Irv Blackman Irv Blackman
Independent Financialservices Professsional

The New Estate Tax Law—Good News, and Bad

May 1, 2011
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Last December, the President signed the 2010 Tax Relief Act, extending for two years the Bush-era income-tax cuts (highest rate for all of 35 percent) retaining the favorable tax rates (15 percent) for long-term capital gains and qualified dividends; and significantly changing estate and gift taxes, among other changes. Here we’ll address the most significant changes related to estate and gift taxes.

The Good News

Bottom line: The new law applies to lifetime gifts and transfers of death for only 2011 and 2012, offering an exemption (pay no taxes) on the first $5 million of your wealth, per person. That’s a delightful $10 million—tax-free—for those that are married. Any excess above the $5 million ($10 million if married) is taxed at a 35-percent flat rate.

Note: Gift and estate taxes are unified into one tax. You can use part or all of the $5 million/$10 million during 2011 and 2012 as a gift; any unused gift amount is tax-free for estate-tax purposes.

The Bad News

The new law includes a sunset provision: After December 31, 2012, the old law will be reincarnated, offering only a $1 million exemption ($2 million if married) and a stratospheric tax rate of 55 percent.

But wait—there actually is some good news here. Let’s talk about the 2-yr. window available to make a $5 million ($10 million if married) gift. While the window will close on December 31, 2012, what about gifts that you (and your spouse) make during 2011 and 2012? The gifts are good forever—the IRS can’t take ’em back, nor tax you.

Unquestionably, Congress made an unintended mistake. Here’s how. Consider Joe and Mary (married and affluent), who provide $10 million in gifts of various assets to their kids during 2011 and 2012. That $10 million, plus future income earned by the $10 million worth of assets and any asset appreciation, will never be taxed to Joe and Mary, for as long as they live or when they die.

Note: In addition, Joe and Mary each can make annual gifts (including 2011 and 2012) of $13,000 ($26,000 total) to every one of their kids—a continuation of the old law.

So, the real question becomes: How can we maximize the tax benefits of this 2-yr. gift-tax window? Completed gifts made in 2011 and 2012 are a made-in-heaven tax opportunity.

Following are examples of how readers can enrich their families rather the IRS.

Business Succession

Joe (married to Mary) owns 100 percent of Success Co., which is run by Joe’s son, Sam. Joe wants to transfer Success Co., worth $12 million, to Sam.

Here’s the simple plan: First, recapitalize Success Co. to provide Joe with nonvoting stock (say 10,000 shares) and voting stock (say 100 shares)—a tax-free transaction. Then, Joe gifts the nonvoting shares to an intentionally defective trust (IDT), with Sam as the beneficiary.

Note: For tax purposes, Success Co., because of discounts (typically, about 40 percent) allowed by current law, is worth only about $7.2 million—the actual gift tax amount—for tax purposes.

A few significant bonuses for Joe:

Not only is Success Co. out of Joe’s estate, but the future substantial income will not be added to his estate. Nor is the company’s future appreciated value a continuing problem. Also, the IDT acts as a perfect asset-protection device, protecting Joe and Sam, and keeping the trust assets a from Sam’s wife should he get divorced. Lastly, Joe retains control of Success Co., since he still owns all of the voting stock.

Finally, because Joe intends to continue working for Success Co., he can continue to take a salary and fringe benefits. We can include a wage-continuation plan, as well, so Joe can continue earning a salary to the day he dies.

You Own Investment-Type Assets

…such as real estate (whether income producing or not, but excluding any residence), stocks, bonds, CDs, cash and similar assets. When real estate is involved, we start by putting the real estate in one or more limited liability companies (LLC) as an asset-protection device. Then we transfer the real estate LLC interest and the other assets to a family limited partnership (FLIP). For example, consider Jake (married to Sue), who transfers $11 million of such assets to his FLIP. The discounts (about 30 percent) under current law make the assets transferred worth only about $7.7 million for tax purposes.

Jake and Sue then gift the limited partnership units (cannot vote), which own 99 percent of the FLIP, to their kids. Jake and Sue retain all of the voting units (1 percent) of the FLIP and keep absolute control of the assets transferred.

If Jake needs or wants to use the funds inside the FLIP, the FLIP loans the funds to Jake. He may pay back the loan, or die owing it, which would reduce his taxable estate dollar for dollar.

Note: Instead of transferring the assets to a FLIP, an IDT or other irrevocable trust might be used, depending on the exact facts and circumstances.

You Want To Create Additional Wealth Without Risk

This strategy has a number of variations, all legally taking advantage of the tax law and the favorable economic possibilities if you (or your spouse, or both) are insurable for life insurance.

For example, consider Jim and his wife Jane, both 70 yr. old and with a large portfolio of conservative cash-like assets—stocks, bonds, municipals, CD, etc.—which they will never need to maintain their lifestyle. However, Jim hates that the IRS will get 35 percent or more in estate taxes when he and Jane die.

Strategy 1: Jim and Jane gift $6 million to a FLIP, which purchases $21 million of second-to-die life insurance on Jim and Jane. The FLIP limited partnership interests are gifted to their kids (valued at $4.2 million for tax purposes). Result: The $6 million leaves their estate, so when Jim and Jane go to heaven, the kids receive $21 million tax-free.

Strategy 2: Same facts as above, except this time the $6 million gift goes to a family foundation created by Jim and Jane. The foundation purchases the $21 million in life insurance, which Jim and Jane leave to their alma mater. This saves Jim and Jane about $2.1 million in federal and state income taxes due to the $6 million contribution to their foundation. They’ll use the income from the $2.1 million (and principal, if necessary) to buy $8 million of life insurance in an irrevocable life-insurance trust. Result: The foundation receives $21 million, tax-free; the family keeps $8 million, or more—$6 million, tax-free.

Tick Tock

The clock is ticking. By the time you read this, you will have little more than a year to take advantage of the new law. What are you waiting for?

Any questions or concerns? Call me: 847/674-5295. MF
Industry-Related Terms: Die, Run, Transfer
View Glossary of Metalforming Terms

Technologies: Management

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