It’s December.  The holiday season is a time of families and gift-giving.  It is also the time of tax planning and annual exclusion giving. 

The annual exclusion refers to the amount a person can give away, to as many people as they wish, without the gift being considered “taxable” for purposes of the Federal Gift Tax. Under Section 2503(b) of the Internal Revenue Code, in 2012 each person may give (cumulatively throughout the year) up to  $13,000 to anyone else without the gifts being treated as taxable.  The amount of the annual exclusion is determined by adjusting the exclusion for the 1997 base year of $10,000 for inflation.  The IRS has already announced that for 2013 (Rev. Proc. 2012-41), the annual exclusion will be $14,000. 

So a couple with two children could give away $52,000 to their children (each parent giving each child $13,000) this year without any of those gifts being considered taxable.  If the children were married themselves, the parents could give away $104,000 in 2012.  The exclusion does not require any relationship between the donor (giver) and the donee (recipient), so gifts to a friend (or even a stranger) are not a problem.

Generally, each donor has to make his or her gift from his or her own assets.  However, if the couple is married, one spouse can allow the other to use his or her exclusion by “gift-splitting”.  So, instead of each spouse giving $13,000, one spouse can give $26,000.  This would generally occur when the spouses are using one of their separate assets to make the gift.  Beware, however, that to “gift-split”, each spouse must file a Federal Gift Tax Return.   

In addition to the Annual Exclusion, under Section 2503(e), a donor may make unlimited gifts in the form of qualified transfers for tuition or medical expenses.  A qualified transfer for tuition is a payment made directly to a qualifying educational organization for the tuition of a full or part-time student.  The exclusion does not apply to non-tuition expenses such as room and board.  A qualified transfer for medical expenses is again the direct payment of the expense.  The exclusion applies to medical expenses for the diagnosis, cure, mitigation, treatment or prevention of disease, but also includes amounts paid for medical insurance for the donor.  However, it does not apply to amounts which would be reimbursed by the donee’s insurance.  These unlimited exclusions from gift tax can provide valuable tax planning opportunities to donors.

Annual exclusion gifts and qualified transfers for tuition and medical expenses can be a valuable part of a person’s estate and wealth preservation planning.  However, it is important to understand the overall impact of these gifts on your estate plan, your taxes and tax reporting, and your short and long term financial situation.  As such, it is always a good idea to discuss these types of gifts with your Attorney, Accountant and Financial Advisor before taking action. 

As part of National Estate Planning Awareness Week, we’ve posted a series of items on estate planning issues.  Check out the series Introduction, the post on Beneficiary Designations, and the post on Joint Property.  

This time, I am writing about estate planning for young adults, particularly those in their late teens and twenties such as college students or recent graduates.  Now these people are unlikely to need sophisticated wills, trusts, or tax planning, but that doesn’t mean that they should ignore estate planning.  Remember estate planning is about much more than the documents, it is about understanding your assets and having a plan for you and your assets if you become incapacitated or die.

At the very least young adults should have Powers of Attorney for both financials and health care matters and should seriously consider an advanced directive for health care (living will), because once a child turns eighteen his or her parents lose the legal ability to make decisions on the child’s behalf.  If a young adult (perhaps a college student) gets into an accident and is seriously injured the parents (or another person) may not be able to make decisions about the student’s care, or possibly even get information about the student’s treatment, without a valid Health Care Power of Attorney.  Also, the parents will not be able to access the student’s finances, or make financial arrangements on his or her behalf without a financial Power of Attorney.  

Now, whether young adults need a Will is a more complicated issue. Having a Will is preferable, but for a young adult whose assets may total only a few thousand dollars (or less) and possibly a net worth below zero, choosing to not have a Will may not be unreasonable. However, young adults who choose not to have a Will, should at least understand what property they have, and where it would go if they were to die (i.e. the laws of intestacy).  In Pennsylvania, if a person has no spouse and no descendants, the property is distributed  in equal shares to the parents.  If that is consistent with the young adult’s intent, perhaps choosing not to have a Will is reasonable.  The key is that the person needs to understand the impact of not having a Will, and make that choice.  

