;
  • disabled or chronically ill individuals;
  • individuals who are not more than 10 years younger than the participant; and
  • a minor child of the participant. (When the minor child reaches the age of majority, their eligible designated beneficiary status ceases and the 10-year period begins).

Situation #11 – Equal or Equitable

Husband has adult children from his first marriage and young children from his second marriage.
He wants the inheritances his children will receive at Wife’s death to be “equitable,” which is different from equal.
Providing for all of his children to share equally in his estate may not be “fair” if the adult children from his first marriage have already received significant financial support from him. For example, if Husband has already paid for his older children to attend college or set aside money in a 529 Plan, it may make sense for his younger children from the second marriage to receive a larger share of his estate.
Solution A: Husband provides for his children from his second marriage to receive larger shares of his estate to account for college expenses or other financial support previously given to the children from his prior marriage.
Note that it is advisable for Husband to include language explaining the reasons for the disparity in the treatment between the sets of children.
Solution B: Husband provide for “equalization” gifts to the younger children now, such as creating 529 Plans for each of them, so that Husband’s estate can be divided equally among all the children.
Solution C: Husband leaves part of his estate to a “pot trust” to be used to educate his younger children, and when the youngest child reaches a set age when education should be complete (perhaps age 25?), the balance of the pot trust is distributed equally to all the children.

Situation #12 – Portability DSUE Planning for Second Marriage

Wife’s first Husband died when the lifetime gift and estate tax exemption was $5 million. He left his entire estate outright to Wife. The executor of Husband #1’s estate filed an estate tax return to elect portability, “porting” over his unused $5 million lifetime exemption (the Deceased Spouse Unused Exemption amount or “DSUE” amount) to Wife.
Wife is now remarried to Husband #2 who has already fully-used his lifetime exemption.
An important aspect of portability is that a surviving spouse can only use the DSUE amount of their “last deceased spouse.”
Husband #2’s health is failing. At his death, Wife stands to forfeit the $5 million DSUE amount from Husband #1.
Solution: While Husband #2 is still alive, Wife makes a $5 million gift to a trust for her children.
The $5 million gift eats up Wife’s DSUE amount from Husband #1. When Husband #2 dies, Wife can receive another DSUE amount from his estate (if Husband #2’s estate has any unused exemption) without having wasted the first DSUE amount.
The Lesson: Be sure to use the DSUE amount from your first deceased spouse before killing off your second spouse.

Situation #13 – Who Bears Cost of Making DSUE Election?

Husband and Wife both have children from prior marriages. Husband dies. His Will provides for his estate to pass to his children. His taxable estate is well under his available lifetime exemption, so no estate tax return is required to be filed.
Wife, as executor, files an estate tax return solely for the purpose of electing portability to preserve Husband’s DSUE amount.
The fees and expenses associated with the tax return are expenses of Husband’s estate and reduce the amount of assets passing to Husband’s children. But, the portability election only benefits Wife’s estate, reducing the estate tax at her later death and thereby passing more to her children.
Should Wife have to reimburse Husband’s children the cost of filing the return? Equitably, arguably yes, but legally no.
Similar: Husband and Wife both have children from prior marriages. Husband dies. His Will provides for his estate to pass to his children. His taxable estate is well under his available lifetime exemption so no estate tax return is required to be filed.
Husband’s oldest child, as executor, decides that he will not file an estate tax return to elect portability. Wife offers to pay all costs associated with the preparation of the tax return but to no avail.
Does Wife have any recourse?
Solution A: Husband and Wife include a provision in their Wills or Living Trust requiring the executor to file an estate tax return and elect portability upon request by the surviving spouse.
The surviving spouse could be required to reimburse the estate for any expenses of filing the estate tax return that would not otherwise have been incurred.
Solution B: Husband and Wife enter into an agreement that upon death, the executor is required to elect portability upon request of the surviving spouse with the requestor bearing the cost. Such a provision could be included in a prenup or postnup agreement.
The potential DSUE could be a bargaining chip for the less wealthy spouse. 

Situation #14 – Gift-Splitting Must Be 50/50

Husband has children from a prior marriage. Husband wants to create a trust to benefit his children and fund it with $10 million of his separate property assets.
However, Husband only has $2 million of lifetime exemption remaining. Wife has her full $12 million lifetime exemption available.
Not a Solution: Can Husband gift $10 million worth of his separate property assets to the trust and gift-split the gift such that 20% ($2 million) is from him and 80% ($8 million) is from Wife? No, split gifts are deemed to have been made one-half by each spouse.
Also, remember that if the election is made to gift-split, it’s “all or nothing.” All separate property gifts made by both spouses during the year are split 50/50. You cannot pick and choose what you want to gift-split and what you don’t want to gift-split.
Solution: Husband creates the trust and funds it with $2 million of Husband’s separate property, using all of his lifetime exemption.
Husband also gifts $8 million of assets to Wife.
LATER, Wife gifts the $8 million of her new separate property assets to the trust. There needs to be enough time between the gift to Wife and Wife contributing the assets to the trust that Wife has the opportunity to do what she wants with the assets. She could even file for divorce and keep her new separate property assets.
Otherwise, you will run into the situation of the recent Smaldino case (Smaldino v. Commissioner, T.C. Memo. 2021-127).
In the Smaldino case, the wife held the assets for just one day before contributing them to a trust for the benefit of the husband’s children from a prior marriage. The Tax Court opined that the wife never had an opportunity to exercise any ownership rights with respect to the assets and as such the husband gifted the assets directly to the trust, resulting in the husband owing gift tax.
Our Husband would file a gift tax return reporting a $2 million gift. Wife would file a gift tax return reporting an $8 million gift. Neither elects to gift-split.

Situation #15 – You Can Make the Gift, But You Cannot Use My Exemption 

Husband and Wife have children together, and Husband has children from a prior marriage.
Husband and Wife have substantial community property assets. Neither has much separate property assets.
Husband wants to create and fund a trust for his older children. Wife is agreeable to gifting community property assets to the trust but does not want to use any of her lifetime exemption for the gift.
Solution: Husband and Wife enter into a marital property agreement in which they agree to convert a portion of their community property into two separate property halves.
Husband will then have separate property to make the gift, and Wife will not have to use any of her lifetime exemption for the gift.

Situation #16 – Homestead Occupancy Rights

Husband and Wife both have children from prior marriages, and they have a child together.
Their residence is Husband’s separate property. In Husband’s Will, he leaves the house to his older children and leaves other, substantial assets to Wife and the shared child.
Husband plans for his older children to sell the house and split the proceeds as their inheritance.
Husband dies. Wife decides to remain in the house until the youngest child is grown and out of school. Husband’s older children cannot sell the residence as long as Wife asserts her homestead occupancy rights.
Husband’s older children receive nothing at their father’s death and must wait years until the house is sold and they receive the proceeds. Wife receives the substantial other assets left to her.
Solution A: They enter into a marital property agreement whereby Wife waives her homestead right. In the agreement, Husband could commit to leaving Wife sufficient funds to find a replacement residence.
This situation is especially notable when there is a large age disparity between spouses. If Wife is not much older than Husband’s older children, it may be decades before Wife dies.
Solution B: Instead of the residence passing to Husband’s older children and other assets passing to Wife, swap them. Plan for Wife to inherit the residence, should she survive Husband, and Husband’s children to inherit the other assets.

Situation #17 – Is the House Paid For?

Add to the previous situation that the house has a mortgage on it. Wife asserts her homestead occupancy rights and stays in the house until she dies.
Husband’s older children are responsible for paying the mortgage principal payments and the insurance premiums for the house. Wife is responsible for paying mortgage interest, property taxes, and other maintenance expenses typically imposed on the owner of a legal life estate.
Husband’s older children do not have the funds to pay the mortgage or the insurance.
Solution: If Husband wants to provide for the residence to pass to his children at Wife’s death, leave the residence to a trust.
The trust could also be funded with funds sufficient to cover any future mortgage payments, insurance, property taxes, and other associated expenses.
Husband’s children will still have to wait to be able to do what they want with the house, but there won’t be issues with funds for maintaining the house.

Situation #18 – Household Contents Can Be More (Emotionally) Valuable than the House

Adding on to the previous situation, the majority of the house contents are Husband’s separate property which he leaves to his older children in his Will. Homestead rights do not cover contents of the house.
Husband’s older children come get the furniture and furnishings they’ve inherited.
Wife, the shared child, and Wife’s older children who all live in the house have no furniture.
Solution: Household contents need to be addressed in the estate plan. Provisions need to be made for furniture for Wife if the majority of the furnishings are Husband’s separate property.
And, the contents need to be addressed with sufficient specificity. Imagine that their premarital agreement provides that Husband’s tallboy chest of drawers, framed mirror, and antique chair from his grandfather will remain his separate property but does not provide any further description or photos of the items. Now you have Wife and Husband’s children arguing over whether a particular framed mirror was Husband’s grandfather’s or was purchased by Husband and Wife.
To prevent wars over contents and personal effects, Husband and Wife need to clarify in an agreement which assets are Husband’s separate, which assets are Wife’s separate, and which are community.

Bonus: Impact on a Family Legacy Plan

When blended families combine their collective values, experiences, and finances, there is a significant risk that family harmony and the family legacy could be disrupted.
Estate planners should be vigilant in looking out for issues that have the potential to threaten the human capital of the family. Human capital is one of the five key components of a family’s wealth (along with intellectual, social, spiritual, and financial capital). Human capital consists of the individuals who make up a family, celebrating each one’s personal identity, self-worth, and well-being.
While many feel comfortable guiding clients through the prenup process, too few estate planners take the next step to help guide clients on how to effectively incorporate new family members into the family. Marriage adds a new member to the family, so it instantly impacts the make-up of a family’s human capital.
An estate planner has the ultimate goal of maintaining the wealth of a family for generations to come, and accordingly, planners should take an active role in helping clients establish policies that foster good relationships and promote family development and success.
Because entering a new family can be overwhelming, estate planners should coach families to “immediately acculturate new family members, helping them to feel like valued members of the team.” Acculturation can be accomplished through two big steps: (1) Sharing information, and (2) Getting involved in the family.
Sharing information is a significant part of making the new family member feel included. Often, a new spouse finds themselves in a predicament in which they appear disinterested if they fail to ask enough questions but appear nosey if they ask too many questions. Granting them a backstage pass to the inner workings of the family will ease anxiety and make them feel like less of an outsider.
There are consultants who can help a family navigate these new relationships. Having an experienced, objective third party serve as the facilitator at a family meeting can moderate the conversation, guide the process, and restore calm when feelings are hurt or tempers flare.
A successful transfer of wealth from generation to generation is a lofty and admirable goal, but within the estate planning world, there should be more emphasis placed on preservation of the family. Estate planners must seize opportunities presented by second marriages to address the human capital factor and pay a little more attention to the “family” in “family wealth.”

Final Point: CAVEAT Regarding Conflicts of Interest in Representing Both Spouses

Be on guard for potential conflicts of interest. If it appears there could be irreconcilable differences or difficulty achieving a plan that’s compatible with both spouses’ best interests, don’t represent both. If both spouses’ consent, choose one and let the other have separate, independent counsel. If the situation appears compatible, have both spouses sign a mutual representation letter and waive any conflicts of interest. Of course, if things go bad, withdraw from representing either spouse.

I DO, ROUND TWO:SECOND MARRIAGE ESTATE PLANNING Read More »

Estate Tax Update for Whitley Penn

MARVIN E. BLUM is an attorney and CPA based in Fort Worth. He is Board Certified in Estate Planning and Probate Law and is a Fellow of the American College of Trust and Estate Counsel.

Mr. Blum founded The Blum Firm, P.C. over 40 years ago. The firm specializes in estate and tax planning and the related specialties of asset protection, business planning, business succession planning, charitable planning, family legacy planning, fiduciary litigation, and guardianship. The Blum Firm has grown to be one of the premier estate planning firms in the nation, known for creating customized, cutting-edge estate plans for high-net-worth individuals. 

Mr. Blum serves on the Editorial Advisory Committee for Trusts & Estates magazine. He is Treasurer for the Texas Cultural Trust.

Mr. Blum earned his BBA (Highest Honors) in Accounting from The University of Texas and received his law degree (High Honors) from The University of Texas School of Law.

The “Golden Age” of Estate Planning

  • Conditions for estate planning have never been better:
       ― Doubled estate tax exemption
       ― Valuation discounts
       ― Low interest rates
       ― Wide array of “squeeze & freeze” planning tools
       ― Use of grantor trusts to supercharge estate tax planning:
            o Grantor avoids recognizing income on sales between grantor and grantor trusts.
            o Grantor’s personal payment of income tax on the trust’s taxable income isn’t a gift.
  • Congress has not closed an estate planning loophole in over 30 years.
  • The “Golden Age” came under risk on January 5, 2021 when Georgia’s two Senate run-offs shifted the Senate to Democratic control.

Key Legislative Developments

  • December 2020: Consolidated Appropriations Act (longest bill ever passed by Congress) became law, at a cost of $2.3T and no revenue in it to pay for it.
  • March 2021: American Rescue Plan became law—$1.9T of spending, with no revenue in it to pay for it.
  • November 2021: Bipartisan Infrastructure Bill became law, spending $1.2T on infrastructure (roads and bridges, etc.) but does not include tax increases to raise the funds for the spending.
  • November 2021: Build Back Better Act passed the House and is pending in the Senate. It is legislation intended to implement President Biden’s social and educational reforms (provisions for education, labor, childcare, healthcare, taxes, immigration, and the environment) with an expected cost of between $1.75T and $3.5T.

How to Pay for It?

  • Three words: TAX. THE. RICH.
  • By including Build Back Better in a budget reconciliation bill, it can pass the Senate with only 51 votes (50 Democrats plus the Vice President tie breaker vote) instead of 60 votes.
  • Will be challenging to get all 50 Democratic Senators on board, especially Joe Manchin (W.Va.) and Kyrsten Sinema (Az.).

Pending Tax Law—What’s the Latest?

Not in Revised Bill Passed by House

Were in original proposed legislation:

  • Early sunset of lifetime gift and estate tax exemption (accelerated from December 31, 2025).
  • Limitation of valuation discounts when transferring entities holding “non-business assets” (passive assets not used in the active conduct of a trade or business).
  • Grantor trust assets includable in grantor’s estate.
  • Sales to grantor trusts recognized for income tax purposes and therefore subject to tax on the gain.
  • Distributions from a grantor trust subject to gift tax if made to someone other than grantor or grantor’s spouse.
  • Grantor trust status ending treated as a gift of the entire trust on that date. 
  • Increase to income tax rates or change to thresholds for brackets.
  • Increase to highest long term capital gains tax rate.
  • Cap on maximum allowable Section 199A 20% pass-through deduction.
  • Change to carried interest rules.
  • Prohibit investment of IRA assets in entities in which owner has substantial interest.
  • Prohibit IRA from holding any security that is subject to an issuer-imposed income or net worth test (Private Placement Investments).

Were discussed earlier but were not in prior proposal either:

  • No repeal of basis step-up at death.
  • No forced recognition of gain at death.
  • No limits on annual exclusion gifts.
  • No limits on 1031 like-kind exchanges of real estate (limiting gain deferral).

What IS in the Revised Bill?

1) New high income surtax based on modified adjusted gross income (“MAGI”), beginning in 2022. MAGI is adjusted gross income reduced by investment interest expense.

  • First Tier: 5% surcharge for individuals with MAGI over $10M if married or single, $5M if married filing separately, and $200K for trusts and estates. Surcharge applies to only the income over the threshold.
  • Second Tier: Additional 3% surcharge for individuals with MAGI over $25M if married or single, $12.5M if married filing separately, and $500K for trusts and estates. Surcharge applies to only the income over the threshold.
  • Note that charitable deductions (and other itemized expenses) do not reduce MAGI.
  • For trusts and estates, the surcharge is based on the AGI under Section 67(e) – not computed in the same manner as for an individual. AGI for a trust or estate can be offset by deductions for certain expenses to administer the trust/estate. Unlike an individual taxpayer, a trust or estate can offset its income by charitable deductions. 

