February Estate Planning Notes
February 1, 2000
Probate avoidance techniques continued
Life insurance - contract between owner (often, but not necessarily the same as the insured) and the insurance company (the insurer). In exchange for payment of premiums the insurer will pay to a beneficiary proceeds when the insured dies.
Reasons people have life insurance
a.. to provide money for families; to pay off expenses (taxes, mortgages, liens, etc.) otherwise the payments might not be made and the creditors would get the property.
b.. replace income of decedent
insurance proceeds do not go through probate
1.. way to avoid time lag - within 2 weeks from time of death you can get insurance proceeds
2.. proceeds are not subject to creditors of the decedent - pay only to named beneficiaries
3.. proceeds can be a funding method for buyout upon death type arrangements
4.. companies take out life insurance policies on key employees
Have to have a reason for other person to live in order to get life insurance on someone’s life. Called an insurable interest.
-/- everyone has an insurable interest in their own life
-/- parent/child is an example of owner and insured being different people
Three things to know about life insurance:
what a life insurance policy is?
why you would want one ?
need an insurable interest
Term Life Insurance - insurance during a specified period of time; if death occurs during term then beneficiaries get the proceeds
a.. cheapest form of life insurance
b.. the younger and healthier you are, the cheaper the insurance
c.. as you get older, the premiums will go up; renuibility problems if your health deteriorates; good to look for guaranteed renuewability
whole life policy - in the beginning you pay more than the policy is worth because they need to have the money available because you will be underpaying in the later years of the policy; called the cash value of the policy (a reserve); also called cash surrender value
-/- if cash value is big you can surrender the policy and get it back
-/- can also use cash value as collateral for a loan, mortgage; some companies will let you borrow the cash value
joint life policies - can organize first to die or last to die
a.. first to die - second insured person gets the proceeds; goal is the protection of the surviving spouse; used by married folks without a family they are worried about supporting
b.. second to die - protects children (most common situation); married folks with families they want to protect
Insurance is a method of forcing people to save money; but you are also overpaying for what you are getting
Insurance agents like whole life policies better because they get bigger commissions.
Term insurance policies are getting to be most popular.
Universal life policy - cash value earns a competitive rate of return; becomes much more like an investment vehicle
Variable life insurance - insured gets to manipulate the investments to some extent; insured determines where cash value is placed
Life insurance can save a huge amount of tax
Other concerns - effect of a divorce on life insurance
Very common to combine a trust technique with life insurance
-/- name beneficiary trustee of trust and owner/insured is settlor of trust
Most states require beneficiary to outlive by a certain length of time
How much life insurance is enough? 5 times annual income is common figure but also depends on other factors.
Very important to look at beneficiary designation form for life insurance
Annuities - give all money now to company, and then the company agrees to pay you for the rest of your life. Annuities protect you from living too long. They pay no matter how long you live.
Annuitant pays money to company - then the annuity company pays you monthly payments.
In some cases you can make private annuities - give money to family member in exchange for monthly payments
Wisdom of buying an annuity (usually for older clients) - what kind of annuity to buy?