It is worth noting that estate administration, and the associated legal fees, tend to be somewhat higher than for intestate estates, as compared to estates where the decedent had a Will. 

Also, as noted in our prior post, Beneficiary Designations on retirement accounts are important aspects of estate planning, and a young adults who have been in the work force should review these forms for any 401(k)s or other retirement assets (or less likely life insurance) they have.

If you have questions about estate planning in general, or would like to meet with us about creating, changing, or just updating your estate plan, or are interested in learning about transfer tax planning, please contact Tim White or one of our other estate planning attorneys to schedule a consultation.

We kicked off our blog series on Estate Planning, in honor of National Estate Planning Awareness Week, with an introduction to what estate planning is, why it’s important, and what it involves, check out that post here.

Yesterday we turned to Beneficiary Designations for retirement assets and life insurance and discussed why these are so important to Estate Planning.

Continuing our series on Estate Planning, today we’ll discuss joint ownership of property.  

There are three main types of joint ownership, Tenants by the Entireties, Joint Tenants with Rights of Survivorship, and Tenants-in-Common.  

Tenants by the Entireties is only available to married couples, and it is the default way married couples own property.  Property owned “by the entireties,” is owned by both spouses in whole, and when one spouse dies the property passes to the surviving spouse by operation of law (outside the deceased spouse’s probate estate).  This also means that one spouse cannot give the property to a third-party by Will (or really any other document) without the other spouse’s consent.  One important aspect of Tenants by the Entireties property is that the property is generally not available to creditors unless both spouses are liable for the debt. 

Joint Tenants with Rights of Survivorship is similar to Tenants by the Entireties, however it is used for non-married persons.  Each joint tenant has equal rights to the whole, and on the death of one joint tenant the property passes automatically to the surviving joint tenant(s) (again this occurs outside the decedent’s probate estate).  However, a joint tenancy can be severed or terminated by any of the Joint Tenants, by obtaining a judgment for the partition of the property, by a joint tenant selling his or her interest, or by execution of a judgment against a joint tenant’s interest in the property.  If a Joint Tenancy is severed or terminated it becomes a Tenancy in Common.

Tenants in Common is very different from the first two, because each Co-Tenant has a dividable interest in the property.  Also, the interests do not need to be equal (i.e. halves, or thirds), but often are.  Importantly, there are no survivorship rights in a Tenancy in Common, and on the death of a Co-Tenant that property becomes part of the decedent’s probate estate.  For example, if siblings own property as Tenants in Common and the sister dies, the sister’s interest passes with the rest of her probate property in accordance with her Will (or by intestacy is she doesn't have a Will). 

While not technically a form of joint ownership (and I think increasingly rare) I want to touch on Life Estates and Remaindermen.  A life estate is an interest in property wherein the life tenant has exclusive possession and use of the property during his or her life.  On the life tenant’s death the property passes to the remaindermen by operation of law and outside the life tenant’s probate estate.  While a life tenant can generally sell, lease, or mortgage his interest in the property, he can only do so with respect to his life interest, which can make such transactions difficult, in a practical sense, without the consent of the remaindermen.   You cannot properly plan for your estate if you do not understand how property is owned, and thus how it passes on your death.  Also, each of these forms of ownership can be used in the estate planning process to achieve different objectives such as probate avoidance, asset protection, estate equalization, business succession, and even tax planning.  That said, there are often alternatives to joint ownership of property which may in a particular instance make more sense, such as the use of leases, installment sales, partnerships or other business entities, and trusts.

As always, if you have questions about estate planning in general, or would like to meet with us about creating, changing, or just updating your estate plan, or are interested in learning about transfer tax planning, please contact Tim White or one of our other estate planning attorneys to schedule a consultation.

