The Strategist
4th Quarter 1997 - Volume 4 Issue 4
In our last newsletter, we promised to give
you more highlights of the recent tax bill as well as to point out how to take
advantage of the new provisions that can benefit you and your family.
Under the new tax bill, taxpayers that file
a joint return can exclude from income up to $500,000 in gains from the sale of
the principal residence. This is a permanent exclusion and not a deferral or
rollover of gains until a later time. There is no reinvestment required of your
capital gains portion. Under the old rules, an individual was allowed a
one-time $125,000 exclusion as long as the individual was at least 55 years
old. Other than that, the taxpayer was typically required to rollover the
capital gains on their principal residence to a new residence within a
specified period of time. This is no longer the case.
Single taxpayers can exclude up to $250,000
in gains from the sale of their principal residence. The taxpayer must have
owned and used the property as his or her principal residence for at least 2 of
the 5 preceding years. This exclusion can be claimed once every 2 years.
Now if you wish to down size your home due
to being an empty nester, up to $500,000 in gains on the sale of your home may
be excluded for taxation purposes.
On January 1, 1998, the Unified Credit
equivalent amount increases an additional $25,000 to $625,000. We recommend
that those individuals that can afford to do so gift this increase to their
children, grandchildren, or a trust for them. The gift does not have to be a
gift that the beneficiary receives immediately (present interest gift). Instead,
it can be a gift the beneficiary will receive in the future (future interest
gift).
You previously have read in our newsletters
about the benefits of a grantor retained annuity trust (GRAT). A GRAT holds
gifts of future interest in which the grantor retains a stated annuity amount
each year for a specified term of years. The gift is equal to the total assets
transferred to the GRAT, which is an irrevocable trust, less the present value
of the annuity payments retained by the grantor. For example, an individual age
52 could transfer $400,000 of stock to a GRAT retaining a 12% annuity
($48,000/year) for 13 years. In this situation, $48,000 in annual payments will
be paid to the grantor for 13 years.
According to the IRS tables for December
1997, the value of the gift is only $23,838.40. This is less than the increased
Unified Credit equivalent amount of $25,000 for 1998. If the grantor survives
the 13 year term and the stock appreciates at 10% per year and pays a 2%
dividend, over $400,000 of assets would be paid out of the GRAT to the
beneficiaries who are typically the children of the grantor. So, in this
circumstance, although $400,000 of assets were gifted away, the value for gift
tax purposes is less than $25,000. Remember, an individual must outlive the
term of the GRAT or the assets are brought back into the taxable estate of the
grantor.
There have been changes in the tax law that
deal with charitable gifting. The first is that an individual can now
contribute qualified appreciated stock to their private foundation and take a
deduction based on the full fair market value. This provision has been extended
retroactively from June 1, 1997 through June 30, 1998. For high net worth
individuals that desire to create their own private foundation, they can now
gift appreciated public securities at their full fair market value and take the
corresponding income tax deduction. After June 30, 1998, when this provision is
scheduled to end, only a deduction equal to the basis in the stock will be
allowed.
There have been changes to the charitable
remainder trust rules. A charitable remainder trust, as you might remember, is
a trust which an individual generally gifts appreciated assets and then the
trust sells the assets without paying any form of taxes. The trust will pay the
donor an income each year either as a stated dollar amount or as a stated
percentage of the value of the trust. At the death of the donor or at the last
death of the donor and the spouse, the payments end and the remaining assets in
the charitable remainder trust pass to the charity or charities of the donor's
choice. Under the new rules, the payment rate to the donor(s) cannot exceed 50%
of the fair market value. Previously, some people used extremely high payout
rates to avoid large capital gains taxes and they virtually recovered their
entire gifted amount to the trust over a very brief period of time. This is no
longer allowed.
The second change, which will have more of
an impact on a majority of our clients, is that a charitable remainder trust
arrangement must now provide a minimum charitable benefit as calculated on the
date the trust is created of at least 10% of the initial fair market value of
the property transferred to the trust. This 10% minimum charitable benefit rule
applies to all charitable remainder trusts created after July 28, 1997. We
believe that this was an unnecessary provision in the new tax act.
Prior to the new tax bill, a charitable
deduction would have been disallowed if there was a greater than 5% probability
that the assets in the charitable trust would have been exhausted at the life
expectancy of the donor(s). Now there is the 5% probability test and the
10% minimum remainder interest test that new charitable remainder trusts must
meet.