1.. look at how much the person wants to receive
a.. if they want the biggest payout possible get straight life annuity - pays only for annuitant’s life
i.. also provides biggest profit for company if you die early
b.. refund annuity - pays for annuitant’s life, but if annuitant dies before getting back investment, then named beneficiary gets balance of investment; you will get smaller monthly payments under this plan compared to a straight life annuity
c.. life annuity with a term certain - buy for term and you know for sure you will get a minimum of payments for term of years; so even if you die earlier you will get the payments (the beneficiary gets those payments)
d.. joint life and survivor annuity - annuity pays until the last spouse dies; one of the most common methods; payments will be smaller; payments are the lowest - because you have two people and company does not stop paying until both are dead
2.. some policies have inflation adjustment and investment adjustment
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February 3, 2000
More on probate avoidance techniques
Retirement planning
Employment retirement income security act (ERISA)
1.. If you comply with the rules in ERISA and IRS then you can achieve great tax benefits
2.. if it complies with the governmental rules then it is called a qualified plan
Benefits of having a qualified retirement plan
1.. contributions you make out of your income is not taxed as your income
2.. as contributions continue to grow, that income will not be taxed either, instead contributions and interest is taxed when you withdraw it (which typically is when you are in a lower income bracket and therefore a lower tax bracket)
Types of retirement plans:
1.. defined benefit plan
a.. employee receives a fixed amount upon retiring from employer
b.. if employer goes out of business then you will loose the pension
2.. defined contribution plan
a.. employer contributes to an outside plan on the employee’s behalf
3.. cash or deferred arrangement (known as a 401k plan) (limit is $10,500 per year)
a.. employer allows employee to take part of his salary and put it into this type of retirement plan; in some cases employer may match what employee puts in
4.. Employee Stock Ownership Plan (ESOP)
a.. contributions go into trust in exchange for shares in the company
5.. KIO - HR10 plan
a.. method for self employed people to get some of the same benefits as people who work for companies get
6.. IRA - Individual Retirement Account
a.. can be used by self employed people and employees
b.. contributions are limited ($2,000 per year) and some of the benefits are limited
to lower income individuals
c.. two types of IRAs:
1.. classic - pay no tax now on contribution (limited to lower income people); don’t pay any tax on income that money earns until you withdraw it; if you did not get tax deduction on income you only pay tax on amount it earned
2.. ROTH IRA - pay tax when you make contribution but no income tax on withdrawal
7.. simplified employee pension plan - employer contributes directly to the employee’s IRA; for small employers who don’t set up their own retirement plans
Deferred compensation arrangements - if you make lots of money you pay lots of income tax. Have employer save salary for when person retires and then pay the salary when in a lower income tax bracket.
NEW TOPIC: TAX PLANNING
Wealth transfer taxation - tax on the privilege of giving and receiving property
a.. tax imposed when you make a gift when alive (gift tax) or dead (estate tax)
b.. also when you skip a generation the government imposes a separation tax
A.. why impose estate and gift tax?
1.. method of raising money
2.. earns only 1-2% of government’s revenue
3.. policy reason: redistribution of wealth - inherited money is bad; prevents
wealthy people from giving money to other’s who did not earn it
B.. ways on which transferrrable wealth can be imposed
1.. tax on privilege of giving - tax is paid by donor
2.. tax on privilege of receiving (inheritance tax) - tax paid by recipient of
property - this is done by a few states - not federal level
C.. history of tax on giving
1.. been around since Greek, Roman, Egyptian, English times
2.. Started in WWI - tax used to be imposed only in times of revenue crisis
a.. inheritance tax paid for the US Civil War
b.. 1916 - estate tax was imposed because of WWI and never been
repealed although altered and amended numerous time
c.. first tax was only on estate, if you did not own it when you were alive
then no tax; government closed this loop whole quickly
3.. 1977 - gift and estate tax got together; before they had to be planned for separately; enactment of the Uniform Estate and Gift Tax; in effect gift tax is a prepayment of estate tax; gift tax are advance payments of estate tax you own when you die
a.. if there is no transfer of property there is no tax; tax is only on transfer of property
6 Basic steps of computing the gift tax:
1.. Determine all gifts made by donor. Have 5 columns:
a.. name of item
b.. date of gift
c.. identity of the donee
d.. relationship between donor and donee if any
e.. how the gift was used
2.. add column number 6 - determine the value of each gift (fair market value on date of gift)
3.. subtract out of the list excluded gift (gifts not subject to tax)
a.. annual exclusion
b.. educational and medical expense exclusion
4.. subtract deductions
a.. marital deduction
b.. gifts to charity
5.. make adjustments that occurred before 1977 (before the estate and gift tax unification)
6.. compute the tax - add tax for all gifts donor has ever made including this year, then subtract tax made on all gift made in donors life except this year, and the difference is the tax owed this year; then subtract the applicable credit amount (changes each year)
Comprehensive overview of the gift tax steps:
1.. make list of gifts - figure out what transfers end up on the list of gifts
a.. irrevocable gifts - where donor has no right to reacquire the property or rename the beneficiary; transfer must really occur; it cannot be a promise to do something in the future; only applies to a present transfer of property
b.. transfers for less than full and adequate consideration (sell something for $10,000 worth $20,000 it is a gift of $10,000)
c.. exercise of general power of appointment for someone other than the holder or holder’s creditors (name someone other than yourself or creditors then you have now made a gift of that property)
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February 8, 2000
National Network of Estate Planning Attorneys - possible “trust mill” organization; have to pay lots of money to belong
American College of Trusts and Estates Council - reputable group; have to have been in practice for a certain number of years
Failure to exercise general power of appointment is a gift; except there is a 5 and 5 exception: if power of appointment is relatively small, you won’t have to pay gift tax. Cannot exceed $5,000 or 5% of the trust corpus
Start with presumption that failure to exercise general power of appointment is a gift
Tax free loans to family members are bad. Parent will be treated as making a gift of the interest and have to pay gift tax on that amount. Will also have to pay income tax on interest they should have got.