2) Expansion of reach of the 3.8% Net Investment Income tax to include income from active trade or business if taxable income is over $500,000 for joint filing, $400,000 for single, and for all trusts and estates, effective for 2022 tax year.
3) New minimum tax of 15% on profits of corporations that report over $1B in profits.

  • Is a change from prior proposed new graduated corporate tax rate structure of 18%, 21%, and 26.5% rates.

4) Crypto-currency:

  • Digital assets would be included in the constructive sale rules.
  • Crypto-currencies as well as foreign currencies and commodities now subject to wash-sale rules.

5) Limit on exclusion rate for Qualified Small Business Stock (“QSBS”) gains for sales on or after September 13, 2021.

  • Section 1202 permits excluding a percentage of capital gain (up to $10M of gain) from income when selling QSBS.
  • For taxpayers with AGI over $400,000 selling QSBS, the 75% and 100% exclusion rates are no longer available—only the 50% exclusion rate is available.
  • All trusts and estates are limited to the 50% exclusion rate.
  • The excluded gain is subject to Alternative Minimum Tax (“AMT”).


6) Limit on State and Local Tax (“SALT”) deduction raised from $10,000 to $80,000 for the years 2022 through 2030. It would drop to $10,000 for 2031 and then expire.
7) The Section 461 limit on Excess Business Losses of noncorporate taxpayers becomes permanent.
8) Corporate interest expense deduction—the interest expense deduction of certain domestic corporations—would be limited by a new Section 163(n).
9) Surtax on corporate buybacks:

  • When a company buys back its own shares, the stock price generally increases, creating a form of dividend that isn’t currently taxed.
  • The bill would impose a tax equal to 1% of the fair market value of any stock of a corporation that the corporation repurchases during the year, effective for repurchases of stock after Dec. 31, 2021. The provision would apply to any domestic corporation the stock of which is traded on an established securities market.

10) Additional funding to IRS to beef up enforcement. “Mega-IRA” Provisions:
11) Restricts Roth conversions beginning in 2032 if income is over $450,000 for joint filers, $400,000 for single, $425,000 for head of household.
12) Caps IRA size if income is over $450,000 for joint filers, $400,000 for single, $425,000 for head of household. Cannot make additional contributions to Roth or traditional IRA if the combined value of IRAs and defined contribution plans exceeds $10M, effective for 2029 tax year.
13) Increases minimum distribution from large IRA if income is over $450,000 for joint filers, $400,000 for single, $425,000 for head of household. If combined value of IRAs, Roth IRAs, and defined contribution plans exceeds $10M, new minimum distribution rules apply, effective for 2029 tax year.

  • Combined value over $10M: Required minimum distribution of 50% of overage.
  • Combined value over $20M: Required minimum distribution of lesser of (i) 100% of overage or (ii) total balance held in Roth IRA and Roth defined contribution plans.

14) Additional reporting required for accounts with at least $2.5M.
15) No back-door Roth conversions beginning in 2022. Can no longer convert any after-tax contributions (in a traditional IRA or an employer sponsored plan) to a Roth IRA or Roth 401K.

Planning to Do Now

Planning for the New High Income Surcharge

With the surcharge becoming effective beginning in 2022, there could be a planning opportunity for accelerating gains into the current tax year. No surcharge would apply this year (2021) regardless of income level. However, a sale next year may be subject to the
surcharge.

  • When selling a business, taxpayers may find it beneficial to receive payments over a period of years and use installment sales tax treatment to spread the gain over several tax years. For example, a sale of a business under an installment sale could be structured to keep the proceeds under $10M annually.
  • If you expect to be subject to the surcharge in 2022, consider postponing charitable contributions to 2022. Although charitable contributions do not reduce MAGI for purposes of determining if you are subject to the high income surcharge, charitable deductions are still deductible for purposes of calculating your income tax. The tax savings in 2022 will be greater if your income tax rate is higher.
  • Since a trust, unlike an individual, can offset its income by charitable deductions for purposes of the new high income surcharge, this might create planning opportunities for creating and funding trusts to facilitate charitable gifts.
  • The surcharge could be a strong impediment to accumulating wealth inside a non-grantor trust. For instance, a trust with income of $500,000 would pay a marginal tax rate of 45% on its next dollar of income, whereas an individual with similar income would be in a 37% bracket—a rate differential of 8%. The material rate differential would also create a further incentive to shift the income to the settlor by creating the trust as a grantor trust. After the grantor’s death, the trust could consider distributing income to its beneficiaries in an effort to lower taxable income of the trust and shift such income to individual beneficiaries who may be well below surcharge thresholds.
  • Taxpayers may want to also give thought to smoothing income and recognizing capital gains over an extended time period so as to avoid a sharp increase in income in a single year and the accompanying surcharge(s). While a sale of marketable securities cannot be made on an installment basis, a sale could be made through a charitable remainder trust, which could replicate an installment sale.

Take Advantage of Doubled Exemption (“Use It or Lose It” Planning)

  • To lock in the benefit of the doubled exemption before the December 31, 2025 sunset date, a couple has to transfer $23.4M out of their estate.
  • If a couple decides to only give $11.7M instead of $23.4M, make the gift entirely from one spouse and don’t gift-split. Compare the outcomes:

            ― Gifts first eat into the old or “original” exemption before eating into the “extra” exemption. If each spouse gives a gift of half the $11.7M, after sunset they will have each used all of their “original” exemption and none of the “extra” exemption, so their
remaining exemption is zero.

             ― Instead, if the husband gives the entire $11.7M, the wife will still have her “original” $5M exemption (adjusted for inflation) after her “extra” exemption sunsets. 

Create and/or Fund a Children’s Trust Now

 

  • Create an Intentionally Defective Grantor Trust (“IDGT”) to benefit children or grandchildren. Assets held in the trust will be outside the taxable estate.
  • Creating as a grantor trust allows you to personally pay the income tax on the trust income rather than the trust paying its own income tax (and depleting trust assets to do so).

“Squeeze & Freeze” While You Still Can

 

  • Some are hesitant to engage in estate planning for fear of losing control of the assets, losing access to the assets, or losing the flexibility to change their mind. There are some “freeze” planning techniques which allow the client to retain all these things. (You CAN have your cake and eat it too.)
  • The Squeeze:
    ― First, the client transfers the assets to a Family Limited Partnership (“FLP”) to “squeeze” down the value of assets by the FLP units qualifying for valuation discounts.
    ― Valuation discounts for lack of marketability and lack of control are routinely applicable to limited partnership interests as they are less marketable than assets held outright or assets traded on an exchange, such as stock of public companies or bonds.
  • Next, “freeze” the value and lock in the discount by transferring the FLP units to a trust that is outside of the estate through gifts and/or sales.
  • Make a gift to the trust equal to the balance of your lifetime exemption and then sell the rest to the trust in exchange for a promissory note.
    ― Intentionally Defective Grantor Trusts (“IDGTs”) for the benefit of children: gifts to IDGTs & sales to IDGTs.
    ― Spousal Lifetime Access Trusts (“SLATs”): gifts to SLATs & sales to SLATs.
    ― 678 Trusts (also called Beneficiary Defective Trusts or “BDTs”): sales to 678 Trusts.
    ― Grantor Retained Annuity Trusts (“GRATs”): Gifts to a GRAT, especially for mega-sized estates where it is difficult to have enough equity in the trust (or through a guaranty) to support a sale.
  • Note: In freeze sales, the trust buying the assets from you pays with a promissory note. We customarily structure it as a 9-year note to use the mid-term AFR. However, with rates so compressed, consider a 25-year note, locking in the currently low long-term AFR. Also consider restructuring old notes as 25-year notes now in order to lock in the currently low long-term AFR.

Utilize Spousal Lifetime Access Trusts

  • The most popular way for married couples to use each spouse’s gift/estate tax exemption is for each spouse to create a trust for the benefit of the other because doing so preserves the resources for the spouses’ benefit. This type of trust is often referred to as a Spousal Lifetime Access Trust (“SLAT”).
  • Each spouse’s gift would use part or all of their lifetime exemption amount, depending on the amount of assets transferred. Assets held in the SLAT would not be included in either spouse’s estate at death. Think of it as a “Lifetime Bypass Trust” for the benefit of a spouse.
  • Locks in the higher lifetime gift and estate tax exemption before it sunsets in half, yet the spouses continue to benefit from the assets removed from their estates.
  • The two SLATs must be substantially different to avoid the Reciprocal Trust Doctrine.
  • Example:
    ― A husband and wife enter into a marital property agreement in which they agree to convert a portion of their community property into two separate property halves.
    ― The husband creates a trust for the benefit of the wife and funds it with $11M of his separate property. The wife has access to her SLAT for her needs during her lifetime. After her death, the remaining assets are split into separate trusts for the children.
    ― At a later date (the more time, the better), the wife creates a separate trust for the benefit of the husband and funds it with $11M of her separate property. The husband has access to his SLAT for his needs during his lifetime. After his death, the remaining
    assets are split into separate trusts for the children.
    ― While both the husband and wife are alive, the married couple retains access to the full $22M. However, after the first death, the survivor only has access to $11M. To replace the lost assets, each SLAT could buy an $11M life insurance policy on the life
    of the other spouse.
    ― If the husband dies first, at his death, the wife continues to benefit from her SLAT, plus her SLAT collects $11M on the husband’s life, so her access to the full $22M isn’t diminished when the husband dies. If the wife dies first, at her death, the husband
    continues to benefit from his SLAT, plus his SLAT collects $11M on the wife’s life, so his access to the full $22M isn’t diminished when the wife dies. 

     

“Use It or Lose It” for a Single Person

  • If the single person can part with access, the easiest approach is a gift of $11M to an IDGT for the benefit of children or others.
    ― If the donor needs access, consider having the donor borrow from the IDGT on arms’ length terms.
    ― The donor can retain a swap power to reacquire trust assets for assets of an equivalent value.
    ― An Independent Trustee could have ability to reimburse the donor for income taxes on trust income.
    ― Alternatively, to retain access, consider creating a Special Power of Appointment Trust (“SPAT”). The donor makes a gift to a trust for others but gives an independent party a special power of appointment to make distributions to a class of donees that
    includes the donor. For example, the class of donees could be “the descendants of the donor’s mother.”

Utilize a 678 Trust

  • By utilizing a 678 Trust in the “freeze” stage, the client does not have to give up control of the assets or give up access to them.
  • Why choose a 678 Trust?
    ― The clients can remain in control.
    ― The clients can be beneficiaries of the 678 Trust and can continue to have access to the assets for their needs.
    ― The assets in the 678 Trust are not taxed in the clients’ estates.
    ― The clients can have a special power of appointment to direct where the assets pass upon their deaths.
    ― The assets in the 678 Trust are protected from creditors.
  • A 678 Trust is established by a third party (such as the client’s parents, sibling, or close friend) with a gift of $5,000.
  • The client is the primary beneficiary of the 678 Trust and can receive distributions for health, education, maintenance, and support.
  • With careful drafting, the client may also be named as trustee of the 678 Trust. 
  • The client-beneficiary is given a withdrawal right over the initial $5,000 contribution.
  • The trust agreement provides that a Special Trustee has the power to terminate the trust in favor of the client-beneficiary, even after the client-beneficiary’s withdrawal right over the $5,000 gift lapses.
  • The 678 Trust technique works because of a “disconnect” between the income tax code and the estate tax code.
    ― For estate and gift tax purposes, when the client-beneficiary allows the withdrawal right to lapse, the client-beneficiary is not viewed as the grantor of the trust because of the 5 and 5 exception in the estate tax code, and so the trust assets are not includable in the client-beneficiary’s estate.
    ― For income tax purposes, when the client-beneficiary is given the withdrawal right and when the withdrawal right lapses, the client-beneficiary is viewed as the grantor of the trust, making the client-beneficiary the owner of the trust for income tax purposes. (Note that although the withdrawal right is limited to $5,000, there is no 5 and 5 exception in the income tax code.)
  • The clients “burn down” the assets that remain in their taxable estate to pay for living expenses and to pay the income taxes generated by the 678 Trust.
  • After the notes are paid off, the trustee of the 678 Trust will make distributions to the clients to cover their living expenses and income taxes.

     

The Trade-Off: Squeeze & Freeze vs. Stepped-Up Basis

  • For years, we’ve urged clients to transfer assets out of the estate, typically to a grantor trust so the gift is super-charged because the grantor continues to pay the income tax generated by the assets.
  • The problem is that at the grantor’s death, the assets in the trust won’t receive a basis step-up.
  • Do the math. Determine if the expected estate tax savings exceeds the projected capital gain tax cost from loss of the step-up.
  • Have your cake and eat it too. Transfer assets to irrevocable grantor trusts to remove them from the estate. But, before the grantor’s death, take action to move the assets from the grantor trust back into the estate so that the assets will receive a step-up at the grantor’s death.

     

Planning Idea: Swap Assets Back Into Estate

  • Grantor trusts commonly give the grantor a swap power, allowing the grantor to remove assets from the trust and swap them with assets of equal value. The grantor would exercise that power to remove the low-basis assets from the trust and replace them with cash or high-basis assets. The low-basis assets would be in the estate at death and receive the step-up.
    ― Example: Norman bought a ranch 60 years ago for $500,000. He previously gifted the ranch to an irrevocable trust he created for the benefit of his daughter. The trust contained provisions allowing the grantor to swap assets to and from the trust
    (making it a grantor trust). The ranch has a current fair market value of $5M. At Norman’s death, the ranch would not be included in Norman’s estate and therefore would not receive a step-up in basis.
    Recognizing that he has a short life expectancy and that the ranch has a low basis, Norman decides to exercise his swap power. Norman transfers high-basis assets and/or cash with a total value of $5M into the trust and pulls the ranch out of the
    trust.
    At Norman’s death, the ranch is includable in his estate and receives a basis step – up to $5M.
  • What if the client doesn’t have enough cash or high-basis assets to swap? Consider borrowing cash.
    ― The borrowed cash could be swapped for the trust’s low-basis assets, or the borrowed cash could be used to purchase high-basis assets to swap. Or, alternatively, the client can buy the assets from the trust and the trust will carry a note. The sale will not be subject to income tax because the grantor is purchasing assets from his own grantor trust.
    ― Example: Norman can buy the low-basis assets from the grantor trust. Norman signs a promissory note owing to the trust. Norman should hire an appraiser to appraise the value of the assets in the trust and, ideally, to appraise the value of the promissory note. To bolster the value of the promissory note, the note should be secured by the assets being purchased or by other assets. If it is likely that the assets will substantially appreciate inside Norman’s estate prior to his death and it’s a concern that it’ll throw Norman over the exemption level, Norman should use an interest rate on the note that is higher than the AFR. The higher interest Norman pays can offset some of the growth in his estate.
    ― What if Norman bought the low-basis assets from the grantor trust for a promissory note but dies before he repays the note? The unpaid balance of the note would be includible in Norman’s estate for estate tax purposes. 
    When the note is later paid off by the estate, there is no clear answer on whether the gain portion of the note payments received by the trust after the grantor’s death are subject to income tax.
    So, this scenario works best if the note is repaid before the grantor dies.
  • What if the trust isn’t a grantor trust? If the trust isn’t a grantor trust, the problem with swapping or buying the high-basis assets in exchange for low-basis assets is that it would be a taxable sale. To avoid having the exchange treated as a sale, first convert the
    trust to a grantor trust.
    ― Convert by Court Reformation- The trust can be converted from a non-grantor trust to a grantor trust by court reformation.
    ― Convert by Trust Merger- Create a new trust with all the same terms but add a power to swap assets. Then, merge the old trust into the new trust, and the assets are now in a grantor trust. Texas has a fairly liberal trust merger statute. Non-grantor trusts can be merged into grantor trusts as long as none of the beneficiaries will have their interests substantially impaired.
    ― Example: Norman creates a new trust with all the same terms as the original trust, plus it grants Norman a “swap power,” exercisable in a non-fiduciary capacity and without the approval or consent of any person in a fiduciary capacity, to reacquire trust property by substituting other property of an equivalent value. The swap provision makes the new trust a grantor trust. The assets of the original trust are transferred to the new trust. (Technically, the original trust combines, or merges, with the grantor trust such that only the grantor trust survives under a non-judicial combination of trusts under Texas law.) Norman can now swap high-basis assets for the ranch. Since transactions between a grantor and a grantor trust are ignored for income tax purposes, no income tax would be due on the sale or on the interest payments received by the trust.

