12/15/09Copyright 2009 Scott Dondershine1 Estate Planning Concepts In an Age of Uncertainty Scott Dondershine, CPA, Esq. David, Brody & Dondershine, LLP (703)

12/15/09Copyright 2009 Scott Dondershine2 Introduction Status of the Federal Estate Tax Laws Summary of Basis Estate Planning Concepts –Use and Purpose of RLTs –Use and Purpose of ILITs Succession Planning for Businesses

12/15/09Copyright 2009 Scott Dondershine3 WHY DO I NEED AN ESTATE PLAN? Distribute your assets in the time & manner you intend Creditor Protection Avoid Need for Probate Incapacity Planning Prevent IRS from becoming the major beneficiary of your estate

12/15/09Copyright 2009 Scott Dondershine4 Distributing Assets in the Intended Manner How should the assets be distributed? –Outright to your children in a lump- sum? –Remain in trust until: Children/grandchildren reach certain age? Stagger distributions Longer period of time Special concerns? –Special needs trust? –Education? –Creditors? –Charity?

12/15/09Copyright 2009 Scott Dondershine5 Avoid Probate Although the states have simplified the procedures: –Still time –Still money –Still public process –Still a hassle Assets in trust avoid probate

12/15/09Copyright 2009 Scott Dondershine6 Creditor Protection Although generally does not protect grantor from his/her creditors: –Can protect kids from their creditors (two slides from now) –Divorce of a child –Bankruptcy or other creditor Exception to general rule for grantors in VA (next slide)

12/15/09Copyright 2009 Scott Dondershine7 VA Code Section TBE Property Protection for: –Assets held jointly (AS TBE) and then transferred to trusts –Personal or real property May require multiple transfers to take advantage of provision –Intermediate transfer to TBE –Then transfer to the trusts

12/15/09Copyright 2009 Scott Dondershine8 Dynasty Trusts Like a Tube of Toothpaste (Better off inside) Problem with mandatory or staggered distributions

12/15/09Copyright 2009 Scott Dondershine9 Incapacity Planning Easier to Manage Assets Through Trusts Without Trust: –Power of Attorney (“POA”) –Is the POA going to be recognized in the distant future? –Risk of revocation Do not have same risk with a trust and can specify instructions

12/15/09Copyright 2009 Scott Dondershine10 Taxes, Taxes,Taxes “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing” Jean Baptiste Colbert (King Louis XIV Finance Minister)

12/15/09Copyright 2009 Scott Dondershine11 Applicable Exclusion Amount (Unified Credit) Shelters assets from: –Estate taxes, or –Gift taxes Important to maximize use to minimize taxes Has increased as part of 2001 Tax Act Increases are then rescinded in 2011

12/15/09Copyright 2009 Scott Dondershine Tax Act Key to understand – The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) Huge act but three main points for today: –Increase in estate credit until 2010 repeal –Phase-out of tax brackets –Repeal of step-up in favor of modified basis increase

12/15/09Copyright 2009 Scott Dondershine13 Sunset? Why? Sunset provision needed to comply with “Byrd Rule” Byrd Rule permits Senators to raise points of order against “extraneous” provisions such as a budget impact beyond period covered in the applicable reconciliation measure Can waive rule if have 60 votes Republicans did not have 60 votes So, Republicans choose sunset to avoid implementation of the Byrd Rule

12/15/09Copyright 2009 Scott Dondershine14 Amount of Exclusion from Estate Taxes $ 675, $1,000, $1,000, $1,500, $1,500, $2,000, $2,000, $2,000, $3,500, – N/A: no estate taxes 2011 & after - $1,000,000* *(this is not a typo!)