On Friday we kicked-off our series for National Estate Planning Awareness Week, check out that first post here.  Today I’ll talk about Beneficiary Designations! 

Beneficiary designations on retirement accounts and life insurance policies are an important part of your estate plan.  These are important documents because the designations (not your Will), govern the disposition of these assets on your death.  The documents are also important because for many people retirement assets and life insurance policies may make up a substantial portion (and perhaps a majority) of their wealth.  

There have been many instances where a decedent’s failure to coordinate his or her beneficiary destinations with the rest of the estate plan has led to unintended results.  You could end up leaving retirement assets to an ex-spouse, or unintentionally disinheriting newly born children or grandchildren.  In addition, if you name a beneficiary who is a minor, someone may end up having to go to court for the appointment of a guardian for the child.  However, if the beneficiary is a trust for that minor’s benefit, the problem of having a guardian appointed is eliminated.

If you fail to name a beneficiary, the plan or policy documents may determine where the assets go.  Some plans will require distribution of the asset to your probate estate (which can increase administrative costs and taxes), other plans may provide for direct distribution to your spouse or heirs (but not necessarily in the manner you intended).  In either case, you lose control.  

So when developing your estate plan, and every time you review it, make sure you coordinate your beneficiary designations on retirement assets and life insurance.

Next Week, October 15-21, is National Estate Planning Awareness Week!

Antheil Maslow & MacMinn encourages you to use this as an opportunity to discuss estate planning with your family, your attorney, and your other professional advisors.  To help get you started, during National Estate Planning Awareness Week we will be posting on a number of important estate planning issues.  As a Prologue, I'll talk today about what estate planning is, why it is important, and what it involves.   

We spend most of our lives working hard to earn money and accumulate wealth so our needs, and the needs of our families and loved ones, are met.  “Estate planning” involves the organization of your financial and legal affairs so that when you die your family and loved ones continue to benefit (in the manner you choose) from the assets and wealth you have accumulated.

Incomplete, or improper, estate planning can have devastating results.  The wrong people may inherit your property, family members may be required to go to court to obtain guardianships, and otherwise avoidable taxes may be paid.  In addition, the costs of dealing with these issues after death can deplete the assets you intended to benefit your loved ones.  Of course, poor planning can also increase the likelihood of disputes between beneficiaries, and destroy previously healthy and happy family relationships.

Proper estate planning, on the other hand, ensures that your beneficiaries receive the property you want them to have, in the manner you intend them to have it.  It reduces the cost of administration by organizing your property, and its disposition, in advance.  It provides protections to avoid unnecessary court intervention, costs, and taxes.  And, while estate planning cannot solve long standing family issues, it can provide clear guidance on your intent and goals which can reduce the chances those issues will lead to litigation over your estate.

Proper estate planning requires that you know what property you own, how much it is worth, how you own it, and how it is legally disposed of at death.  As a result, there are almost always some financial planning and accounting issues to deal with in the process.  Qualified and trusted financial advisors and CPAs are great resources and should be part of your estate planning team.

Attorneys are critically important advisors in the estate planning process, because it requires the structuring, drafting, and coordination of the numerous legal documents which can affect the disposition of your property.  The most basic document involved is your Will, but it is not the only document you need to consider.  Other documents which may need to be reviewed, created, or changed include: trusts, deeds, account ownership and beneficiary designation forms, insurance policies, employment and business agreements, and even vehicle titles and documentation on your tangible personal property.  The interaction of these documents can be very complicated, and ad hoc planners and do-it-yourselfers often create more problems than they solve.   The value of a good estate planning attorney is in the advice, planning, and coordination of the overall estate plan, not just the drafting of documents.

Of course, proper and complete estate planning should also address the possibility that you may become incapacitated before you die.  To address the issues related to your finances, your health care, and your end-of-life decisions an estate plan should include Powers of Attorneys, Health Care Powers of Attorney, and a Living Will (Advanced Directive for Heath Care). 