     

Planning Idea: Use Court Reformation to Move Assets Into Estate

  • Court reformation is especially useful (i) when the first spouse has died and left assets to a bypass trust and the surviving spouse has enough exemption available to cover the survivor’s own assets plus the assets in the bypass trust, or (ii) when a trust doesn’t
    allow for swapping assets.
  • Assume the value of the wife’s outright assets together with the value of the assets in the bypass trust total less than the wife’s estate tax exemption. We can remove the assets from the bypass trust and put them in the wife’s name, and the wife will still not  owe any estate tax. The assets that were in the bypass trust would now get a step-up at the wife’s death. How do we make this happen?
  • Ask the court to grant the surviving spouse (the beneficiary of the bypass trust) a general power of appointment (“GPOA”) over the appreciated assets, causing the assets to be included in the surviving spouse’s estate.
  • Or, alternatively, the court could order the trustee to distribute the assets outright to the wife due to changed circumstances.

Planning Idea: Make Distribution to Move Assets Into Estate

  • How can we do this without going to court?
  • Assume a surviving wife is the beneficiary of a bypass trust that owns low-basis assets, and her estate is below the exemption level. Is there a way to transfer an amount of low-basis assets to the wife to soak up her unused exemption so that the assets will  Get a step-up at her death?
  • If the trustee of the bypass trust can justify a distribution to the wife for her health, education, maintenance, and support (“HEMS”) needs (or however the trust’s applicable distribution standard reads), the distributed assets would go back into her estate and
    qualify for a step-up.

     

IRA Planning

  • Consider converting your traditional IRAs to Roth IRAs.
    ― If you expect income tax rates to rise, convert to Roth now and pay the tax at today’s lower rate.
    ― Remember that the amount converted will be taxed as ordinary income and, therefore, could push you into a higher income tax bracket.
  • Consider withdrawing assets from a traditional IRA, paying the income tax, and gifting the net to an IDGT or SLAT to remove the IRA from the estate. You are paying the income tax early but avoiding a 40% estate tax on the IRA at death.
  • Consider leaving the IRA to charity, avoiding both estate tax and income tax on the IRA. ― Note: If you do this, don’t engage in either of the above two ideas, as you would be paying income tax unnecessarily on the portion of your IRA ultimately going to charity.

     

What Will be Popular in 2022?

Planning Going Forward in 2022

  • Lifetime exemption increases from $11,700,000 to $12,060,000.
  • Annual exclusion level increases from $15,000 to $16,000 per donee.
  • Will become more popular:
    ― Private Placement Life Insurance (“PPLI”)/Private Placement Variable Annuities (“PPVA”).
    ― Mixing bowl partnerships for basis shifting.
    ― Loans to trusts to enable the trust to invest in deals from inception.
    ― “Upstream” gifts to elderly loved-ones to get a basis step-up when the loved-one dies and leaves the assets back to you. To avoid a one-year rule under Section 1014(e) if the assets come back to you within a year, the assets should go to a trust for your benefit with a third-party trustee.

Estate Tax Update for Whitley Penn Read More »

“Last Chance” Tax Planning:The Golden Age of Estate PlanningWon’t Last Forever

MARVIN E. BLUM is an attorney and CPA based in Fort Worth. He is Board Certified in Estate Planning and Probate Law and is a Fellow of the American College of Trust and Estate Counsel.
Mr. Blum founded The Blum Firm, P.C. over 40 years ago. The firm specializes in estate and tax planning and the related specialties of asset protection, business planning, business succession planning, charitable planning, family legacy planning, fiduciary litigation, and guardianship. The Blum Firm has grown to be one of the premier estate planning firms in the nation, known for creating customized, cutting-edge estate plans for high-net-worth individuals.
Mr. Blum serves on the Editorial Advisory Committee for Trusts & Estates magazine. He is Treasurer for the Texas Cultural Trust.
Mr. Blum earned his BBA (Highest Honors) in Accounting from The University of Texas and received his law degree (High Honors) from The University of Texas School of Law.

The “Golden Age” of Estate Planning

› Conditions for estate planning have never been better:
• Doubled estate tax exemption
• Valuation discounts
• Low interest rates
• Wide array of “squeeze & freeze” planning tools
• Use of grantor trusts to supercharge estate tax planning:
– Grantor avoids recognizing income on sales between grantor and grantor trusts.
– Grantor’s personal payment of income tax on the trust’s taxable income isn’t a gift.
› The “Golden Age” came under risk on January 5, 2021 when Georgia’s two Senate run-offs shifted the Senate to Democratic control.
› Congress has not closed an estate planning loophole in over 30 years.
› We’re in the lowest tax regime since 1930.

Key Legislative Developments

› December 27, 2020: Consolidated Appropriations Act (longest bill ever passed by Congress) became law, at a cost of $2.3 trillion and no revenue in it to pay for it.
› March 11, 2021: American Rescue Plan became law—$1.9 trillion of spending, with no revenue in it to pay for it.
› $1.2T Bipartisan Infrastructure Bill: This summer, President Biden reached a $1.2 trillion infrastructure compromise with a bipartisan group of senators. The bill provides for spending on infrastructure (roads and bridges, etc.) but does not include much in tax
increases to raise the funds for the spending. The Senate passed this “Bipartisan Infrastructure Bill” in August, and the bill is now sitting in the House waiting for a vote.
› $3.5T Build Back Better Act: Legislation intended to implement President Biden’s social and educational reforms is commonly referred to as the “Build Back Better Act.” It includes provisions for funding, establishing programs, and otherwise modifying provisions relating to a variety of areas, including education, labor, childcare, healthcare, taxes, immigration, and the environment.

How to Pay for It?

› Tax the rich?
› Billionaire’s tax?
› $3.5 Trillion Reconciliation Bill: The House Ways and Means Committee has the tax code in its jurisdiction and has proposed tax increases to pay for the new spending, commonly called the “$3.5 Trillion Reconciliation Bill.” As a budget reconciliation bill, it can pass the Senate with only 51 votes (so 50 Senators and 1 Vice President), instead of requiring 60 votes.

Pending Tax Law—What’s the Latest?

What’s in the Reconciliation Bill?

1) Accelerates the sunset of the lifetime gift and estate tax exemption back to $5 million adjusted for inflation to now be effective December 31, 2021, rather than December 31, 2025. For 2022, estimated to be $6,020,000.
2) Valuation discounts no longer available when transferring entities holding “non-business assets” (passive assets not used in the active conduct of a trade or business), effective for transfers made after the date of enactment.
3) Grantor trust assets now includible in grantor’s estate, applicable to trusts created on or after the date of enactment AND to any portion of a trust created before the date of enactment which is attributable to a contribution made on or after the date of enactment.
4) Sales to grantor trusts no longer ignored for income tax purposes and therefore subject to tax on the gain, whether it’s a sale to an old grantor trust or a new grantor trust, effective the date of enactment.
5) Distributions from a grantor trust now subject to gift tax if made to someone other than grantor or grantor’s spouse.
6) Grantor trust status ending is now treated as a gift of the entire trust on that date, such as when a done by toggling off a defect.
7) Increases top income tax rate from 37% to 39.6%, effective for 2022 tax year, and lowers threshold for highest bracket to $450,000 for joint filers, $400,000 for single, $425,000 for head of household, $12,500 for trust or estate. (Current threshold for top bracket is $628,300 for joint filers and $523,600 for single.)
8) Increases highest long term capital gains tax rate from 20% to 25%, for gains realized after Sept 13, 2021. Also aligns income threshold to highest new ordinary income tax bracket ($450,000 for joint filers, $400,000 for single, $425,000 for head of household, $12,500 for trust or estate). For 2021, current income bracket applies.
9) Expands reach of the 3.8% Net Investment Income tax to include income from active trade or business if taxable income is over $500,000 for joint filing, $400,000 for single, and for all trusts and estates, effective for 2022 tax year.
10) New 3% surtax on modified adjusted gross income above $5 million for joint filers AND for single, above $100,000 for trusts and estates (excluding charitable trusts), effective for 2022 tax year.
11) Caps maximum allowable Section 199A 20% pass-through deduction at $500,000 for joint filers, $400,000 for single, $10,000 for trusts and estates, effective for 2022 tax year.
12) Modifies carried interest rules to increase holding period from 3 years to 5 years to be taxed as capital gain, effective for 2022 tax year.
EXCEPTION: If adjusted gross income is less than $400,000, still get 3-year period.
EXCEPTION: Real property trades or businesses still get 3-year period.
13) New graduated corporate tax rate structure, effective for 2022 tax year, of 18% tax rate on first $400,000 of income, 21% on income $400,001–$5 million, 26.5% on income above $5 million.
EXCEPTION: For corporations with income over $10 million, the amount of tax determined above is increased by the lesser of (i) 3% of such excess, or (ii) $287,000.
EXCEPTION: Personal services corporations taxed at flat 26.5% rate.
14) Limits exclusion rate for Qualified Small Business Stock gains for sales on or after September 13, 2021. For taxpayers with AGI over $400,000 and all trusts and estates, the 75% and 100% exclusion rates no longer available—only the 50% exclusion rate is
available.
15) Restricts Roth conversions beginning in 2032 if income is over $450,000 for joint filers, $400,000 for single, $425,000 for head of household.
16) Caps IRA size if income is over $450,000 for joint filers, $400,000 for single, $425,000 for head of household. Cannot make additional contributions to Roth or traditional IRA if the combined value of IRAs and defined contribution plans exceeds $10 million, effective for 2022 tax year.
17) Increases minimum distribution from large IRA if income is over $450,000 for joint filers, $400,000 for single, $425,000 for head of household. If combined value of IRAs, Roth IRAs, and defined contribution plans exceeds $10 million, new minimum distribution rules apply, effective for 2022 tax year.
• Combined value over $10 million: Required minimum distribution of 50% of overage.
• Combined value over $20 million: Required minimum distribution of lesser of (i) 100% of overage or (ii) total balance held in Roth IRA and Roth defined contribution plans.
18) Prohibits IRAs from owning interests in Private Placement Investments, effective for 2022 tax year. Subject to a 2-year transition period for IRAs already holding such investments.

What’s not included?

› No repeal of basis step-up at death.
› No forced recognition of gain at death.
› No limits on annual exclusion gifts.
› No repeal of SALT cap ($10,000 cap on deduction of state and local taxes).
› No limits on 1031 like-kind exchanges of real estate (limiting amount of gain deferral per year).

Planning to Do Between Now and

“the Date of Enactment”

Extend the Term of Promissory Notes
› After the date of enactment, in-kind note payments will be taxable transactions (even on old “pre-enactment” notes).
› If possible, do in-kind note repayments before the date of enactment. Or, convert the notes to 25-year notes at the Long-Term AFR (1.86% for November). This gives you more time to either repay in cash or postpone the income tax from repaying in-kind.
› For new sales where you carry a note, use a 25-year term for the note instead of the typical 9-year mid-term duration.

Examine Irrevocable Life Insurance Trusts

› If the Irrevocable Life Insurance Trust (“ILIT”) is a grantor trust, contributions made after the date of enactment will cause a percentage of the trust to be includable in the taxable estate.
› Contribute substantial assets now to cover insurance premiums for coming years.
› Or, toggle off the defect so it’s no longer a grantor trust so that additional gifts can be made to the trust in the future.
› If it’s not possible to toggle off the grantor trust status, create a new non-grantor ILIT with substantially the same terms and merge the old ILIT into the new ILIT.

Create and/or Fund a Children’s Trust Now

› Create an Intentionally Defective Grantor Trust (“IDGT”) to benefit children or grandchildren. 
Assets held in the trust will be outside the taxable estate.
› Creating as a grantor trust allows you to personally pay the income tax on the trust income rather than the trust paying its own income tax (and depleting trust assets to do so).
› If you wait until after the date of enactment, the assets will be includable in the taxable estate.
To avoid inclusion, will have to create as a non-grantor trust, meaning that the trust would have to pay the income tax on the trust income.

“Squeeze & Freeze” While You Still Can

› Some are hesitant to engage in estate planning for fear of losing control of the assets, losing access to the assets, or losing the flexibility to change their mind. There are some “freeze” planning techniques which allow the client to retain all these things. (You CAN have your cake and eat it too.)
› The Squeeze:
• First, the client transfers the assets to a Family Limited Partnership (“FLP”) to “squeeze” down the value of assets by the FLP units qualifying for valuation discounts.
• Currently, valuation discounts for lack of marketability and lack of control are routinely applicable to limited partnership interests as they are less marketable than assets held outright or assets traded on an exchange, such as stock of public companies or bonds.
• After the date of enactment, these valuation discounts will no longer be available when transferring entities holding passive assets not used in the active conduct of a trade or business.
› Next, “freeze” the value and lock in the discount by transferring the FLP units to a trust that is outside of the estate through gifts and/or sales.
› Make a gift to the trust equal to the balance of your lifetime exemption and then sell the rest to the trust in exchange for a promissory note.
• Intentionally Defective Grantor Trusts (“IDGTs”) for the benefit of children:
– Gifts to IDGTs before the Date of Enactment
– Sales to IDGTs before the Date of Enactment
• Spousal Lifetime Access Trusts (“SLATs”):
– Gifts to SLATs before the Date of Enactment
– Sales to SLATs before the Date of Enactment
• 678 Trusts (also called Beneficiary Defective Trusts or “BDTs”):
– Sales to a 678 Trust

Utilize Spousal Lifetime Access Trusts

› The most popular way for married couples to use each spouse’s gift/estate tax exemption is for each spouse to create a trust for the benefit of the other because doing so preserves the resources for the spouses’ benefit. This type of trust is often referred to as a Spousal Lifetime Access Trust (“SLAT”).
› Each spouse’s gift would use part or all of their lifetime exemption amount, depending on the amount of assets transferred. Assets held in the SLAT would not be included in either spouse’s estate at death. Think of it as a “Lifetime Bypass Trust” for the benefit of a spouse.
› Locks in the higher lifetime gift and estate tax exemption before it sunsets in half, yet the spouses continue to benefit from the assets removed from their estates.
› The two SLATs must be substantially different to avoid the Reciprocal Trust Doctrine.
› If you wait until after the date of enactment, the assets will be includable in the taxable estate. To avoid inclusion, will have to create as a non-grantor trust (called a “SLANT”), which is hard to do.
16
› Example:
• A husband and wife enter into a marital property agreement in which they agree to convert a portion of their community property into two separate property halves.
• The husband creates a trust for the benefit of the wife and funds it with $11 million of his separate property. The wife has access to her SLAT for her needs during her lifetime.
After her death, the remaining assets are split into separate trusts for the children.
• At a later date (the more time, the better), the wife creates a separate trust for the benefit of the husband and funds it with $11 million of her separate property. The husband has access to his SLAT for his needs during his lifetime. After his death, the remaining assets are split into separate trusts for the children.
• While both the husband and wife are alive, the married couple retains access to the full $22 million. However, after the first death, the survivor only has access to $11 million. To replace the lost assets, each SLAT could buy an $11 million life insurance policy on the life of the other spouse.
• If the husband dies first, at his death, the wife continues to benefit from her SLAT, plus her SLAT collects $11 million on the husband’s life, so her access to the full $22 million isn’t diminished when the husband dies. If the wife dies first, at her death, the husband
continues to benefit from his SLAT, plus his SLAT collects $11 million on the wife’s life, so his access to the full $22 million isn’t diminished when the wife dies.