Support of minor children - in 1954 there were proposed regulations to tax expenditures for minor children are not taxable gifts; were never enacted; no place in tax code that says expenditures for children are tax free
Valuation of gifts - fair market value at date of gift
-/- price between willing buyer and seller - retail value
-/- know basic stock transaction valuation - mean between high and low: add high and low price for day and then take the average.
Half and asset is worth less than half its value - because you share it with someone else so not worth as much.
Take things off the list that qualify for the annual exclusion. Can exclude $10,000 worth of property per year per donee. The amount is going to be adjusted upward for inflation. But won’t go up to the next level until inflation gets to next thousand dollar level.
-/- this is the biggest way to save money because there are no limits to number of donees or the maximum amount of gifts
-/- we have 38 people in our extended family
-/- must be gifts of present interest - not gifts of future interest; so if people you want to give money to are less than 18 you probably want to put money in trust; trusts won’t work since donee has to have the ability to use posses and enjoy the money
a.. are some exceptions: the Crummey trust - way of giving the beneficiary a power of appointment, but tell them not to do it; this way they sort of have ability to use the money
b.. special exception for people under 21; called minor’s trust or 2503c trust; $10,000 can be transferred but not as much benefits as a Crummey trust - person under 21 has to be only life beneficiary; only last until they are 21
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February 10, 2000
Year end gifts should be made in some other method than personal checks. Personal checks can be revoked until they clear at the bank. If you give a check at the end of the year and the person does not cash it until the next year, it counts for the deduction in which the check was cashed.
No limit to amount you can subtract under medical and educational exclusion. All payments regardless of amount to educational institution or medical expenses are tax free gifts.
LIMITATIONS: with regard to education they must pay the school directly; with medical provider they must pay medical provider directly; with regard to education it only pays for tuition - only tuition, not books, living expenses, etc.
Next step is to subtract deductions - all gifts to spouse are tax free
Steps for determining gift tax:
1.. determine all gifts made by donor
2.. value each gift
3.. subtract excluded gifts
4.. subtract deductions
5.. adjust for certain pre-1977 gifts
6.. compute gift tax
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February 17, 2000
Life insurance proceeds - non probate asset; do not go through estate unless made payable to the estate
-/- however, a life insurance policy IS part of the gross estate
-/- if decedent no longer had ownership of the policy (incidents of ownership: ability to change the beneficiary; cancel policy and get cash value; use policy as collateral for a loan; to borrow the cash value; transfer policy to someone else) then the policy is NOT part of the decedent’s gross estate
-/- good idea for children to be owner of parent’s life insurance policy so that the proceeds from the life insurance policy stay out of the probate estate
Powers of Appointment
1.. general power of appointment (one that you can appoint to yourself, or anyone) then it IS part of your gross estate; does not matter if power was exercised or not (§2041)
2.. special power of appointment NOT in gross estate
health, education, support, and maintenance - exception to general power of appointment; not a general power of appointment if person with power can use the property for his “health, education, support, and maintenance”
-/- cannot be broader than this - DO NOT add anything else, or else the exception might not apply; otherwise the property will be part of the gross estate
if consent is needed and if the person who consents gets less property as a result of their consent, then not a general power of appointment.