See the rest of this series:  Beneficiary Designations; Joint Ownership of Property; Estate Planning for Young Adults.

If you have questions about estate planning in general, or would like to meet with us about creating, changing, or just updating your estate plan, or are interested in learning about transfer tax planning, please contact Tim White or one of our other estate planning attorneys to schedule a consultation.

With less than 5 months remaining in 2012, we have had many clients take advantage of the current $5,120,000 exemption from federal estate taxes by engaging in some form of lifetime gifting. We have helped clients to establish Family Limited Partnerships (FLPs), Grantor Retained Annuity Trusts (GRATs), and Intentionally Defective Grantor Trusts (IDGTs).   In many cases, multiple strategies have been combined to provide the client with additional planning benefits, including the potential for even greater estate tax savings. 

Although the above strategies are excellent ways to take advantage of the current planning opportunity, we have also been encouraging our clients to consider using Qualified Personal Residence Trusts (QPRTs).  For those not familiar with a QPRT, it is simply the transfer of a personal residence to a trust, wherein the donor retains a right to reside and use the residence for a term of years.  At the expiration of the term, the real estate passes to the trust beneficiaries or is held in further trust for them.  The QPRT provides for an initial discount on the gift because of the donor’s retained right to live there and it also allows any appreciation in the value of the property to move out of the donor’s estate tax free.  However, when discussing the QPRT strategy with fellow estate planners, CPAs, financial advisors, and in some cases, even the clients themselves, the strategy is often dismissed out of hand, on account of the low interest rate environment we are in.  The stock response I usually get is… “QPRTs work better in high interest rate environments.”  In many ways, the low interest rates have caused the QPRT to be forgotten.  But it should not be.

While it is true that low interest rates decrease the value of the retained interest (right to live in the property for a term of years), which increases the value of the gift, there are a few factors currently in play which mitigate the higher gift value assigned to the transfer.  The primary factor is the depressed real estate values.   Most of our clients’ primary residences are located in Bucks and Montgomery counties, the Philadelphia suburbs, Princeton, New Jersey, and the Saucon and Center Valley areas to the north. Their vacation residences are often located in Florida or at the Jersey Shore.  These locations are very desirable places to live and vacation, yet such properties are being appraised at 25%-50% below market values from just a few years ago.  While we do not have a crystal ball, we feel such properties have the potential to increase in value, with such appreciation outside of the Donor’s estate. This would likely make up for the smaller discount attributable to the current low rates.

Another major factor in favor of using a QPRT, even in this low interest rate environment, is the current $5,120,000 lifetime exemption from federal estate tax.  This unprecedented exemption makes the smaller discount on the gift less problematic than in prior years when the exemption was substantially lower.  In my experience, the donor often does not feel as compelled to drive down the value of the gift given the larger exemption the donor currently has to work with.

Finally, gifts of fractional interests in real property allow for discounting of the gifts to the QPRT.   Assuming clients don’t mind the added complication and cost associated with gifting fractional interests to two separate QPRTs, the transfer of fractional interests adds value to the trust. 

Similar to a GRAT, a donor who transfers real property to a QPRT must survive the QPRT term for the strategy to work.   However, like a GRAT, a QPRT is as close as you can get to a no lose proposition in that, if the donor does not survive the term, the donor is in no worse position than if the donor had done nothing, except of course for the legal fees incurred to implement the strategy.

One advantage the QPRT has over the GRAT or the FLP is that the strategy has not been under attack in recent years, and if done properly will be a safe harbor.  Additionally, some clients feel more comfortable gifting an asset that is not generating income, which is the case with most personal residences.  The retained right to live at and use the residence for a number of years also provides a measure of security not found with outright gifts.  Finally, upon the end of the term, the QPRT will usually provide that the donor may lease the residence from the QPRT or the trust remainder beneficiaries.  This provides another mechanism to move additional assets out of the donor’s estate (via rent) without using any gift tax exemption.