12/15/09Copyright 2009 Scott Dondershine15 Phase-out of Tax Rates Highest Tax Rate: % – 45% %2010 – N/A %2011 – back to %so 55% % %

12/15/09Copyright 2009 Scott Dondershine16 Impact on Gift Taxes Credit for gift taxes does not change and is frozen at $1mm For 2010, the maximum gift tax rate is 35% - §2502 After 2010, if sunset applies then back to pre-EGRRTA rules apply (linkage to estate tax system as a “unified system”)

12/15/09Copyright 2009 Scott Dondershine17 Generation Skipping Taxes GSTT exemption: – $3,500,000 –2010 – N/A (no GST) – $1,060,000 per sunset

12/15/09Copyright 2009 Scott Dondershine18 Partial Step Up in Basis Before EGTRRA –Assets subject to estate tax but basis in all assets increased to market value on (§1014): Date of death; or Value on alternate valuation date (6 months after death) EGTRRA “repeals” the estate tax laws and for decedents dying after 12/31/09, there is no more basis increase (§1014(f))

12/15/09Copyright 2009 Scott Dondershine19 Complicated Basis Rules Since step-up repealed, there instead is a modified carry-over basis (§1022) Subject to certain conditions: –General basis increase is an additional $1.3mm –Assets to surviving spouse can receive a $3mm additional basis increase So, need to track the allocations and it can be very complicated series of computations This rule also sunsets as it is part of EGTRRA

12/15/09Copyright 2009 Scott Dondershine20 If Modified Rules Continue Estate planning documents (RLT and/or Will) should: –Direct representative to use discretion to allocate basis increase to certain assets –Prefer allocation to: assets that are most likely to be sold in the future assets, which if sold, would produce ordinary income rather than long term capital gains –Don’t allocate to: assets that will, or are likely to pass to, charitable beneficiaries

12/15/09Copyright 2009 Scott Dondershine21 Lot of Confusion What is going on?

12/15/09Copyright 2009 Scott Dondershine22 How to Plan? How does one plan? –Will the sunset of EGTRRA occur resulting in a $1mm credit and full-step up in basis under §1014? –Will there be a full permanent repeal with the “modified basis increase” (basically keeping 2010 in the future)? –Will there be compromise legislation?

12/15/09Copyright 2009 Scott Dondershine23 Survey Says! Proposals: –Before the recent budget crisis thoughts of permanent and full repeal –Now: Most seem to predict credit of $3.5 mm per person Some predict credit of $2 mm per person Top rate probably will be 45% Possible portability of the credit from spouse to spouse

12/15/09Copyright 2009 Scott Dondershine24 Senate/House Bills House passed on 12/3/09, H.R (225 v. 200) –$3.5mm permanent exemption for estate & GSTT (not indexed) –Maintain $1mm exemption for gift taxes –Reinstatement of step-up in basis rules –45% top rate for estate and gift taxes Senate is considering S –$3.5mm permanent exemption with inflation index adjustment –Credit is unified – applies to estate and gift taxes –45% top rate for estate and gift taxes –Portability of unused credit Not exactly sure what will happen in reconciliation Bottom line: amendment likely will be the one with “the smallest possible amount of hissing”

12/15/09Copyright 2009 Scott Dondershine25 Timing of Change Back in 2001 conventional wisdom was for quick adoption Now, issue not priority and 2010 is approaching Best guess: change before first return for 2010 is due

12/15/09Copyright 2009 Scott Dondershine26 Retroactive Effect Initial reaction is for no retroactive effect –No ex post facto laws – Art I, Sect 9 of Cons However, per US Supreme Court: –Calder v. Bull (1798) – Art 1, Sect 9 applies to criminal laws –U.S. v. Carlton (1994) – retroactive application of amendment to estate tax code does not violate due process clause of 5 th amendment unless since retroactive impact rationally related to a legitimate legislative purpose

12/15/09Copyright 2009 Scott Dondershine27 Where Go From Here? Lots of confusion Plan for worst case scenario: –Estate taxes with $1,000,000 credit in 2011 –A/B trust, unless both spouses have less than $1,000,000 “for sure” May want to amend plan if estate tax repeal is made permanent

12/15/09Copyright 2009 Scott Dondershine28 A/B Trust – Slide I Avoid Pitfalls –Joint Ownership –Life Insurance –Retirement Assets –“I Love You Will” Problem with above is “wasted credit of first spouse”