Utilize a 678 Trust

› By utilizing a 678 Trust in the “freeze” stage, the client does not have to give up control of the assets or give up access to them.
› Why choose a 678 Trust?
• The clients can remain in control.
• The clients can be beneficiaries of the 678 Trust and can continue to have access to the assets for their needs.
• The assets in the 678 Trust are not taxed in the clients’ estates.
• The clients can have a special power of appointment to direct where the assets pass upon their deaths.
• The assets in the 678 Trust are protected from creditors.
› A 678 Trust is established by a third party (such as the client’s parents, sibling, or close friend) with a gift of $5,000.
› The client is the primary beneficiary of the 678 Trust and can receive distributions for health, education, maintenance, and support.
› With careful drafting, the client may also be named as trustee of the 678 Trust.
› The client-beneficiary is given a withdrawal right over the initial $5,000 contribution.
› The trust agreement provides that a Special Trustee has the power to terminate the trust in favor of the client-beneficiary, even after the client-beneficiary’s withdrawal right over the $5,000 gift lapses.
› The 678 Trust technique works because of a “disconnect” between the income tax code and the estate tax code.
• For estate and gift tax purposes, when the client-beneficiary allows the withdrawal right to lapse, the client-beneficiary is not viewed as the grantor of the trust because of the 5 and 5 exception in the estate tax code, and so the trust assets are not includable in the
client-beneficiary’s estate.
• For income tax purposes, when the client-beneficiary is given the withdrawal right and when the withdrawal right lapses, the client-beneficiary is viewed as the grantor of the trust, making the client-beneficiary the owner of the trust for income tax purposes. (Note
that although the withdrawal right is limited to $5,000, there is no 5 and 5 exception in the income tax code.)
› The clients “burn down” the assets that remain in their taxable estate to pay for living expenses and to pay the income taxes generated by the 678 Trust.
› After the notes are paid off, the trustee of the 678 Trust will make distributions to the clients to cover their living expenses and income taxes.

Fast Track “Squeeze & Freeze”

› Fast track funding the FLP by using a Nominee Agreement:
• Instead of taking the time to transfer assets, transfer the economic equivalent of ownership without transferring title.
• Especially beneficial if assets are difficult to retitle or transfer.
› Fast track the 30-day seasoning of FLP assets:
• If can’t wait at least 30 days between funding the FLP and transferring the FLP interest to a trust, include someone else as a partner in the FLP with you, represented by separate counsel, so it’s a bona fide partnership.

Planning to Do Between Now and

December 31

Take Advantage of Doubled Exemption (“Use It or Lose It” Planning)
› To lock in the benefit of the doubled exemption before its proposed December 31, 2021 sunset date, a couple has to transfer $23.4 million out of their estate.
› Of course, if the planning includes the use of grantor trusts or valuation discounts for FLP interests, it needs to be completed before the Date of Enactment.
› If a couple decides to only give $11.7 million instead of $23.4 million, make the gift entirely from one spouse and don’t gift-split. Compare the outcomes:
• Gifts first eat into the old or “original” exemption before eating into the “extra” exemption. If each spouse gives a gift of half the $11.7 million, after sunset they will have each used all of their “original” exemption and none of the “extra” exemption, so their
remaining exemption is zero.
• Instead, if the husband gives the entire $11.7 million, the wife will still have her “original” $5 million exemption (adjusted for inflation) after her “extra” exemption sunsets.

IRA Planning

› Convert IRAs to Roth IRAs.
• Before income tax rates rise. The top income tax rate increases from 37% to 39.6%.
• Before the bracket for the highest rate lowers.
– Current threshold for top bracket is $628,300 for joint filers and $523,600 for single.
– New proposed top bracket is $450,000 for joint filers and $400,000 for single.
• Remember that the amount converted will be taxed as ordinary income and, therefore, could push you into a higher income tax bracket.
• Proposed tax changes also include new 3% surtax on modified adjusted gross income above $5 million.
› Withdraw assets from a traditional IRA, pay the income tax, and make a gift of the net to a IDGT or SLAT to remove the IRA from the estate. You are paying the income tax early but avoiding a 40% estate tax on the IRA at death.

What Will be Popular in 2022?

Planning Going Forward in 2022

› Private Placement Life Insurance (“PPLI”)/Private Placement Variable Annuity (“PPVA”).
› Mixing bowl partnerships for basis shifting.
› “Freeze” sales to old grantor trusts (note that the sale will be taxable, but the appreciation escapes estate tax).
› Loans to trusts to enable the trust to invest in deals from inception.
› Planning with non-grantor trusts including non-grantor ILITs and non-grantor SLATs.
› “Squeeze” planning with trade or business assets or with undivided interests in real estate not held in an entity.
› “Upstream” gifts to elderly loved-ones to get a basis step-up when the loved-one dies and leaves the assets back to you. To avoid a one-year rule if the assets come back to you within a year, the assets should go to a trust for your benefit with a third-party trustee.

“Last Chance” Tax Planning:The Golden Age of Estate PlanningWon’t Last Forever Read More »

Financial Planning & Wealth Management

Estate Planning Checkup: 10 Questions to Ask

1. Do you own anything in your name (other than retirement accounts)?

If assets are titled in your name, it generally reveals two things, most likely, the assets are exposed to the claims of creditors. And, if the estate is above the exemption, the assets will likely be exposed to a 40% estate tax.
Step 1 – Examine each asset to determine if it is “safe” or “risky.” Risky assets (such as real estate or oil and gas) can give rise to claims. Put an entity wrapper such as a limited partnership (LP) or limited liability company (LLC) around each risky asset, so creditors can only reach the one risky asset and can’t reach other assets outside the entity wrapper.
Step 2 – Protect all assets from being exposed to personal creditors (such as a tort creditor) by transferring safe assets and the risky asset entities to a Family Limited Partnership (FLP). 
Step 3 – Transfer the FLP interests to an irrevocable trust for another layer of asset protection and to remove assets from the taxable estate.

2. After you’re gone, will your retirement assets be protected?

Naming children as outright beneficiaries of a retirement account may not be ensuring the best protection of the benefits.
Naming a trust as beneficiary instead places the funds out of reach of creditors of the trust’s beneficiaries and makes the trust assets unreachable in the event of divorce. Also, any retirement funds remaining in the trust when the beneficiary dies may not be subject to estate taxes.
Normally when a trust is named as the beneficiary of an IRA, the payout is subject to a 5-year rule which requires the balance of the IRA be distributed (and taxed) to the trust beneficiaries within 5 years of the death of the IRA owner.
A special trust called an Accumulation Trust could be named as beneficiary to gain the asset protection qualities inherent to trusts and also “stretch out” the payout period. With an Accumulation Trust, IRA amounts must be paid out from the IRA to the Accumulation Trust within 10 years. The funds can then be held in the Accumulation Trust and dribbled out to the beneficiary as needed.

3. If you died right now, would your children’s inheritance potentially become divisible upon a divorce?

Any asset owned outright by either spouse is “marital property.” All marital property is presumed to be community property. The burden of proof is on the party claiming an asset is separate property. Income from separate property is community property.
On the other hand, none of the assets that are owned by a properly structured irrevocable trust is marital property. Being ”non-marital property” is even more protected than being “separate property.” Non-marital property does not generate community property income and is not divisible upon divorce.
I recommend leaving the inheritance to dynasty trusts for the benefit of children and future generations.

4. Have you taken advantage of the doubled estate tax exemption?

We have a limited window of opportunity to take advantage of the doubled estate tax exemption before it sunsets in half. Proposed legislation moves up the sunset date from December 31, 2025, to December 31, 2021 (2 months from now!). To lock in the benefit of the entire doubled exemption, a couple has to transfer $23.4 million out of their estate. 
The most popular way for married couples to use each spouse’s gift/estate tax exemption is for each spouse to create a trust for the benefit of the other because doing so preserves the resources for the spouses’ benefit.
This type of trust is often referred to as a Spousal Lifetime Access Trust (SLAT).
The two SLATs must be substantially different to avoid violating the Reciprocal Trust rule.

5. Can you have your cake and eat it too?

How can you get assets out of your estate but still have access and control?
If your goal is to transfer appreciating assets out of your estate while continuing to retain access to the trust assets and control of trust investments, consider a 678 Trust. Essentially, a 678 Trust allows a beneficiary to be treated as the owner of the trust for income tax purposes, provided it is properly drafted.
With a 678 Trust, you can access to the trust’s funds for health, education, maintenance, and support purposes and can serve as trustee of the trust. Moreover, upon your death, the trust assets will not be subject to estate taxes. Assets owned by the trust are also not
subject to the claims of your creditors.

6. Do you have any low basis assets?

If you have appreciated assets, you may need some “upstream” planning.
If you have low-basis assets and a parent has unneeded exemption, you could gift the assets to the parent outright or, even better, to a trust for the parent and give the parent a General Power of Appointment over the assets. (Note that the gift eats into your exemption.)

7. Do you love your grandkids equally?

With a traditional per stirpes inheritance, grandchildren with more siblings will receive less than grandchildren with fewer siblings.
Assume Generation 1 has a son with 2 children, a daughter with 4 children, and a $12 million estate. After Generation 1 dies, the son and daughter each receive $6 million. However, after the son and daughter (Generation 2) dies, the son’s children each receive $3 million while the daughter’s children each receive $1.5 million.
To lessen this blow on the cousins, consider taking out a life insurance policy that goes to all the grandchildren per capita. The rest of the estate plan remains intact. This creates new assets to use for gifting to Generation 3 without disrupting Generation 2’s inheritance.

8. Do you have a “Red File”?

People in seemingly excellent health can go quickly and unexpectedly. Imagine you died suddenly or become incapacitated. Do those closest to you have all the information they will need?
Create a “Red File” for what estate planning documents don’t cover.

  • Section 1: Centralized File of Personal Information: Passwords, contacts, listing of assets you own, location of assets and documents.
  • Section 2: Business Continuity Plan: Your will says who will own the business, but not who will manage it. Give your family management succession guidance to facilitate the transition for the day WHEN (not IF) you are gone.
  • Section 3: Plan for Incapacity: Who will provide care, will they be compensated, where will you live, favorite TV shows, movies, colors, foods (don’t make your caregiver guess).
  • Section 4: Legacy Plan: A Red File is the ideal place to document the “heart” side of your estate plan. Provide information on ancestors, obstacles they overcame, meaningful memories, lessons learned, values, and goals for the family.
    Download our Red File Checklist here: https://theblumfirm.com/2021/Red-File-Checklist.pdf 

9. Do you have a business succession plan in place?

Why is business succession planning such a hot topic? As baby boomers age, many of us seem to think we’re going to live forever and have done no business succession planning.
Before you can start developing a plan, the founder needs to decide if the business will be passed down in the family or sold. There are 3 primary choices in the toolbox when thinking about succession planning:

  • Transfer the business to a family member/family members.
  • Sell the business to people within the business.
  • Sell the business to an outside party.

To start the process, form a planning team (CPA, attorney, financial advisors) and bring all the key stakeholders to the table to develop a plan and implement the succession process.

10. Are you worried an inheritance will ruin your children?

We have all witnessed the disaster when an inheritance passes into unprepared hands. Families who succeed engage in best practices like family meetings and family education, all aimed at preparing heirs to be responsible inheritors. A FAST (Family Advancement
Sustainability Trust) equips your family to remain healthy and connected through the generations.
In a nutshell, the FAST does two things:

  • It is funded with assets that will be used to pay for family enrichment and family education activities such as family retreats, family travel, and preserving the family’s heritage, as well as maintaining legacy real estate assets the family wants to pass down to future generations; and
  • The FAST appoints trustees/committees who are paid to do the legwork in planning these activities and making sure they happen.
    The end result is a gift to your family of a meaningful and lasting legacy.
    A FAST is an add-on to a traditional estate plan, often funded with life insurance.

Bonus: Pending Tax Laws—What’s the Latest?

  • Accelerates the sunset of the lifetime gift and estate tax exemption back to $5 million adjusted for inflation to now be effective December 31, 2021, rather than December 31, 2025. For 2022, estimated to be $6,020,000.
  • Valuation discounts no longer available when transferring entities holding “nonbusiness assets” (passive assets not used in the active conduct of a trade or business), effective for transfers made after the date of enactment.
  • Grantor trust assets now includible in grantor’s estate, applicable to trusts created on or after the date of enactment AND to any portion of a trust created before the date of enactment which is attributable to a contribution made on or after the date of enactment.
  • Sales to grantor trusts no longer ignored for income tax purposes and therefore subject to tax on the gain, whether it’s a sale to an old grantor trust or a new grantor trust, effective the date of enactment.
  • Increases top income tax rate from 37% to 39.6%, effective for 2022 tax year, and lowers threshold for highest bracket to $450,000 for joint filers, $400,000 for single, $425,000 for head of household, $12,500 for trust or estate. (Current threshold for top bracket is $628,300 for joint filers and $523,600 for single.)
  • Increases highest long term capital gains tax rate from 20% to 25%, for gains realized after Sept 13, 2021. Also aligns income threshold to highest new ordinary income tax bracket ($450,000 for joint filers, $400,000 for single, $425,000 for head of household, $12,500 for trust or estate). For 2021, current income bracket applies.
  • Expands reach of the 3.8% Net Investment Income tax to include income from active trade or business if taxable income is over $500,000 for joint filing, $400,000 for single, and for all trusts and estates, effective for 2022 tax year.
  • New 3% surtax on modified adjusted gross income above $5 million for joint filers AND for single, above $100,000 for trusts and estates (excluding charitable trusts), effective for 2022 tax year.
  • Caps maximum allowable Section 199A 20% pass-through deduction at $500,000 for joint filers, $400,000 for single, $10,000 for trusts and estates, effective for 2022 tax year.
  • Modifies carried interest rules to increase holding period from 3 years to 5 years to be taxed as capital gain, effective for 2022 tax year.
    EXCEPTION: If adjusted gross income is less than $400,000, still get 3-year period.
    EXCEPTION: Real property trades or businesses still get 3-year period.
  • New graduated corporate tax rate structure, effective for 2022 tax year, of 18% tax rate on first $400,000 of income, 21% on income $400,001–$5 million, 26.5% on income above $5 million.
    EXCEPTION: For corporations with income over $10 million, the amount of tax determined above is increased by the lesser of (i) 3% of such excess, or (ii) $287,000.
    EXCEPTION: Personal services corporations taxed at flat 26.5% rate.
  • Limits exclusion rate for Qualified Small Business Stock gains for sales on or after September 13, 2021. For taxpayers with AGI over $400,000 and all trusts and estates, the 75% and 100% exclusion rates no longer available—only the 50% exclusion rate is
    available.
  • Restricts Roth conversions beginning in 2032 if income is over $450,000 for joint filers, $400,000 for single, $425,000 for head of household.
  • Caps IRA size if income is over $450,000 for joint filers, $400,000 for single, $425,000 for head of household. Cannot make additional contributions to Roth or traditional IRA if the combined value of IRAs and defined contribution plans exceeds $10 million, effective for 2022 tax year.
  • Increases minimum distribution from large IRA if income is over $450,000 for joint filers, $400,000 for single, $425,000 for head of household. If combined value of IRAs, Roth IRAs, and defined contribution plans exceeds $10 million, new minimum distribution rules apply, effective for 2022 tax year.
    • Combined value over $10 million: Required minimum distribution of 50% of overage.
    • Combined value over $20 million: Required minimum distribution of lesser of (i) 100% of overage or (ii) total balance held in Roth IRA and Roth defined contribution plans.
  • Prohibits IRAs from owning interests in Private Placement Investments, effective for 2022 tax year. Subject to a 2-year transition period for IRAs already holding such investments.

