The IRS has released the Applicable Federal Rate tables for June 2012, and the rates remain very low.
The annually compounded Short-term (0-3 years), Mid-term (3-9 years), and Long-term (9+years) rates are .23%, 1.07%, and 2.64% respectively, and the Section 7520 Rate (used to value annuities, remainders and reversions is 1.2%.
It continues to be an excellent time to use intra-family loans and estate freeze transactions for income, gift, and estate tax planning.
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.
It is not a happy topic, but divorce happens. And, January apparently has the greatest number of divorce filings. When going through a divorce a person’s entire life is rearranged, and there is often a complete reorganization of personal and financial affairs.
One important, but sometimes overlooked, part of that reorganization is updating the estate plan in light of changed circumstances. A new Will, Power of Attorney, and Living Will are essential, but just as essential are updates to any beneficiary designations on life insurance and retirement accounts.
While not a reason to delay updating an estate plan, the good news is that both Pennsylvania and New Jersey have laws providing that an ex-spouse’s interest in a decedent’s estate is nullified. The bad news is that these laws do not apply to plans and benefits governed by the Employee Retirement Income Security Act, commonly known as “ERISA”. This means if your 401(k) or 403(b), or your employer provided life insurance names an ex-spouse as beneficiary, the plan administrator is required to pay the money or benefits to the ex-spouse. This has, and will continue to, cause disputes among family members. Particularly, where there are children from different relationships involved.
The United States Supreme Court ruled on this issue in Egelhoff v. Egelhoff, 532 U.S. 141 (2001), and held that ERISA preempted a Washington State statute, which automatically revoked a spouse’s (or domestic partner’s) interest the in life insurance or retirement benefits of the other on dissolution or invalidation of the relationship. The Egelhoff case has been followed numerous times, including other Supreme Court cases, as well as cases in the United States Court of Appeals for the Third Circuit (which includes both PA and NJ), and the Pennsylvania Supreme Court.
In 2009, the Supreme Court decided Kennedy v. Plan Administrator, 555 U.S. 285 (2009), where both a decedent’s ex-wife and the executor of the decedent’s estate (his daughter from a prior marriage) claimed the decedent’s benefits under a company administrated savings and investment plan (SIP). While the ex-wife had waived her interest in the SIP in the divorce, the decedent never changed the beneficiary designation form with his employer; the plan administrator followed the designation on file and paid the benefits to the ex-wife. The Supreme Court held that the ex-wife’s waiver to the benefits was not invalid, but that because the wavier was not part of a Qualified Domestic Relations Order (QDRO), the plan administrator was obligated to follow the plan documents and pay the benefits to the ex-wife. In a footnote, the Court stated that it was not opining on whether, and left open the possibility that, the Estate could bring an action directly against the ex-wife for the benefits received.
And, just this past November the Pennsylvania Supreme Court, in In re Estate of Sauers, held that a Pennsylvania statute, 20 Pa. C.S.A. § 6111.2, which in effect, revokes an ex-spouse’s interest in the life insurance or retirement accounts of a decedent (similar to the Washington statute addressed in Egelhoff), is preempted by ERISA with respect to the plans ERISA governs. Going further, the Pennsylvania Supreme Court found that the right of private action against an ex-spouse for benefits paid by the plan administrator provided by the Pennsylvania statute was also preempted by ERISA and was invalid.
The bottom line, if you or a client has been through, or is currently going through, a divorce estate planning should be at or near the top of the list of priorities. And, when updating an estate plan, beneficiary designations are as important as your Will and other documents.
UPDATED 1/19/2012:
The IRS has released the applicable federal rate tables for February 2012. The rates remain virutally the same, with the 7520 Rate at 1.4% and the lowest short term rate at .19%. Check out Rev. Rul. 2012-7.
AFRs remian low in January ---
The IRS recently released the AFR (applicable federal rate) tables for January 2012. Rates continue at historic lows. The 7520 Rate, which is used to value a taxpayer’s interest in many common estate planning structures, such as the grantor retained annuity trust (GRAT) is only 1.4%. Other rates are similarly low. Certain loans, typically made between family members, can be made at rates as low as .19% without triggering imputed interest income to the lender.
The low interest rate environment means that there continues to be opportunities for wealthy individuals and families to engage in Federal Estate Tax planning.
Check out the January AFR Tables here.
After a Wednesday night meeting between legal counsel for West Vincent Township and the Ludwig's Corner Horse Show board. The Supervisors voted today, Friday, to rescind the resolution authorizing condemnation proceedings for the horse grounds.
It appears the Township is still interested in the property, and has asked the Horse Show for, among other requests, a right of first refusal on any sale in the future.
Get more information, here and here.
West Vincent Supervisors to Meet with Horse Show Board, but Refuse to Rescind Condemnation.