12/15/09Copyright 2009 Scott Dondershine29 A/B Trust – Slide 2 Goal: –Make sure that each spouse can utilize applicable exclusion amount (unified credit) Pitfalls: –If do not implement, then may only be able to utilize one spouse’s unified credit –For instance, based upon credit in 2011 (if complete sunset) want to shelter $2,000,000 not just $1,000,000 –Savings: up to $435,000

12/15/09Copyright 2009 Scott Dondershine30 Family Trust Amount up to Estate Tax Credit Income and principal to spouse and children for (“HEMS”): –Health –Education –Maintenance –Support Spouse can be sole trustee

12/15/09Copyright 2009 Scott Dondershine31 Marital Trust Amount in excess of credit Income annually to spouse Principal for health, education, welfare of support of the spouse (“HEMS”)

12/15/09Copyright 2009 Scott Dondershine32 Why Should We Worry – We Have Less than $1,000,000 in Assets! Include: –Assets of both spouses unless A/B trust and retitling –Life insurance –Portion of jointly-owned property –IRA and other retirement plans –Household and personal effects –Collectibles –Assets in a revocable living trust Appreciation Anticipated inheritances or gifts

12/15/09Copyright 2009 Scott Dondershine33 What if Assets > Both Credits If assets exceed the credits of both spouses then: –Consider ILIT –Consider CRT –Consider GRATs –Consider discounting & leveraged gifts –Other vehicles beyond scope, e.g., QPRT

12/15/09Copyright 2009 Scott Dondershine34 ILIT - Basics Purpose – insurance not taxed and can pay for taxes on remaining assets Watch out for three year rule Some flexibility in trustees but consider “reciprocal trust doctrine” Can incorporate dynasty trust provisions

12/15/09Copyright 2009 Scott Dondershine35 ILIT – Flexibility Trust protector provisions Possible to transfer insurance to new trust Possible to cancel policy and have new trust with different terms obtain new policy But be mindful of: –Fiduciary duties

12/15/09Copyright 2009 Scott Dondershine36 Charitable Remainder Trusts CRATs and CRUTs –Lifetime annuity or percentage to decedent and/or spouse –Remainder to charity Large asset and appreciation removed from estate Income tax deduction

12/15/09Copyright 2009 Scott Dondershine37 Replace Lost Principal of CRT -Purchase life insurance using cash generated from tax savings (income tax deduction) -Own insurance in ILIT -Best of both worlds – lot of assets out of estate, benefit charity and replace principal with no estate tax increase due to ILIT

12/15/09Copyright 2009 Scott Dondershine38 GRATs Retained annuity for the grantor Remainder passes to beneficiary, e.g., children Benefits: –Annuity stream –Grantor taxed on income, i.e., grantor trust –Tax structure very clear as it is a statutory vehicle (§2702(b)) –Appreciation on trust property in excess of §7520 rate (120% of mid-term AFR) is removed from estate if grantor survives the term –Can “zero out” gift tax –Remainder removed from estate if survive term

12/15/09Copyright 2009 Scott Dondershine39 GRATs (Slide II) Disadvantages: –If die during term, value of the property included (so, use series of rolling GRATs) –If survive annuity term, then annuity stops so need to have replacement “stream” if Grantor needs same –Discount or “hurdle” rate is higher than used in a private annuity or installment sale since 120% of mid-term rate not 100%

12/15/09Copyright 2009 Scott Dondershine40 Gifts Gift of assets using up estate tax credit Gift of assets using annual credit Future appreciation in the assets avoids estate/gift taxation Discounts may be available through FLP and other means

12/15/09Copyright 2009 Scott Dondershine41 Goals of Buy-Sell Agreements Provide a Market for Shares Upon Death of a Stockholder or Termination of Employment Restrict Transfer of Shares During Lifetime Lock in the Value of Shares for Estate Tax Purposes Secure Successful Transition of Business from One Generation to the Next

12/15/09Copyright 2009 Scott Dondershine42 Provide a Market for Shares Insurance proceeds –Death –Disability –Retirement or other termination of employment - CSV