Financial Planning & Wealth Management Read More »

Pending Tax Laws—What’s the latest?

The “Big 4”

1) Accelerates the sunset of the lifetime gift and estate tax exemption back to $5 million adjusted for inflation to now be effective December 31, 2021, rather than December 31, 2025. For 2022, estimated to be $6,020,000.
2) Valuation discounts no longer available when transferring entities holding “non-business assets” (passive assets not used in the active conduct of a trade or business), effective for transfers made after the date of enactment.
3) Grantor trust assets now includible in grantor’s estate, applicable to trusts created on or after the date of enactment AND to any portion of a trust created before the date of enactment which is attributable to a contribution made on or after the date of
enactment.
4) Sales to grantor trusts no longer ignored for income tax purposes and therefore subject to tax on the gain, whether it’s a sale to an old grantor trust or a new grantor trust, effective the date of enactment.

What do we do between now and the date of enactment?

› Fund grantor trusts now. Create grantor trusts if need to.
› If you have an Irrevocable Life Insurance Trust (“ILIT”), contribute substantial assets now to cover insurance premiums for coming years.
• Contributions made after the date of enactment will cause a percentage of the trust to be includable in your estate.
› Create a trust to benefit your children or grandchildren as an Intentionally Defective Grantor Trust (“IDGT”). Assets held in the IDGT would be outside your taxable estate.
• Creating as a grantor trust allows you to personally pay the income tax on the trust income rather than the trust paying its own income tax (and depleting trust assets to do so).
• If you wait until after the date of enactment, the assets will be includable in the taxable estate. To avoid inclusion, will have to create as a non-grantor trust, meaning that the trust would have to pay the income tax on the trust income.
› Each spouse create a Spousal Lifetime Access Trust (“SLAT”) to benefit the other. Assets held in the SLATs would not be included in either spouse’s estate at death. Think of a SLAT as a “Lifetime Bypass Trust” for the benefit of a spouse.
• Locks in the higher lifetime gift and estate tax exemption before it sunsets in half, yet the spouses continue to benefit from the assets removed from their estates.
• The two SLATs must be substantially different to avoid the Reciprocal Trust Doctrine.
• If you wait until after the date of enactment, the assets will be includable in the taxable estate. To avoid inclusion, will have to create as a non-grantor trust, which is hard to do.
› Put assets into a Family Limited Partnership (“FLP”) and then transfer the FLP interests to a IDGT or SLAT to take advantage of valuation discounts and the higher exemption.
• To transfer the FLP interests, make a gift to the trust equal to the balance of your lifetime exemption and then sell the rest to the trust in exchange for a promissory note.
• Currently, valuation discounts for lack of marketability and lack of control are routinely applicable to limited partnership interests as they are less marketable than assets held outright or assets traded on an exchange, such as stock of public companies or bonds.
• After the date of enactment, these valuation discounts will no longer be available when transferring entities holding passive assets not used in the active conduct of a trade or business such as FLPs.

Other Tax Proposals

› Increases top income tax rate from 37% to 39.6%, effective for 2022 tax year, and lowers threshold for highest bracket to $450,000 for joint filers, $400,000 for single, $425,000 for head of household, $12,500 for trust or estate. (Current threshold for top
bracket is $628,300 for joint filers and $523,600 for single.)
› Increases highest long term capital gains tax rate from 20% to 25%, for gains realized after Sept 13, 2021. Also aligns income threshold to highest new ordinary income tax bracket ($450,000 for joint filers, $400,000 for single, $425,000 for head of household, $12,500 for trust or estate). For 2021, current income bracket applies.
› Expands reach of the 3.8% Net Investment Income tax to include income from active trade or business if taxable income is over $500,000 for joint filing, $400,000 for single, and for all trusts and estates, effective for 2022 tax year.
› New 3% surtax on modified adjusted gross income above $5 million for joint filers AND for single, above $100,000 for trusts and estates (excluding charitable trusts), effective for 2022 tax year.
› Caps maximum allowable Section 199A 20% pass-through deduction at $500,000 for joint filers, $400,000 for single, $10,000 for trusts and estates, effective for 2022 tax year.
› Modifies carried interest rules to increase holding period from 3 years to 5 years to be taxed as capital gain, effective for 2022 tax year.
Exception: If adjusted gross income is less than $400,000, still get 3-year period.
Exception: Real property trades or businesses still get 3-year period.
› New graduated corporate tax rate structure, effective for 2022 tax year, of 18% tax rate on first $400,000 of income, 21% on income $400,001–$5 million, 26.5% on income above $5 million.
Exception: For corporations with income over $10 million, the amount of tax determined above is increased by the lesser of (i) 3% of such excess, or (ii) $287,000.
Exception: Personal services corporations taxed at flat 26.5% rate.
› Limits exclusion rate for Qualified Small Business Stock gains for sales on or after September 13, 2021. For taxpayers with AGI over $400,000 and all trusts and estates, the 75% and 100% exclusion rates no longer available—only the 50% exclusion rate is
available.
› Restricts Roth conversions beginning in 2032 if income is over $450,000 for joint filers, $400,000 for single, $425,000 for head of household.
› Caps IRA size if income is over $450,000 for joint filers, $400,000 for single, $425,000 for head of household. Cannot make additional contributions to Roth or traditional IRA if the combined value of IRAs and defined contribution plans exceeds $10 million, effective for 2022 tax year.
› Increases minimum distribution from large IRA if income is over $450,000 for joint filers, $400,000 for single, $425,000 for head of household. If combined value of IRAs, Roth IRAs, and defined contribution plans exceeds $10 million, new minimum distribution rules apply, effective for 2022 tax year.
• If combined value is over $10 million, annual minimum distribution required of 50% of amount over $10 million.
• If combined value is over $20 million, annual minimum distribution required of lesser of (i) amount over $20 million or (ii) the total balance held in Roth IRA and Roth defined contribution plans.
› Prohibits IRAs from owning interests in Private Placement Investments, effective for 2022 tax year. Subject to a 2-year transition period for IRAs already holding such investments.

Pending Tax Laws—What’s the latest? Read More »

Estate Planning Checkup: Top 10 Questions to Ask Your Client

MARVIN E. BLUM is an attorney and CPA based in Fort Worth, Texas. He is Board Certified in Estate Planning and Probate Law and is a Fellow of the American College of Trust and Estate Counsel.
Mr. Blum founded The Blum Firm, P.C. over 40 years ago. The firm specializes in estate and tax planning and the related specialties of asset protection, business planning, business succession planning, charitable planning, family legacy planning, fiduciary
litigation, and guardianship. The Blum Firm has grown to be one of the premier estate planning firms in the nation, known for creating customized, cutting-edge estate plans for high-net-worth individuals.
Mr. Blum serves on the Editorial Advisory Committee for Trusts & Estates magazine. He is Treasurer for the Texas Cultural Trust.
Mr. Blum earned his BBA (Highest Honors) in Accounting from The University of Texas and received his law degree (High Honors) from The University of Texas School of Law.

Estate Planning Checkup: Top 10 Questions to Ask Your Client

It’s a whole new world of estate planning—a current high estate tax exemption that soon sunsets in half, the prospect of higher capital gains rates and/or the loss of stepped-up basis, larger inheritances, complicated family dynamics, rising rates of divorce and litigation, electronic data. The list goes on and on. Your daddy’s way of doing estate planning doesn’t work anymore. Here’s a list of questions you should ask every client. The answers almost always lead to a need for a serious estate planning update.

1. Do you own anything in your name (other than retirement accounts)?
2. After you’re gone, will your retirement assets be protected?
3. If you died right now, would your children’s inheritance potentially become divisible upon a divorce?
4. Have you taken advantage of the doubled estate tax exemption? (“Use it or lose it.”)
5. Can you have your cake and eat it too (i.e., how can you get assets out of your estate but still have access and control)?
6. Do you have any low basis assets? (If so, you may need some “upstream” planning.)
7. Do you love your grandkids equally? (Consider a life insurance policy that goes to them per capita instead of per stirpes.)
8. Do you have a “Red File”?
9. Do you have a business succession plan in place?
10. Are you worried an inheritance will ruin your children? (Consider a FAST solution to legacy planning—the Family Advancement Sustainability Trust.)

1 Do you own anything in your name (other than retirement accounts)?

› If assets are titled in your name, it generally reveals two things:
• Most likely, the assets are exposed to claims of creditors.
• If the estate is above the exemption, the assets will likely be exposed to a 40% estate tax.
› Step 1 – Examine each asset to determine if it is “safe” or “risky.”
• Risky assets (such as real estate or oil and gas) have “inside” liability exposure because they can give rise to claims.
• Address inside liability exposure by putting an entity wrapper (family limited partnership, limited liability company, or corporation) around each risky asset, so creditors can only reach the one risky asset and can’t reach other assets outside the entity wrapper.

› Step 2 – Address “outside” liability exposure, protecting safe and risky assets from being exposed to the owner’s personal creditors (such as a tort creditor).
• By transferring safe assets and all risky asset entities into a family limited partnership (“FLP”) or limited liability company (“LLC”), outside creditors can’t reach the assets and are limited to a charging order.
• Note that this protection doesn’t apply to stock in a corporation, as personal creditors of the stockholder can seize and vote the stock.
› Step 3 – Transfer the FLP or LLC units to an irrevocable trust for another layer of asset protection and to remove assets from the taxable estate.

2 After you’re gone, will your retirement assets be protected?

› What is the best way to pass down the retirement plans? Naming the children as outright beneficiaries of the plan may not be ensuring the best protection of the retirement account.
› Naming a trust as beneficiary instead:
• Places the retirement benefits out of the reach of creditors of the trust’s beneficiaries. Creditors’ claims or judgments from lawsuits will not place the retirement accounts in jeopardy of being seized.
• Makes the assets held in the trust unreachable in the event a beneficiary of the trust goes through a divorce.
• Any retirement funds remaining in the trust when the beneficiary of the trust dies may not be subject to estate taxes.

› Prior to the Setting Every Community Up for Retirement Enhancement Act of 2019 (“SECURE Act”), when a child or spouse was named as beneficiary of an IRA, the Required Minimum Distributions (“RMDs”) could be calculated based on the beneficiary’s life expectancy, up to 58 years, thus “stretching out” the payout period. The SECURE Act changed this for most children, imposing a 10-year payout rule, requiring that IRA amounts must be paid out within 10 years of the account owner’s death. (A surviving spouse may still withdraw retirement benefits based on his or her life expectancy.)
› In addition to a surviving spouse, the 10-year payout rule does not apply to the following individual beneficiaries:
• Disabled individuals.
• Chronically ill individuals.
• Individuals who are not more than 10 years younger than the IRA owner.
• A minor child of an IRA owner (the 10-year period for a minor beneficiary begins when the beneficiary reaches the age of majority).

 › If a trust is named as the beneficiary of an IRA, unless the trust meets certain requirements, the payout is subject to a 5-year rule. This rule requires the balance of the IRA to be distributed (and taxed) to the trust beneficiaries within 5 years of the death of the IRA owner.
› Special trusts called Conduit Trusts and Accumulation Trusts (sometimes called “see through” trusts) could be named as beneficiary to gain the asset protection qualities inherent to trusts as well as qualify for a 10-year payout instead of a 5-year payout.
• With a Conduit Trust, payouts received by the trust are immediately distributed to the beneficiary. Under the SECURE Act’s 10-year payout rule, IRA amounts will be paid to the Conduit Trust within 10 years and then distributed immediately to the beneficiary.
• With an Accumulation Trust, IRA amounts received can be held in the trust rather than paid out immediately. So, although IRA amounts must be paid out from the IRA to the Accumulation Trust within 10 years, they can be held in the Accumulation Trust and dribbled out to the beneficiary as needed. 
Accumulation Trusts will now be the “go to” technique to gain the asset protection qualities inherent to trusts.

3 If you died right now, would your children’s inheritance potentially become divisible upon a divorce?

› Any asset owned outright by either spouse is “marital property.”
• All marital property is presumed to be community property.
• The burden of proof is on the party claiming an asset is separate property.
• Income from separate property is community property.
› On the other hand, none of the assets that are owned by a properly structured irrevocable trust is marital property. Therefore it:
• Cannot be community property.
• Does not generate community property income.
• Is not divisible upon divorce.
› Strongly urge clients to leave the inheritance to dynasty trusts for the benefit of children and future generations.

› Any asset owned outright by either spouse is “marital property.”
• All marital property is presumed to be community property.
• The burden of proof is on the party claiming an asset is separate property.
• Income from separate property is community property.
› On the other hand, none of the assets that are owned by a properly structured irrevocable trust is marital property. Therefore it:
• Cannot be community property.
• Does not generate community property income.
• Is not divisible upon divorce.
› Strongly urge clients to leave the inheritance to dynasty trusts for the benefit of children and future generations.

4 Have you taken advantage of the doubled estate tax exemption? (“Use it or lose it.”)

› We have a window of opportunity with a doubled estate tax exemption of $11.7 million, but “USE IT OR LOSE IT” before it sunsets in half on December 31, 2025 (or sooner??).
› To lock in the benefit of the doubled exemption, a couple has to transfer $23.4 million out of their estate.
› The $11.7 million exemption is one-half “original” exemption and one-half “extra” exemption. Note that if a couple only transfers a total of $11.7 million instead of $23.4 million (50/50 from each spouse) in an effort to lock in the “extra”
exemption, they’ve actually only used the “original” exemption amount. After sunset, that couple would have zero exemption remaining. To lock in the “extra” exemption amount, each spouse has to transfer $11.7 million.
› Anti-Claw Back Regulation – The IRS issued final regulations providing that the benefit of the temporary increase in the gift and estate tax basic exclusion amount would not be clawed back on the taxpayer’s subsequent death after 2025.

Spousal Lifetime Access Trust
› The most popular way for married couples to use each spouse’s gift/estate tax exemption is for each spouse to create a trust for the benefit of the other because doing so preserves the resources for the spouses’ benefit. This type of trust is often referred to as a Spousal Lifetime Access Trust (“SLAT”).
› Each spouse’s gift would use part or all of their lifetime exemption amount,  depending on the amount of assets transferred. Assets held in the SLAT would not be included in either spouse’s estate at death.
› Think of it as a “Lifetime Bypass Trust” for the benefit of a spouse.

› Example:
• Husband and Wife enter into a marital property agreement in which they agree to convert a portion of their community property into two separate property halves.
• Husband creates a trust for the benefit of Wife and funds it with $11 million of his separate property.
• Wife has access to Wife’s SLAT for her needs during her lifetime. After her death, the remaining assets are split into separate trusts for the children.
• At a later date (the more time, the better), Wife creates a trust for the benefit of Husband and funds it with $11 million of her separate property. Husband has access to Husband’s SLAT for his needs during his lifetime. After his death, the remaining assets are split into separate trusts for the children.

• While Husband and Wife are both alive, the married couple retains access to the full $22 million. However, after the first death, the survivor only has access to $11 million. To replace the lost assets, each SLAT could buy an $11 million life insurance policy on the life of the other spouse.
• If Husband dies first, at Husband’s death, Wife continues to benefit from her SLAT, plus her SLAT collects $11 million on Husband’s life, so her access to the full $22 million isn’t diminished when Husband dies. If Wife dies first, at Wife’s death, Husband continues to benefit from his SLAT, plus his SLAT collects $11 million on Wife’s life, so his access to the full $22 million isn’t diminished when Wife dies.
› Note that the two SLATs must be substantially different or will violate the reciprocal trust doctrine. 