If you need consent of person that created general power of appointment, then not a general power of appointment.
-/- Consent of creator rule.
Annuities
1.. straight life annuity (makes payments for you for as long as you live; stop when you die) - not in gross estate because stops when you die
2.. any other type - if there are payments remaining then the annuity is in the gross estate
a.. the amount in the estate is the present value of the gross estate; this is the amount the annuity could be sold for
Property allowed a marital deduction in the predeceased spouse’s estate
n included in the surviving spouses gross estate since it was excluded from the first spouse’s estate
if revocable transfer - they get taxed as part of the gross estate - if decedent had ability to alter, amend, terminate transfer then part of gross estate
person who transferred property retained a reversion - property will be included in gross estate if two conditions are met:
1.. donee must survive decedent
2.. decedent has reversionary interest exceeding 5% of the property
Rare because when you create a trust you have remainder beneficiaries, not the estate
Transfers with a retained life interest
Decedent transferred something but retains rights over it (such as a life estate; retained right to designate person who shall enjoy or possess the property)
Transfers made within 3 years of death - law changed in 1982 - does not matter any more; these gifts do not come back into gross estate
EXCEPTIONS:
1.. transferring life insurance within 3 years (this is why it is better to have your children buy the policy)
2.. all gift tax you paid within 3 years of death comes back into your gross estate; IRS wants to tax you on the money you used to pay the tax - because with gift tax - don’t pay tax on the money used to pay gift tax with
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February 24, 2000
Valuation of property in gross estate
Generally the value is as of time of death - does not matter what it is worth when distriubuted
1.. fractional interest discount - owning a share as a tenant in common may not be as valuable as owning it outright, so you only are taxed on your value of the property
2.. marketability discount - asset that is hard to sell; costly to find a buyer
3.. blockage discount - especially common with stock; if you own a ton of stock and try to sell it all at once the price will go demand; based on supply and demand
Alternate valuation date - 6 months after decedent’s death; can only be made if to do so would reduce the value of the gross estate and the amount of estate tax due; tax is not due until 9 months after date of death anyway, so it does not have any drawbacks to wait 6 months
-/- cannot be used to manipulate income tax basis rules
-/- must have both the value of the gross estate going down AND the estate would pay less tax
Special use valuation - Special rules for real property used for farming or in a closely held business - possible to value the property as it is being used, not at its market value
Need to be very careful about making valuations because you will be penalized if you make the wrong ones. Intentional misstatements of value will be penalized.
NEXT STEP - subtract deductions (want to have lots of deductions)
1.. marital deduction - unlimited deduction for all property passing to surviving spouse
2.. charitable deduction - gifts to charity; all of the gifts are deductible
3.. charges against the estate - for expenses, debts, taxes (such as funeral expenses), administrative expenses - reasonable compensation for personal representative, compensation to attorney serving as personal representative, court costs, appraiser’s fees, accountant’s fees, storage expenses, expenses rising from paying debts and taxes, mortgages, liens, utility bills that existed as of time of death, principal due on credit cards, interest due on credit cards up to the date of death, property taxes that accrued before date of death,
-/- general rules - if decedent owed money at date of death then it can be deducted from gross estate
4.. losses against the estate - house destroyed by fire that was uninsured, underinsured amount for property that was destroyed
Subtract gift tax payable on gifts made on or after January 1, 1977; do not subtract gift tax that was actually paid; if made before 1977 get to subtract tax actually paid, assuming the gift is still in the gross estate
Previously taxed property credit
Tax must be paid within 9 months
Form 706 - federal estate tax form (think of 6 - as in 6 feet under)
Form 709 - gift tax from (think of 9 - cats have 9 lives, this one is filed when person alive)
Most states impose an estate tax which is equivalent of the federal tax credit (known as a pickup tax) - if no state tax there would be no state credit; the amount of the credit is identical to the tax; the state tax costs the citizens nothing because it would go to the federal anyway.