12/15/09Copyright 2009 Scott Dondershine43 Restriction on Transfer of Shares Desired sale to third party Bankruptcy or divorce Gift or pledge Termination: For Cause and Not For Cause Death Drag Along

12/15/09Copyright 2009 Scott Dondershine44 Lock in Value for Estate Tax Purposes Section 2703 of IRC and 2031 Avoid worst case scenario of valuation greater than sales price per buy-sell agreement Minimize audit exposure and avoid worst case scenario Save a lot of estate taxes and attorney fees A lot of agreements do not sufficiently consider this issue

12/15/09Copyright 2009 Scott Dondershine45 Six Requirements for Locking in Value (Req. 1 & 2) The estate must be obligated to sell the stock at the price set forth in the agreement. From (h) and case law but not Section The agreement must be applicable to transfers during life. From (h) and case law but not Section (If not from §2703 then “presumption” for non-family buy-sells does not apply)

12/15/09Copyright 2009 Scott Dondershine46 Requirements for Locking in Value (Req. 3 & 4) Agreement must either fix a price or set forth a mechanism for its determination and the price must be fair and reasonable. From (h) but not from Agreement must be entered into for a valid business purpose. From (h) and set forth in Section 2703.

12/15/09Copyright 2009 Scott Dondershine47 Requirements for Locking in Value (Req. 5) The Agreement must not be a substitute for a testamentary devise. From (h) and also set forth in Section Two Tests: –Does the agreement serve a testamentary purpose? –Was formula fair at the time when the agreement was entered into?

12/15/09Copyright 2009 Scott Dondershine48 Requirements for Locking in Value (Req. 6) Terms of buy-sell agreement must be comparable to similar arrangements entered into by persons in an arm’s length transaction. From Section 2703.

12/15/09Copyright 2009 Scott Dondershine49 Business Succession Who will inherit? Who should run the business? –Kids –Spouse –Creditors –Key employees

12/15/09Copyright 2009 Scott Dondershine50 Cross-Purchase Type Cross-Purchase –Increase in basis –Can be complicated if have more than three or four stockholders: Each stockholder needs to own policy on life of every other stockholder unless: Possible to use LLC (but probably need to establish business purpose besides owning insurance)

12/15/09Copyright 2009 Scott Dondershine51 Redemption Type Stock Redemption –No increase in basis –Proceeds subject to creditors of the business –Possible AMT for non-small (§55(e)) C Corps (ACE adjustment when paid) –Avoid potential dividend treatment if not buying all shares –Probably easier to administer

12/15/09Copyright 2009 Scott Dondershine52 Transfer for Value Pitfall Recipient Generally Not Taxed On Receipt of Proceeds Exception that results in tax: If swap policies to start agreement or other transfer occurs Very easy to fall into this trap - even if co- own policies to reduce required number Potential solution if problem difficult to otherwise avoid: Have LLC own policies

12/15/09Copyright 2009 Scott Dondershine53 Who Pays Premiums? Recognize income tax issues Possible use of split-dollar funding arrangement where corporation pays premiums but shareholder owns all or portion of policy

12/15/09Copyright 2009 Scott Dondershine54 Who Owns Policy? If cross-purchase - shareholders need to own policies If redemption - company needs to own policies Possible use of split-dollar arrangement or LLC

12/15/09Copyright 2009 Scott Dondershine55 What Happens to Excess Proceeds? If don't pay attention – you are rolling the dice Generally, excess should be retained by owner of policy: corporation or other

12/15/09Copyright 2009 Scott Dondershine56 Summary – Buy-Sell Very important tool to consider even if estate and gift taxes are repealed But, must carefully consider all issues since there are many traps for the unwary

12/15/09Copyright 2009 Scott Dondershine57 Other Issues Powers of attorney: –Medical –Financial Living Will Creditor Protection Planning Pour-over Will – appoint guardians for children Special Needs Trusts

12/15/09Copyright 2009 Scott Dondershine58 The End