These are exciting times for estate planning, but the current opportunities may not be available on Jan 1, 2013.  Some have even described the situation as the perfect storm, and in many respect it certainly is.   So please carefully consider the use of GRATs, FLPs, and IDGTs, before year end, but don’t forget the QPRT.

Estate Planning and Elder Law practitioners in Pennsylvania routinely recommend to clients that they execute a Durable General Power of Attorney naming an agent to be empowered to act on their behalf as an essential estate planning instrument.  At a recent seminar presented, in part, by Montgomery County Judge Ott, he outlined what he considered the standard to determine capacity for the principal who is executing a Pennsylvania Power of Attorney.

The Principal must:

1. Understand the nature of the authority delegated to the Agent(s); and
2. Understand the nature of his or her assets to be delegated to the Agent(s); and
3. Understand the meaning of the Power of Attorney Notice now required for all Power of Attorneys.

The attorney should establish and document that all three of these standards have been met in order to avoid the instrument being overturned (invalidated, revoked) on the basis of incapacity, which could expose the attorney and/or the Agent to complications and possible liablility.

My wife and I are expecting our third child any day now, so when I saw Erik Canter’s post over at Forbes.com on financial and estate planning for new parents it caught my attention.  It is generally a good article, with solid advice.  He suggests that new parents update their estate plans, which includes their Wills and/or their Revocable Trust documents, powers of attorney and living wills, and any beneficiary designations for retirement accounts and life insurance.  He also suggests that parents re-evaluate life insurance coverage, review the family budget, and begin planning for college expenses.  These are all important steps for new parents.

However, there is one critical error in Erik’s advice.  He appears to suggest that parents should name their child (or children) as a beneficiary of life insurance and retirement benefits directly, which is almost always a terrible idea.  This is because minors are not allowed to manage their own property, and if on the parent’s death a minor child is designated to receive insurance proceeds or retirement benefits directly, a Court will have to appoint a Guardian of the Estate to hold the property for the child until adulthood.  

Having a Guardian of the Estate appointed requires formal legal proceedings which will produce additional legal fees (usually well in excess of the cost of planning to prevent the situation).  Also, the time it takes to obtain an appointment of a Guardian of the Estate may cause delay in the distribution of funds which are often needed for the child’s immediate care.  In addition, in Pennsylvania, a surviving parent may not be appointed as sole Guardian of the Estate (i.e. a co-guardian is required).

Just as troubling, when a child turns eighteen the Guardian is legally required to distribute all of the property to the child directly.  I think that generally speaking, teenagers do not have the life or financial skills required to manage significant wealth.  Also, if life insurance was intended to provide for the child’s higher education, distributing the proceeds (perhaps hundreds of thousands of dollars or more) at age eighteen may have the exact opposite effect.

It is far more advisable to name a trust for the child as the beneficiary.  The trust can be established in the parent’s Will, as part of a Revocable Trust, or even as a stand-alone document.  Using a trust reduces the chance that a Guardian of the Estate will need to be appointed and allows parents to ensure a trusted adult will have control of a child’s inheritance until the child is old enough and mature enough to handle the responsibility.  

It is very important for parents to update their estate plans when they have a child, and beneficiary designations are critical components of a comprehensive estate plan.  That is why parents should make sure their designations name trusts for their minor children as the beneficiaries, and never as the beneficiaries directly.

A recent post by Deborah Jacobsat Forbes.com discussed Facebook’s founder, Mark Zuckerberg’s possible use of tax planning techniques to make large tax free gifts. Ms. Jacobs’ post points to footnotes, contained in the offering statement, which indicate Zuckerberg and several other Facebook executives are each a trustee of their own annuity trust. Jacobs believes these footnotes suggest each of them have established a grantor retained annuity trust (GRAT), and I think that is a reasonable inference. GRATs can be a very effective wealth transfer tool, particularly where rapidly appreciating assets are used. I think stock in a company which has changed the way a large portion of the population interacts with each other qualifies as such an asset, even more so when the stock will soon be offered in the largest tech IPO in history.