“Tax Fence” With SLAT Planning

If Only Willing to Gift $11.7 Instead of $23.4 Million

› If a couple decides to only give $11.7 million, make the gift entirely from one spouse and don’t gift-split.
› Compare the outcomes:
• If each spouse gives a gift of half the $11.7 million, after sunset they will have each used all of their “original” exemption and none of the “extra” exemption, so their remaining exemption is zero.
• Instead, if the husband gives the entire $11.7 million, after sunset, the wife will still have her “original” $5 million exemption (adjusted for inflation). 

“Use It or Lose It” for a Single Person
› If the single person can part with access, the easiest approach is a gift of $11 million to an Intentionally Defective Grantor Trust (or “DGT”) for the benefit of children or others.
• If the donor needs access, consider having the donor borrow from the DGT on arms’ length terms.
• The donor can retain a swap power to reacquire trust assets for assets of an equivalent value.
• An Independent Trustee could have ability to reimburse the donor for income taxes on trust income.
• Alternatively, to retain access, consider creating a Special Power of Appointment Trust (“SPAT”). The donor makes a gift to a trust for others but gives an independent party a special power of appointment to make distributions to a class of donees that includes the donor. For example, the class of donees could be “the descendants of the donor’s mother.”

5 Can you have your cake and eat it too (i.e., how can you get assets out of your estate but still have access and control)?

Dispel Planning Myths
› Some are hesitant to engage in estate planning for fear of losing control of the assets, losing access to the assets, or losing the flexibility to change their mind. There are some “freeze” planning techniques which allow the client to retain all these things.
• First, the client transfers the assets to an FLP to “squeeze” down the value of assets by the FLP units qualifying for valuation discounts.
• Next, “freeze” the value and lock in the discount by transferring the FLP units to a trust that is outside of the estate, e.g., sales to a Beneficiary Defective Trust (“678 Trust”), gifts/sales to a SLAT, or gifts/sales to a DGT for the benefit of the children.
• Control – Client is president of general partner of FLP; also, can serve as trustee of 678 Trust.
• Access – Notes receivable from sales; client is also beneficiary of 678 Trust or SLATs.
• Flexibility – Special trustee or trust protector provisions; special power of appointment in 678 Trust or SLATs.

› By utilizing a 678 Trust (also called a Beneficiary Defective Trust or “BDT”) in the “freeze” stage, the client does not have to give up control of the assets or give up access to them.
› Why choose a 678 Trust?
• The clients can remain in control.
• The clients can be beneficiaries of the 678 Trust and can continue to have access to the assets for their needs.
• The assets in the 678 Trust are not taxed in the clients’ estates.
• The clients can have a special power of appointment to direct where the assets pass upon their deaths.
• The assets in the 678 Trust are protected from creditors.

678 Trust Basics

 › A 678 Trust is established by a third party (such as the client’s parents, sibling, or close friend) with a gift of $5,000.
› The client is the primary beneficiary of the 678 Trust and can receive distributions for health, education, maintenance, and support.
› With careful drafting, the client may also be named as trustee of the 678 Trust.
› The client-beneficiary is given a withdrawal right over the initial $5,000 contribution.
› The trust agreement provides that a Special Trustee has the power to terminate the trust in favor of the client-beneficiary, even after the client-beneficiary’s withdrawal right over the $5,000 gift lapses. 

› The 678 Trust technique works because of a “disconnect” between the income tax code and the estate tax code.
• For estate and gift tax purposes, when the client-beneficiary allows the withdrawal right to lapse, the client-beneficiary is not viewed as the grantor of the trust because of the 5 and 5 exception in the estate tax code, and so the trust assets are not includable in the client-beneficiary’s estate.
• For income tax purposes, when the client-beneficiary is given the withdrawal right and when the withdrawal right lapses, the client-beneficiary is viewed as the grantor of the trust, making the client-beneficiary the owner of the trust for income tax purposes. (Note that although the withdrawal right is limited to $5,000, there is no 5 and 5 exception in the income tax code.)
› The clients “burn down” the assets that remain in their taxable estate to pay for living expenses and to pay the income taxes generated by the 678 Trust.
› After the notes are paid off, the trustee of the 678 Trust will make distributions to the clients to cover their living expenses and income taxes.

“Tax Fence” With 678 Trust Planning

6 Do you have any low basis assets? (If so, you may need some “upstream” planning.)

› If the client has appreciated assets, the client should look “upstream” to the client’s parent for obtaining a stepped-up basis, especially if the parent is ailing.
“At the risk of being tactless, the death of a parent, grandparent, or other older relation or friend is a sad enough event without also wasting the opportunity for a significant basis increase.” ~Howard Zaritsky, nationally-known tax & estate planning attorney
› If the client has low-basis assets and the client’s parent has unneeded exemption, the client could gift the assets to a parent outright or, even better, to a trust for the parent and give the parent a General Power of Appointment (“GPOA”) over the assets.
› CAUTION: IRC Section 1014(e) denies the basis step-up if the assets come back to the child or the child’s spouse within one year. This potential limitation may be avoided if the assets pass (i) to a trust for the benefit of the client and/or the client’s spouse with a trustee other than the client or client’s spouse or (ii) to the client’s child or a trust for the child’s benefit.

› Example:
• The client creates a trust benefitting the parent and gifts low-basis assets to the trust.
• In drafting the trust, the client gives the parent a GPOA over the trust assets. 
• The GPOA will cause the assets to be included in the parent’s estate under IRC Section 2041(a)(2).
• In the parent’s will, they exercise the GPOA and leave the assets to a trust for the client.
• When the parent dies and the assets come back to a trust for the client, the assets will have a new stepped-up basis (under IRC Section 1014(b)(9)).
• Note that the outcome is the same if the trust is drafted so that if the GPOA is not exercised, the assets pass back to the donor child or to a trust benefitting the donor child. In this case, there would be no need for the parent to even exercise the GPOA.

Upstream Planning: GIFT Appreciated Assets to Parent with GPOA

 › What if the client or the parent doesn’t have enough lifetime exemption? Or, what if we don’t want to use up their exemptions? Instead of the client making a gift to the parent, consider a SALE to the parent’s trust.
› Example:
• The client sells low-basis assets to a grantor trust, taking back a note secured by the assets. By selling instead of gifting the assets, the client’s exemption won’t be used up.
• When the parent dies, under IRC Section 2053(a)(4), the assets included in the parent’s estate will be offset by the secured debt owing by the trust. So, the parent’s estate would only increase by the amount of any appreciation on the assets between the date of sale and the date of death, less any interest paid on the note.
• The assets get a stepped-up basis, but the net increase to the parent’s estate is zero (assuming there was no appreciation between the date of sale and the date of death). Therefore, none of the parent’s exemption is used.

Upstream Planning: SELL Appreciated Assets to Parent with GPOA

7 Do you love your grandkids equally? (Consider a life insurance policy that goes to them per capita instead of per stirpes.)

› Do you love your grandchildren equally? With a traditional per stirpes inheritance, grandchildren with more siblings will receive less than grandchildren with fewer siblings.

› Assume Generation 1 (“G-1”) has a son with 2 children, a daughter with 4 children, and a $12 million estate. After G-1 dies, the son and daughter each receive $6 million. However, after the son and daughter (Generation 2 or “G-2”) dies, the son’s children each receive $3 million while the daughter’s children each receive $1.5 million.

› To lessen this blow on the cousins, consider taking out a life insurance policy that goes to all the grandchildren per capita.

› The policy can be on G-1’s life for the benefit of Generation 3 (“G-3”) per capita, paid to G-3 at G-1’s death.

› Or, the policy can be on G-2’s life for the benefit of G-3 per capita, paid to G-3 at G-2’s death. Doing a policy on G-2 instead of G-1 would provide more coverage since G-2 is younger. With this scenario, G-1 can either pay the premiums as a gift or can lend money to G-2 to pay the premiums.

› The rest of the estate plan remains intact. This creates new assets to use for gifting to G-3 without disrupting G-2’s inheritance.

8 Do you have a “Red File”

› Statistics:

• The leading cause of death in the United States is heart disease.

• For two-thirds of women and half of men who die from heart disease, their first symptom was death—not chest pain, not discomfort in an arm, not shortness of breath.

› People in seemingly excellent health can go quickly and unexpectedly. Imagine you died suddenly or become incapacitated. Do those closest to you have all the information they will need?

› Create a “Red File” for what estate planning documents don’t cover.

Section 1 – Centralized File of Personal Information

› Centralized file of personal information, such as key contacts, location of assets, passwords, etc.

› Typically, a spouse, child, or other loved one takes on the role of executor with only part of the instructions they need.

› They may know who is to receive mom’s assets, but what exactly did mom own? How many bank accounts did she use? What insurance policies did she have? Was there a safety deposit box? What bills did she owe? How do I access her email or shut down her social media accounts?

Section 2 – Business Continuity Plan

› Business continuity planning (also called business succession planning) is the number one most neglected area of estate planning.

› The estate plan addresses who will own the business but not who will manage it.

› As baby boomers age, many seem to think they’re going to live forever and have done no business succession planning. The problem is even worse for a long held family business, where owners are more emotionally tied to the business and have a hard time being objective. › Provide information on management succession to facilitate the transition when (not if) you are no longer able to manage your business.

Section 3 – Plan for Incapacity

› Create a plan in case of incapacity, including guidance for future care, preferences, and a clear expression of financial intentions.

› Clients typically don’t make preparations for the possibility of becoming incapacitated. In many instances, clients may actually be more willing to discuss preparations for their death than the possibility of incapacitation. This may be because the term “incapacitated” often invokes images of nursing homes and hospital beds. In reality, incapacitation most often comes in the form of cognitive deterioration.

› Many individuals assume a family member will take care of them in the event of incapacity, but few appreciate the number of decisions a guardian or caretaker must make on behalf of an incapacitated person. From housing situations to medical treatment to simple living and eating preferences, without guidance, a family member is left to simply guess at what their loved one wanted.

Section 4 – Legacy Plan

› Aside from money or assets, what do you want to leave behind? A Red File can help you gather information about the legacy you want to leave behind—aside from money or assets.

› Sheltering at home with family during the COVID-19 pandemic has made many of us acutely aware of any communication or family harmony issues.

› The recent increase in the use of video-conferencing services (such as Zoom) has shown us there is no need to put off having the first family meeting until everyone can be in the same room. 41

› Most importantly, once you’ve created your Red File with all of this information, tell someone where it’s kept.

› Be sure to update it periodically.

› Download a copy of our Red File Checklist here: https://theblumfirm.com/2021/Red-File-Checklist.pdf

9 Do you have a business succession plan in place?

› Why is business succession planning such a hot topic?

• As baby boomers age, many seem to think they’re going to live forever and have done no business succession planning. The problem is even worse for a long-held family business, where owners are more emotionally tied to the business and have a hard time being objective.

• According to the Small Business Administration, half of small business owners are over age 50, and statistics show that from now until 2029, 10,000 baby boomers will reach age 65 every day.

• Talk to your business owners. Ask them what’s going to happen WHEN, not IF, they’re no longer running the business.

• Form a planning team (CPA, attorney, financial advisors) and bring all the key stakeholders to the table to develop a plan and implement the succession process.

Weigh the Options

› Before you can start developing a plan, the founder needs to decide whether the company will be passed down in the family or sold.

› There are 3 primary choices in the toolbox when thinking about succession planning:

• Transfer the business to a family member/family members.

• Sell the business to people within the business.

• Sell the business to an outside party.

› When considering transferring the business to a family member/family members…

• What do your kids want? Do they even want the business?

Keeping It in the Family

› Every family is different. There’s no single succession plan that will work for all families. Searching for a solution involves evaluating a toolbox of planning options to find what works best.

› When developing a business succession plan to pass a business down to family members, there are 5 key components of a good plan.

› FIRST, you need to decide the timing—when the change in control of the business should happen. It’s often best to transfer control while the founder is alive so that he can participate in the process and influence the stakeholders. The founder is the “glue” that keeps everyone together and makes the process a smoother transition.

› SECOND, it’s time to start training the successor. To groom a successor, the founder needs to shift from being quarterback to coach. The process of having a successor “ride around in the truck” with the founder may take many years, so it’s important to start early. 

› While the successor is being groomed, offer him or her a role as an observer at board meetings. Expose the successor to the process.

• I work with one family business that invites family members to observe board meetings beginning at age 14. They call this the “junior board.” The founder wants the children to understand what the family business does before the children enter college or decide on career paths because it may affect what the child decides to study in college and the child’s choice of a career path.

› THIRD, who will manage the business? The business needs to run like a business and not like a family. You may have to come to grips with the fact that some children aren’t qualified to run the business. (Again, management is a separate concept from ownership of the company.)

› Who will be on the Board of Directors?

• Needs to include someone with hands-on experience in the business world, perhaps with training in management.

› Who will elect the Directors?

• If you have only one class of stock and you leave it in equal shares outright to children (some active and some not), this is a recipe for friction. Instead, consider different classes of stock (such as voting and nonvoting or common and preferred).

• Also consider leaving the stock in trust with a carefully-selected trustee. The trustee needs to be either an objective party or someone who’ll do what’s best for the well-being of the business. When designing the trust, consider naming an independent (or special) trustee with powers to remove and replace the trustee and powers to make certain amendments if unforeseen events arise.

› FOURTH, a good succession plan needs to provide a cash flow for all family members who will own the business.

• If a family business is passed to children in equal shares and only some of the children work in the business, the other children may not receive a cash flow from the business. The non-active children may push for the business to be sold so they can see a cash flow. 

• Are there assets that you can divide up and distribute out to the owners? For example, does the company own real estate that can be separated out from the operating business and put in a separate entity, then enter into a longterm lease? This could provide a cash flow for those not employed in the business.

• Life insurance can provide a cash flow for the children who will not receive a salary from the business.

› FIFTH, provide an exit strategy for an owner wishing to sell his share.

• Explore buy/sell arrangements (ideally funded with life insurance).

• Buy/sell arrangements are especially effective in family businesses where family members active in the business can buy out those not in the business. The non-active sibling sells and gets cash. The active sibling buys and gets control.

Selling to an Outside Party

› If the decision has been made that the company will be sold, work to position the company to be ready to be bought when you’re ready to sell.

› Remedy inefficiencies in the business. Optimize the value of the business to maximize the sales price.

› Look at the company through the eyes of a potential buyer:

• Are the business financials in order?

• Will key employees and relationships necessary for the business to continue be retained?

• What are the intangible values of the company (key employees, internal processes, reputation for quality)?

Tax Planning Before the Sale

› Tax planning before a sale is about minimizing taxes and therefore maximizing the amount of the sales proceeds the family actually gets to keep, after paying income tax and estate tax.

› To minimize estate tax, transfer the business to trusts at a time when it qualifies for the maximum amount of valuation discounts.

› The earlier you start, the greater the discount, and the more estate tax you can save. 51

› Estate Freeze Planning

• Estate freeze planning “freezes” the asset’s value for estate tax purposes by moving future appreciation to a pocket that is outside of the taxable estate.

• For closely-held business owners, the largely illiquid business is often the most valuable asset in the estate. Without proper planning, the business may have to be sold to pay the estate tax. The client may have intended for the business to stay in the family but didn’t put a plan in place for that to be possible.

• A Section 6166 long-term payout of estate tax is just putting off the problem.

• Even if the client is currently under the federal estate tax exemption level, many are growing their estates and their net worth will exceed the exemption level at death.