Dec. 13, 2011 -
Nearly 300 supporters of the Ludwig’s Corner Horse Show turned out on Monday night to voice displeasure with West Vincent Township Supervisors. The crowd wanted action, specifically a vote on the rescission of the Township resolution to take the horse show grounds through the use of eminent domain. Some in the crowd held signs which read, “Rescind or Resign.” However, despite the large turnout and lengthy public comment on the matter, the Supervisors told the crowd that no vote on rescission would occur. Instead, the supervisors stated that a meeting with the board of the Horse Show would occur on Wednesday. More information available here.
With the way things are going do not count on a quick resolution of this matter, and prolonged litigation may be inevitable. If the Township Supervisors pressed forward with eminent domain now, hoping to acquire the land at a bargain because of a depressed real estate market. They may have miscalculated. Extended litigation on the matter could eat into any potential savings, and it may cost more in the end.
In a related matter, Township Supervisor Clare Quinn was fired as executive director of the French and Pickering Creeks Conservation Trust, according to reports the firing was because of, “a fundamental conflict with the trust’s long-standing mission of voluntary land conservation.”
UPDATED Dec. 7, 2011
The friends and supporters of the Ludwig's Corner Horse Show are encouraging people to attend the December 12, 2011 supervisors' meeting at the West Vincent Township Building. The meeting is scheduled for 7:30 p.m. Two of the supervisors have reportedly committed to supporting the rescission of the resolution calling for the initiation of condemnation proceedings on the horse show grounds, which passed at a previous meeting.
Dec. 6, 2011
The West Vincent Township Supervisors’ Meeting Monday night was attended by nearly 100 members of the equine community opposed to the Township’s plan to use the power of eminent domain to condemn the Ludwig’s Corner Horse Show Grounds and turn it into a township park. The supervisors told the crowd that they would vote on rescinding the condemnation resolution issued last week at a future meeting, to be held at a larger venue to accommodate the large number of attendees expected. The supervisors said that they didn’t vote on whether to rescind the resolution Monday because one of the Supervisors, Ken Miller, was not in attendance.
Check out more coverage here and here.
It looks like the Township will move to eventually purchase the horse show grounds one way or the other, regardless of the supervisors’ vote. The issue is really only whether the township will negotiate the purchase with the property owner directly, or will use eminent domain to take the property. Challenging condemnation based on eminent domain is difficult, particularly where the government seeks the property for a public use, but the Property Rights Protection Act limits the government’s ability to condemn property for private business. It is unclear whether the taking of Ludwig’s Corner would implicate the private business limitations. The township’s press release states that they will use the property for a public park to fulfill the vision of, “a compact, walkable, traditional village center containing a blend of municipal, commercial and residential uses.” The more likely point of contention will be the value of just compensation for the property taken. If the township doesn’t make a deal with the Ludwig’s Corner owners directly, the issue of compensation will be settled in court.
December 2, 2011 – Yesterday evening West Vincent Township supervisors announced the township’s plan to condemn the 33 acre facility owned and operated by the Ludwig’s Corner Horse Show Association (LCHSA). The township says that it plans to turn the grounds into a township park, using some of the property for playing fields for youth sports. However, the township says that it wants to maintain the equine facility and will work with the LCHSA to continue the annual horse show and other equine activities. Some LCHSA supporters are upset about the township’s discussion, so there may be a legal battle ahead. These are developing issues, and we’ll try to keep you informed about the legal issues implicated.
See the West Vincent Township press release here.
Follow the story with The Mercury, here.
Recently, the media has brought a lot of attention to the expiration of the 2011 payroll tax holiday, which reduced for this year only an employees tax to 4.2%. As it stands, the tax holiday will end and payroll taxes will be increased to 6.2% beginning January 1, 2012.
However, the media has given less attention to the expiration of a number of other tax incentives designed to increase investment, create jobs, and encourage philanthropy. The expiring provisions include these five, and many others.
- The 15 year depreciation schedule for qualified leasehold improvement property, qualified restaurant property, and qualified retail property under Section 168(e), for property placed in service after 2011, will generally be increased to 39 years.
- The 100% bonus depreciation allowance for certain qualified property under Section 168(k)(1) and 168(k)(5), will be reduced in 2012 to 50% for most property.
- The expensing election under Section 179, $500,000 in 2011, will be reduced to $139,000 in 2012.
- The Work opportunity tax credit (WOTC) under Sec. 51(c)(4) expires (except for qualified veteran hires).
- The elimination of enhanced charitable contribution deductions for food, books, and computer equipment under Section 170(e).
Congress could step in and extend some or all of the expiring tax incentives, and there are several current proposals with respect to the payroll tax holiday. However, it is hard to have confidence that Congress can agree on anything these days. It may only be December 1, but the holiday could be over.