A GRAT, for which there is expressed authority in the tax code, involves the transfer of assets to a trust in exchange for an annuity payment for a set number of years. The value of the annuity interest is calculated based on the size and term of the annuity, along with an imputed interest rate prescribed by the IRS (the section 7520 rate). The difference in value between the assets transferred and the annuity interest retained by the Settlor is a gift, but if the values are the same there is no gift.

This is where the magic comes in. If the assets transferred appreciate at a rate higher than the section 7520 rate, which is currently 1.4%, the trustee can make all of the required annuity payments and all the excess appreciation is effectively transferred with no gift tax liability. Between 1965 and 2005 the average rate of return in the first 21 days following an IPO was 22%.

Jacobs suggests that Zuckerberg transferred a little over 3.6 million shares at a value of $0.83/share for a total value just above $3 Million. She assumes that the Facebook stock appreciates 3.6% for 4 years, and in year five the company goes public at $40/share. At the end of a five year GRAT term, Zuckerberg’s trust could hold more than $37 Million worth of stock, without incurring gift tax, a potential $17 Million in tax savings for his heirs.

But you do not need to be worth $17.5 Billion (Zuckerberg’s estimated wealth) to make a GRAT work for you, and you don’t have to own the next Facebook. At AMM we have helped clients who own companies whose stock is expected to appreciate in the near to mid-term use GRATs with great effectiveness.

As a general illustration, let us take a corporate executive (unmarried with a net worth of $8 Million), who over the course of several years has received stock grants as part of his compensation for a privately held company. The stock, valued at the IPO offer price, is worth $1,000,000. If that executive transferred his stock into a GRAT this month and took back approximately $150,000 for 7 years, there would be no gift on the transfer. If the Trustee then cashed out the stock interest in the first three weeks following the IPO, invested the proceeds and earned 5% a year, at the end of the GRAT term the trust would own assets worth $470,000, a potential $211,000 in tax savings.

In addition, the estimated tax savings do not include the possibility of a lower valuation if the transfer is done several years before the IPO is planned, and if the Trustee thinks the originally held stock will out-perform the market (maybe it is Facebook stock) there is no requirement to liquidate and diversify. Also, the estimated tax savings do not take into account possible valuation discounts which may be available on transfers of minority interests in private companies (which can easily be 30% or more). With respect to the above example, $211,000 is probably a conservative estimate of the savings produced by a well designed GRAT.

Moreover, you don’t need to be looking at an impending IPO to use a GRAT. Any asset which is expected to appreciate at a rate above 1.4%, or an asset which currently has a depressed value, but is expected to rebound, may also be good. Closely-held stock, real estate, and even a portfolio of publically traded securities are assets which can be used to fund a GRAT.

The GRAT is one of many tax planning techniques that can be used by wealthy taxpayers to reduce their tax burden. By Ms. Jacobs’ estimates, Mark Zuckerberg and his colleagues may have used GRATs to transfer almost $205 Million dollars without tax; potentially saving them nearly $92 Million in taxes. All wealthy taxpayers have this same opportunity, now that is something to “Like”.

My colleague, Alan Wandalowski, has some additional commentary on opportunities with GRATs, here.

The IRS has released the new applicable federal rate tables for March 2012, and they remain the same as they were in February.  The Short Term (0-3 years) rate is .19%, the Mid-Term (3-9 years) rate is 1.08% and the Long Term (9+ years) rate is 2.65%, with annual compounding. The I.R.C. § 7520 Rate, used to calculate the value of annuities, life interests, and remainders, remains at 1.4%See Rev. Rul. 2012-9.

It continues to be a favorable environment for Federal Estate, Gift, and Generation-Skipping Transfer tax planning, as the use of many common estate freeze techniques including grantor retained annuity trusts (GRATs) and installment sales to grantor trusts (IGTs) work best when interest rates are low.