• Are you sure you know how the IRS will value the business? It can be difficult to determine the value of a closely-held business. The client may believe his estate is below the estate tax exemption level, but the IRS may not.

10 Are you worried an inheritance will ruin your children? (Consider a FAST solution to legacy planning— the Family Advancement Sustainability Trust.)

› Only 10% of families enjoy multi-generation success. 90% fall victim to the proverb “Shirtsleeves to shirtsleeves in three generations.” The successful 10% engage in activities like regular family meetings, preparing their heirs to be responsible inheritors.

› Typically, the patriarch and matriarch (Generation 1 or “G-1”) pay for these activities and make sure they happen. The problem is that after the patriarch and matriarch are gone, the children drop the ball and don’t want to pay for these activities or take the time to do them. It takes more than G-1’s hopes and dreams for future generations to succeed. Hope is not a strategy. G-1 needs to be intentional and implement a practical solution.

› G-1 should create a Family Advancement Sustainability Trust (“FAST”) to endow the cost of conducting regular family meetings, travel, and enrichment activities.

› A FAST is an add-on to a traditional estate plan, often funded with life insurance. 

› A FAST provides FUNDS. A FAST is the best way to pay for best practices of successful families, such as:

• Holding family meetings and retreats.

• Creating curriculum and educating heirs to become responsible inheritors.

• Establishing system of family governance.

• Working to preserve family’s history and heritage.

• Training future generations on concepts like philanthropy and entrepreneurship.

› A FAST provides LEADERSHIP.

• Creates a leadership structure to ensure these activities happen, using a system of trustees and committees who are paid to run the FAST and charged with the responsibility for carrying out these tasks.

› A FAST can act as replacement “glue” to help bind the family together after G-1 is gone.

› James Grubman (Family Legacy expert) uses a football analogy to perfectly illustrate the issue:

• Think of a football game. The focus is on the quarterback. The quarterback has perfect throwing skills. The football (the inheritance) is perfectly thrown to receivers at the other end of the field. But, no one has prepared the receivers. They’ve never been to a practice. As the ball comes their way, the receivers don’t know how to catch it or what to do next if they do catch it. They don’t know how to coordinate with each other as team players. What are the odds the receiving team will catch the ball and carry it down the field, without fumbling it, to score a touchdown? A family with unprepared and disconnected heirs almost always “drops the ball.”

• The Family Advancement Sustainability Trust is the vehicle to make sure the heirs are prepared when the football comes their way.

Estate Planning Checkup: Top 10 Questions to Ask Your Client Read More »

Focusing on the Long Game

Tips and perspectives on raising “baby lawyers”

Ah, the “baby lawyer” -a special beast we all know well, for we were all baby attorneys at some point, yes? So eager and excited to begin practice. Stumbling around, just trying to figure out where the walls were. Working hard to impress those around us-bosses, colleagues, clients. Then, suddenly, we woke up and realized we had made it to the other side. Feeling much more confident in our decisions. Having a firmer grasp on what we didn’t know and knowing exactly where to go for the answer. Developing relationships with clients and advisors and becoming busier and busier as a result. And then, for many of us, it set in: the realization that we needed help. What to do? Hire someone with experience? Someone who can jump right in’without any handholding? Someone who’s probably a bit more … expensive? Or, take a chance on a “baby?” Someone straight out of school, with no real experience to speak of but eager to learn and smart and motivated. We think the latter option is often the better one, if you’re willing to put in the work. Look at the bigger picture. And, focus on the long game. Our firm employs both seasoned and newly licensed attorneys. Marvin founded the firm almost 40 years ago, and Kelsey joined the firm about five years ago and is a “home-grown” attorney. Here are our thoughts on raising baby lawyers.

So Fresh and So Green
Kelsey: When I first joined the firm, I was bright-eyed and bushy-tailed, excited to do some estate planning.
I knew it would be a good fit for my personality (no fighting-yay!), and I figured out that it would give me a better work-life balance than the jobs many of my friends were walking into (it has). But, I was pretty much clueless about the technical aspects of trusts and estates. Of course, I’d taken the classes in law school. I’d enjoyed them and done well, but nothing can really prepare you for the practice of law. You just have to jump in and know when to ask for help, which I did a lot of, especially in those early days. One of my colleagues· probably should have made a recording that asked, “What does the trust agreement say?” in response to about 90 percent of my questions. I learned so much. For years I’ve said that I must have learned more in those first six months than anyone else I graduated law school with. I’m sure that’s not the case, but it sure felt that way.

Marvin: The learning. curve in law practice is pretty steep, especially in estate planning. The tax laws are constantly changing. We’re dealing with increased exemptions, shifting priorities and more and more multijuris-_dictional matters. Frankly, as a result, it can be tempting to hire someone who can hit the ground running. In some situations, that does make the most sense, but, sometimes, a brand new lawyer can be a great fit. She doesn’t know anything yet, so everything she learns is by your hand. How you do things, why you do things-it all becomes ingrained in her before she’s had a chance to pick up bad habits elsewhere. Yes, it does take a while for her to become self-sufficient. There’s a lot of patience involved, and there are certainly times when it would have been easier to do the project yoursel£ But, in the long run, you can help shape that person into someone really special, someone who buys into your firm’s way of doing things and knows exactly why she does things the way she does.

Best Ticket in t he Ho use
Kelsey: If I had to pinpoint the one thing that’s helped me grow the most, it’s sitting in on client meetings and phone calls with the partners. It’s hard to articulate how beneficial it is to hear a partner explain certain concepts to clients over and over again and to hear how recommendations change in various situations. Not only did this help me to learn the concepts better but also to see how to translate very technical matters into manageable pieces that the clients could easily understand. That early and consistent client interaction sort of acted like training wheels. Soon, I had the confidence to start handling signings, and then even some meetipgs, by myself. I’m certain that it helped me transition into (relative) independence faster than I would have if ICl been sitting on the sidelines silently observing, waiting until I thought I was ready for client interaction.

Marvin: When we decided to have associates start sitting in on client meetings with the partners, we were a little nervous that we would get pushback. After all, we know that nobody likes to see multiple lawyers walk into a room. You can practically see the dollar signs in their eyes. But, we’ve actually had very few clients take issue with this approach. I think this is because we explain to them right off the bat that we work in teams and that it’s actually much more efficient to have the associate in on the initial meeting or call. Not only can she take much better notes than I can (since I’m doing most of the talking), but also she walks out of the room knowing all of the facts and exactly what she needs to do to get the ball rolling. I think the clients appreciate knowing that they have at least two people they can reach if they have a question. They’re much more likely to reach out to the associate directly going forward, which is, of course, very efficient from a billi_ng perspective. Because the associate is generally the one closest to the project, she can run with it and just go to the partner as needed.

Doors Wide Open
Kelsey: Another thing I’ve appreciated about the firm is that it truly has an open-door policy. I know many places say that, but in comparing notes with some of my other lawyer friends, I think it’s pretty rare in practice. We truly do pop in and out of each other’s offices all day. We buzz each other with quick questions, and we frequently send out “has anyone ever encountered __ ?” emails. Of course, this is great from a technical perspective. It’s invaluable to have a wealth of knowledge around you from which to harvest information. But, it wouldn’t work if people weren’t on board with the concept itself. Feeling comfortable in your environment and knowing that questions aren’t just accepted but welcomed- that’s a really easy way to help each other grow, regardless of whether you’re a baby lawyer or a seasoned veteran.

Marvin: The open -door concept is great in theory, but nobody wants to use it if they don’t get along with the person on the other side of that door. First and foremost, we’ve approached this issue by being very protective of our culture. If you hire only those people with whom you want to chat, you’ll never hesitate to stop by their office and ask them a question. We also try to foster this atmosphere of collaboration through weekly lunch-and-learns. Sometimes, outside advisors will come in and educate us on a particular planning technique or on their business. But, often we use these lunches to discuss recent CLEs we’ve attended, recent case law or even just ideas we want to bounce off each other. Sometimes we’ll even have some of our newer attorneys present on a topic, be it the President’s revenue proposals or some newly released regulations. It’s educational for the rest of the firm, and it gives that new attorney time to shine too.

Getting Out and About
Kelsey: I think I attended a CLE event on my second day at the firm. I have absolutely no memory of what it was about, but I remember where it was and which attorneys went with me. It became clear to me early on that continuing education (and other similar events) were very important to my firm and to my personal growth as an attorney. At first, I thought it was mostly about the networking. Of course, we want to be on the forefront of people’s minds when they need any . estate-planning work. But, as I started to understand more and more of the technical matters being discussed at these events, I realized that the educational piece was even more critical. The law in this area changes rapidly, and it’s really important that we never be behind the eight ball on those changes. I’m fortunate to be a part of an estate-planning community that’s able to attract lots of highly sought -after speakers, and I’m thankful that my firm has encouraged me to go listen to as many of them as possible.

Marvin: We know that many firms stress the billable hour, and we get it. It’s how we get paid, and, for many attorneys, it can leave no time for non-billable activities such as CLEs. You can just get those during your birth month by watching videos. But, I firmly believe that those non-billable CLEs are invaluable. Not only are they a very efficient way for our attorneys to keep up with changes in the law, but also they’re where many of them develop their professional networks. Because of this, we’ve set a relatively low billable-hour requirement for our associates to allow them the freedom to attend as many as they desire. They also have an (almost) unlimited budget to attend these types of events. We know that we’re giving up some billable hours in the short term, but we think the end result- more educated, better connected lawyers- makes this particular sacrifice a no-brainer.

No Pressure, Man
Kelsey: When I was interviewing with the firm, one of the first questions I asked was about business development. I can’t express how relieved I was when they assured me that I would have no such requirement. I dreaded the thought of schmoozing. It’s just not my gift. Of course, now that I’ve been practicing for a few years, I see that there are actually lots of ways to develop business without even trying. Part of this has to do with regularly attending CLEs and other similar events and developing a network of people through that. But, part of it also just comes naturally through the day-to-day grind. When I work with a client or an advisor and he’s happy with the work, he gives my name to other people. It really is that simple and happens organically like that all of the time. But, that kind of thing didn’t happen right away. There’s also a certain self-assurance that’s required before other people · will have confidence in you, and, at least in my experience, that isn’t formed overnight. So, it was very beneficial for me to have the space to grow as an attorney without the simultaneous requirement to bring in business.

Marvin: Our firm is in that sweet spot where we’re large enough to have attorneys with varied aptitudes, but we’re also small enough that we can tailor certain arrangements to best fit the needs and desires of each individual. So, if we have a partner who’s so busy bringing in business that he no longer has time to draft, then we think that partner should be incentivized to develop business. Likewise, if we have a partner who doesn’t care as much about developing business but really enjoys drafting or putting a second set of eyes on another attorney’s work, that partner should be incentivized to do that type of work. These varying arrangements also solve an age-old issue for law firms: attorneys who are so possessive of their work (and the origination) that they don’t want anyone else to work on the project. When you have several attorneys with different niches and they all fit together harmoniously, there’s no reason not to structure things differently for different attorney proficiencies. And, there’s nothing to say that those proficiencies won’t change over time. If they do, we’ll simply change · the attorney’s structure to continue to reward
what she’s doing well.

The Longest Game
In the end, we believe that incorporating a few very simple principles can turn a law firm practice into an ideal setting for a baby attorney. There will certainly still be growing pains, and there might be days when you wish you’d hired that second-year litigator who at least knew how to keep his time. But, then you’ll remember the opportunity you have: to mold and shape this new attorney into a trusts and estates machine who will, one day, be able to run with things from start to finish, freeing you to do whatever your strength might be. You’re a planner, after all. Are you thinking about the long game?

Focusing on the Long Game Read More »

Filling in the Gaps

Most estate planners will agree that one of the most formidable obstacles to the planning process is the general reluctance of clients to discuss their own mortality. There’s one significant motivating factor, however, that drives clients to confront their mortality and plan for their incapacity and death: control. Clients want to ensure that on incapacity, they’re cared for as they wish and on death, their assets pass exactly how they would like. While crafting an estate plan, both planners and clients tend to focus on the effective and tax-efficient distribution of the client’s assets. It’s all too common for a client to walk away with a perfectly crafted portfolio of estate-planning documents that expertly disseminates the client’s property but fails to provide the control so desperately desired. How is it possible for a perfect plan to be so imperfect? The answer lies outside of the formal estate-planning documents and accordingly often goes overlooked by planners and clients alike, but the answer, itself, is simple. By adding a “red file” to the traditional batch of estate-planning documents, clients increase their level of control in two key areas: (1) incapacity, and (2) administration of the estate at death. As part of the planning process, estate planners should encourage clients to create a red file and guide them on how to do it. Essentially, a red file is a notebook or other centralized source of information that will not only aid an executor in navigating the waters of estate administration, but also will make very clear the wishes of a client in the event he becomes incapacitated in the future. 

While only clients can actually establish the red file, estate planners should provide their clients with a framework of guidelines for what it should contain.
There’s no specific formula for what makes a red file effective, but clients should know that the more information they include, the more helpful it will be to those managing their assets or making care decisions on their behalf.

Control Over Future Incapacitation

In many instances, clients may actually be more willing to discuss preparations for their death than they are preparations for the possibility of becoming incapacitated. The term “incapacitated” often invokes images of nursing homes, hospital beds and beeping medical machines. The truth is, however, that incapacitation most frequently comes in the form of cognitive deterioration. Although individuals are living longer than ever, advances in medical care for physical ailments have far outpaced advances in medical care for mental ailments, and the reality is that almost half of those who reach the age of 85 have “measurable cognitive impairment.”1 In fact, more U.S. dollars are spent on care for dementia patients than on “heart disease and cancer combined.”2 With 10,000 Baby Boomers reaching age 65 every day3 and a projection that cases of  Alzheimer’s will increase over 170 percent by the year 2050 in those over the age of 65,4 estate planners should be helping clients prepare for the possibility that they or someone they love will be affected by Alzheimer’s or some other form of dementia during their lifetime.
Unfortunately, cognitive deterioration generally occurs slowly and, in its early stages, can often be overlooked or ignored by family members. Parents may appear on the surface to be in full control of their lives, while behind the scenes, the tasks they used to complete seamlessly, like balancing a checkbook or keeping up with their finances, are becoming increasingly challenging. And, because it’s more common in today’s world for families to live in different cities or states, the danger of loved ones missing the early signs of dementia has grown. Mom and dad may seem perfectly well and cheerful over the phone, while an extended visit would reveal a troubling amount of information they can no longer remember.
In addition to dementia or Alzheimer’s, catastrophic events such as strokes, aneurysms and traumatic brain injury likewise cause incapacity, but rather than setting in gradually, these traumas are sudden and can occur without warning. Approximately 80,000 individuals per year become permanently disabled as a result of suffering from a traumatic brain injury, most often caused by a fall or motor vehicle accident.5 Although it may be tempting, especially for younger clients, to wait until early signs of incapacity appear to prepare for it, playing the waiting game is risky. By the time an actual diagnosis occurs, it’s often too late for the individual to make plans for future care without some level of assistance.
Many individuals assume a family member will take care of them in the event of incapacitation, but few appreciate the number of decisions a guardian or caretaker must make on behalf of an incapacitated person. From housing situations to medical treatment to simple living and eating preferences, without a plan in place, a family member is left to simply guess at what their loved one would have wanted. As author Debbie Pearson states in Age Your Way, those who fail to “make a con-scious decision for control will inevitably default to no control.”6 Estate planners must stress the importance of putting a plan in place that will allow clients to exercise control over their lives despite any future incapacities.

Control of Estate Administration

From a legal perspective, estate administration is a straightforward process. Documents are filed with the court, proper procedures are followed and the deceased’s wishes are carried out in accordance with his estate plan.
From a practical perspective, however, the day-to-day tasks of wrapping up the affairs of someone else’s life can be daunting and overwhelming.
Typically a spouse, child or other loved one takes on the role as executor with only half of the instructions he needs. He may know who’s to receive mom’s assets, but what exactly did mom own? How many bank accounts did she use? What insurance policies did she have? Was there a safety deposit box? What bills did she owe? Are there magazine subscriptions to cancel? 
How does he access her email or shut down her social media accounts? It quickly becomes clear that there’s a mountain of information to which only the deceased was privy. Indeed, handing an executor a will without any other information is like telling someone exactly where to drive your car without telling them where the keys are located. When it comes to preparing for what will happen after you die, the truth is that even your closest friends and relatives often have no idea how to act as CEO of your life. Just as in any well-run business, there must be a succession plan in place. Planners must remember to incorporate strategies into a client’s estate plan that will enable executors and family members to successfully carry out the client’s wishes.

Solution: The Red File

The solution for clients desiring more control over their care during incapacity and their assets on death is a red file tailored to the client’s unique situation. As a general rule, a red file should cover three main subjects: (1) a plan for future care; (2) a clear expression of financial intentions; and (3) a comprehensive list of personal information.
Plan for future care. Planning for future care necessitates a big picture outlook, as well as a detailed outlook. Big picture items include medical and living preferences.

Does the client prefer to live at home with home health care attendants or with a family member? If these options are physically or financially unavailable, which living facilities does the client prefer? Providing a list of specific senior living or nursing care facilities will ensure the client’s loved ones have a clear understanding of how the client envisioned living out his life.
The more detailed the plan is, the more likely the client can ensure an enriched, comfortable life, despite the setting in which he’ll find himself living. A list of favorite foods, music, colors, books, activities, sports and movies can communicate to future caretakers an idea of who the client is long after the client’s lost the ability to voice an opinion.
In preparing this portion of the red file, it may help clients to confer with someone from the extensive network of consultants who assist with planning for the care of elderly family members. When clients who’ve never been incapacitated are planning for their own incapacity, it’s easy to overlook important considerations. An aging life care professional (also called a “geriatric care manager”) acts as a guide and resource for families caring for older or disabled relatives or planning for their care.
These consultants know, for example, the going rate for in-home care, the physical obstacles to look for in a home environment and which walker would be best for your client. The Aging Life Care Association (ALCA) is a national non-profit association of such consultants.
The ALCA website provides a resource to search for a list of aging life care experts near your client. Dallas-based Cariloop is another such resource. Cariloop provides educational materials and access to a planning coach who can help users work through the options depending on their needs. By speaking with a consultant, clients can identify issues to address in their red file that they might not have otherwise considered.
Financial intentions. Although the final disposition of a client’s assets will be documented in the formal estate-planning documents, it’s important for clients to express their wishes for how their money is to be spent prior to their deaths. The client should complete a power of attorney (POA) as part of his traditional planning documents. A POA, however, only authorizes someone to act financially for the client. It doesn’t provide any guidelines for how the client would have wanted his designated agent to allocate funds. For example, if the client prefers to live with a family member in the event of incapacitation, should a portion of the client’s assets be used to remodel the family member’s home or to purchase a larger home? Should a family member or close friend serving as caregiver receive financial support? Not answering these questions could lead not only to conflict among the client’s family, but also to financial abuse of the client.
The unfortunate truth is that “an estimated one in five older Americans has been financially exploited,”7 and according to a survey conducted by Merrill Lynch Wealth Management, “a child was the suspected perpe-trator 71% of the time.”8 In some instances, the abuse is a result of malicious intent, as in the well-known case of Brooke Astor. Brooke suffered from Alzheimer’s, and her son took advantage of her mental disability to funnel millions of dollars to himself. Eventually, Brooke’s grandson realized what had transpired and petitioned the court to remove the son as Brooke’s guardian.Although this is an example of abuse on a grand scale, even those with modest-sized estates are at risk for exploitation.
The line for what constitutes exploitation can become muddled when a caregiving situation is involved. For example, if a child quits her job to serve as caregiver for a parent, is she entitled to help herself to a salary without the parent’s consent? Another potential abuse situation arises when a parent expressly decides to give a salary to a child willing to serve as caregiver but the client later becomes so debilitated that a professional caregiving service must take over. Does the child get to continue taking the salary, even if her only job is to supervise care? 9 A well-planned red file will state clearly whether money paid to a family member in consideration for caregiving services will constitute compensation, a gift, an advance against a future inheritance or some combination of the three.10
Centralized information. For executors and other loved ones charged with managing a client’s assets during a period of incapacitation or estate administration, a well-compiled list of information in a red file can prevent such a weighty responsibility from becoming
a nightmare. In today’s world, the number of online accounts and subscriptions an individual maintains can increase from day to day. From social media to paying bills online to shopping accounts, the list of passwords can be overwhelming for anyone, but especially so for someone who has to step into the shoes of another to manage his affairs.

Unfortunately, laws haven’t kept up with technological advancements when it comes to legally accessing another individual’s online accounts.11 Due to company privacy policies and rarely read user agreements, trying to shut down a social media page or an email account can be nearly impossible without having the necessary passwords. These potential difficulties only increase the importance of having and maintaining an updated red file.

List of Categories

The best way for estate planners to aid clients in gathering all the pertinent information for the red file is to provide them with a list of categories they need to review. Below is an abbreviated list of classifications of information that clients should consider when compiling their red file:12

  • Assets: checking and investment accounts, private business interests, location of safety deposit boxes, annuities, individual retirement accounts and 401(k)s, trust agreements, real estate, vehicles, collectibles
  • Liabilities: credit cards, mortgages, car payments, cell phone bills, other recurring bills
  • Social media/online accounts: passwords and login information for Facebook, Twitter, Instagram, Pinterest, LinkedIn, Amazon, PayPal, eBay, Netflix, Hulu, iCloud or other cloud storage accounts, online photo storage accounts
  • Miscellaneous subscriptions/memberships: airline rewards programs, Sam’s, BJ’s or Costco member-ships, toll tag accounts, magazines, newspapers 
  • Insurance: life insurance, long-term care, disability, home, auto
  • Home maintenance: water, gas, electricity, telephone, alarm, lawn care, cable television, Internet service
  • Medical: medical conditions, medications, emergency contacts
  • Personal: burial/cremation preferences, funeral plans, pre-paid funeral expenses, birth certificates, marriage certificates, Social Security card
  • Key contacts: financial and legal advisors, doctors, family members, close friends

See “Red File Checklist,” p. 41. This is by no means a comprehensive list, as each client’s red file will require different information, but as clients review the checklist, they’ll begin to appreciate the vast amount of information their loved ones may not know.

A Completed Red File

In addition to providing the checklist, estate planners should instruct clients what to do with the red file once it’s completed.
In Age Your Way, Pearson recommends using a threering binder for the red file, which will allow the client to easily add and update information in the future. It’s also wise to create both hard copies and digital copies of the red file and place a copy in a safety deposit box or other secure location that will be safe in the event of disaster at home. Most importantly, planners should remind clients to share the red file with family or close friends. Some clients may even wish to make copies to provide to family members. Remember, however, that the information contained in a red file is subject to change and should be updated at least twice a year. Clients should be careful to request old copies of their red file back from loved ones to avoid confusion.
Embarking on the journey of creating a red file may seem like an arduous task to some clients, but it’s important to remind them of the peace of mind that will come from knowing friends and family have all the resources they need to ensure the client’s wishes will be fulfilled exactly as planned. Children and loved ones will be relieved from much of the stress that comes with the care of an incapacitated person or the probate of an estate, and clients will likely feel that they’ve retained a sense of control over personal decisions that must ultimately be carried out by someone else.
There’s no medical cure for aging, but there are ways to ease some of the challenges that come along with it. A red file is one way to prevent some of the heartache that can occur when a family member loses control. Although it’s an easy task to put off, 59 percent
of adults in one survey stated that they changed their own financial plans after watching an aging family member.13 The importance of planning now, before a crisis happens, can’t be overstated. Estate planners can craft the most effective planning documents possible, but it won’t matter how well off clients are from an estate-planning perspective if their friends and family are left in shambles trying to pick up the many pieces of their loved ones’ lives.

Red File Checklist

Your client should provide information and answer questions

Consolidation of Personal Information

  • Financial accounts—Account number and bank contact information for checking and savings accounts, credit cards, brokerage accounts, retirement accounts and annuities.
  • Trusts—Copies of trust agreements, contact information for trust officers/trustees for any trusts you created or will inherit from. 
  • Private business interests—Information on any business interests owned, including what’s owned, how owner name is styled, contact information for manager and copies of any appraisals.
  • Real estate—Deeds for any real estate owned, information on any mortgages including payment amount, contact information for bank and if mortgage payment is automatically debited from a bank account.
  • Jewelry, art and collectibles—List of any valuable jewelry, art and collectibles; copies of any appraisals; copies of any insurance policies on these items.
  • Storage locations—Location of any safety deposit boxes or storage units. Include location of keys and access information.
  • Important documents—Copies of birth certificate, marriage certificates, prenuptial or postnuptial agreements, divorce agreements, driver’s license, Social Security card, passport, tax returns for past three years, notes receivable, notes payable and estate-planning documents (will, trusts, powers of attorney, HIPAA authorization, beneficiary designations).
  • Home utilities and maintenance—Account numbers and contact information for electricity, gas, water, telephone, cable television, Internet, alarm monitoring, lawn care and house cleaning services.
  • Vehicles—Titles to any vehicles; information on any auto loans including payment amount, contact information for bank and if payment is automatically debited from a bank account.
  • Insurance—Copies of policies, contact information of insurance agents and carriers, amounts of coverage and deductible amounts for any life insurance, health insurance, long-term care or disability insurance, prescription drug coverage, homeowner’s policies and auto insurance; include all relevant Medicare and Medicaid information.
  • Veteran’s benefits—Copies of military service record and Veteran’s Health Identification Card, information on benefits you’re receiving (pension, disability compensation, medical), information on any additional benefits available (life insurance, health care, long-term care, rehabilitation, nursing and residential care, burial and memorial benefits); contact information for closest Veterans Affairs regional office.
  • Medical—List of medical conditions, medical history, medications, doctor contact information and emergency contacts, health care directives (living will, durable power of attorney for health care, health care proxy).
  • Income—List of income sources including Social Security, pensions, alimony, mineral royalties and trusts.
  • Reoccurring bills—List of all reoccurring bills, including if any are set to be automatically debited from a bank account or charged to a credit card.
  • Subscriptions—Information on any club memberships (including country club, Sam’s, BJ’s, Costco), airline rewards programs, toll tag accounts, magazine subscriptions and newspaper subscriptions; include if any automatically renew.
  • Digital accounts—Passwords, login information and membership fees for any online accounts including email accounts, online banking accounts, social media accounts (Facebook, Twitter, Instagram, Pinterest, LinkedIn), online shopping accounts (Amazon, PayPal, eBay), online entertainment accounts (Netflix, Hulu), and iCloud or other cloud or photo storage accounts; include if any digital accounts automatically renew; include passwords and login information to log on to computers and mobile devices.
  • Financial contacts—Contact information for financial advisors, attorneys, accountants, bankers, insurance agents and the person named as executor of your will.
  • Family contacts—Contact information for family members and close friends.
  • Personal preferences—List of favorite foods, music, colors, books, activities, sports, movies.
  • Funeral plans—Burial/cremation preferences, grave plots owned, prepaid funeral expenses and contact information for anyone you want notified when you die. Guidance for Future Care and Clear Expression of Financial Intentions
  • Do you prefer to live at home with home health care attendants or with a family member?
  • If with a family member, who?
  • If with a family member, do you want a portion of your assets to be used to remodel the home (enlarge doorways to accommodate a wheelchair, hand rails in the restroom, ramps instead of stairs, a bedroom that could accommodate a hospital bed) or to purchase a larger home and, if so, how much?
  • Will this be considered a gift or an advance against a future inheritance?
  • Do you want to provide financial support to a family member or close friend who takes on the role of caregiver?
  • Will this be considered compensation, a gift or an advance against a future inheritance?
  • Is there an adult day care program available that you would consider going to?
  • If you can’t be cared for in a home environment, which living facilities do you prefer?
  • If you don’t have children who can take on one or more of these roles, who will implement your wishes for care during your remaining lifetime? 

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The End Of Valuation Discounts For Family-owned Entities

The IRS has issued proposed new rules related to Internal Revenue Code Section 2704 that affect taxpayers’ ability to take valuation discounts on interests in family-owned entities such as family limited partnerships (“FLPs”). Please be aware of the far-reaching impact of these new regulations:
1) The opportunity to do “squeeze” planning will go away once the proposed regulations become effective. 
With current valuation discounts, the value of an FLP holding assets worth $100 might be squeezed down to just $65. When you gift the FLP interests, you only use up $65 of your lifetime exemption. If you instead sell your FLP interests to your children, the promissory note that you’ll receive in return will be for $65, immediately removing $35 from your estate.
2) Clients that have engaged in “squeeze” planning but have not completed the second step of moving the FLP interests out of their estates (out of their names) have not locked in the discounted value. Continuing with the scenario above, if you die with the FLP interests still in your estate, the value of those interests for estate tax purposes will be at or near the full $100. To lock in the discounted $65 value before your death, you must gift or sell the FLP interests out of your estate before these proposed
regulations become final. An ideal option is to transfer the FLP interests to a 678 Trust so that you can retain access to the assets.

Background

Many clients create FLPs and limited liability companies (LLCs) to hold and transfer family wealth because a greater amount of wealth can be transferred to the next generation at a lower estate and gift tax cost. This structure is used because certain valuation discounts are often applicable when calculating the value of these transferred interests when the interests are in a closely-held entity (including both operating businesses and investment entities) and are transferred to a family member.
Because of restrictions placed on the interest owner by the entity’s governing documents, the discounts most often applicable to these intra-family transfers are for Lack of Control and Lack of Marketability. Assuming the entity’s governing documents restrict the interest owner from managing the entity, the Lack of Control discount is applicable. The Lack of Marketability discount is applicable when the interest owner is restricted from selling or transferring the interest. Together, these discounts can reduce the value of
the transferred interest by 35% or more.
Under IRC Section 2704, these restrictions must be disregarded when determining the value of the transferred interest. However, prior to the date the new regulations become effective, most intra-family transfers fall within exceptions which allow the discounts to still be applied.

Proposed Regulations

In an effort to curtail the use of valuation discounts, the IRS released new proposed regulations under IRC Section 2704 on August 2, 2016. These proposed regulations provide significant, veritably insurmountable, requirements which must be met to qualify for a valuation discount. Gifting interests in a family-owned entity to the next generation for a discounted value will effectively be eliminated.

Window Remains for Locking In Discounts

The proposed regulations are not yet effective. The IRS has requested comments on the proposed regulations, and a public hearing is scheduled for December 1, 2016. This provides a window for clients to undertake planning before the regulations become effective. Clients considering the use of a family entity for estate planning may wish to accelerate those plans and complete the transfers before December.
Additionally, clients who have created an FLP but still own FLP interests in their name will want to lock in the discount before December. For example, many clients have created FLPs but still own a majority of the limited partnership interests. However, in order to take advantage of the potential discounts for these entities, the clients need to transfer the interests to family members or trusts for family members prior to the proposed regulations becoming effective.

Non-Tax Reasons Remain for Using these Entities

While potential discounts are a motivating factor for many clients, there are many other benefits to the use of FLPs. In addition to discounts, FLPs provide a system for the management of diverse assets, an efficient means of gifting assets and most importantly—creditor protection. While the focus of planning for many clients is tax reduction, taxes only present one of many risks to a family’s wealth. In this regard, planning to protect assets from creditors, divorces and lawsuits can be just as crucial as planning for tax savings! FLPs will continue to be a valuable tool even in a world without valuation discounts.

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