For example, a 75 year old couple that
wanted to place $1,000,000 into a charitable remainder annuity trust that would
pay them $90,000 per year (a 9% annuity) meets the 10% test and provides a tax
deduction of $255,000. In other words, a 25.5% remainder to charity. However, the
9% payout fails the 5% probability test and the charitable deduction would be
disallowed. This is a very confusing area of the new bill. We will be glad to
assist any of our clients that are interested in forming or learning more about
charitable remainder trusts.
There have been several recent interesting
developments not associated with the recent tax bill. These developments
specifically affect estate planning. The first is an area known as split dollar
where the IRS has issued many favorable rulings for over 35 years. The second
is an area that you probably have all heard about called family limited
partnerships. Let me address each area individually.
Split dollar, as you may remember from our
previous newsletters, is a method in which the premiums are split typically
between an irrevocable trust and an insured's employer. Generally, the
irrevocable trust must pay what is known as the economic benefit cost of the
insurance. This generally works out to be the term insurance cost. The employer
generally provides the balance of the premium in return for the contractual
promise that they will be repaid all premium advances. This has been one of the
most effective techniques for funding the estate taxes due at a corporation
owner's death. Since the insurance is owned by an irrevocable trust, the
insurance would not be included in the estate. The IRS has gone so far as to
call the technique an interest free loan without adverse tax consequences.
Recently, a twist was added to this in a private
letter ruling. In this particular situation, Mom and Dad established an
irrevocable trust and gifted a large amount of cash to the trust. One of Mom
and Dad's children was the trustee of the trust. The trustee applied for a
large survivorship policy on Mom and Dad and paid the first premium that was
due to place the policy in force from the cash gift received by the trust. Then
the child applied for a ruling from the IRS to determine if it would be an
allowable transaction for the trust to enter into a split dollar agreement with
Mom and Dad. In other words, the trust would pay the term portion of the
premium and the parents would advance the balance in the return for the promise
to be repaid at the last of their deaths.
The IRS ruled favorably that the majority of
the premium payments which would technically be made by Mom and Dad would not
be considered a gift to the trust and that at Mom and Dad's death, the
insurance proceeds received by the trust would not be included in their estate.
The repayment of the cash surrender value back to Mom and Dad's estate would be
included in their estate at their death.
This offers wealthy individuals one of the
most effective techniques possible for acquiring large amounts of insurance
outside of their estate to pay the estate taxes due upon their eventual deaths.
Rather than spelling out the details here about the huge advantages we see in
this, please call so that we can tell you all of the tremendous advantages to
this recently approved technique. Keep in mind, however, that this was a
private letter ruling and only applies to the taxpayer that received the
ruling.
The second recent development has to do with
family limited partnerships. As you may or may not know, the IRS has been
attacking family limited partnerships in general. One of the reasons for this
is that the media has been saying that if you create a family limited
partnership and transfer a large amount of your assets to the partnership, you
can then discount the value of your partnership by 35% or more. The IRS has
taken offense to this approach. First, let me say that both parties are wrong -
the media for publishing broad sweeping statements that have no basis in fact
and the IRS in saying that no discounts should be allowed.
Family limited partnerships are partnerships
generally comprised of family members only and provide numerous planning
opportunities for estate planning purposes as well as family investment
purposes. In many circumstances, if properly structured, these partnerships may
be entitled to substantial discounts. In one recent case, the IRS decided to
take a taxpayer's estate to court. The taxpayer died owning substantial
interests in a family limited partnership. The partnership was discounted for
various reasons including a lack of marketability and a minority interest. The
IRS contended that the value of the partnership should be ignored and the
proper estate value was the percentage ownership of the underlying assets
(investments) of the partnership. This is what they term "property"
under a provision of the Internal Revenue Code. The case was scheduled to go to
Tax Court in February 1998 and was anticipated to be one of the most closely
watched tax court decisions to come out in years. The IRS recently decided not
to litigate this issue and withdrew from this case.
Most professionals believe that if the IRS
had lost in Tax Court, thousands of family limited partnerships would have been
formed immediately for the sole purpose of reducing taxable estates.
Please call our office so that we can
explain to you the numerous benefits of family limited partnerships from asset
protection planning to estate planning.
We wish all of you a very, very
prosperous 1998.
The
Wealth Transfer Group, Inc. is not engaged in the practice of law or accounting
nor are any of its employees, representatives, or agents. Tax and legal advice
should be obtained from qualified personnel.
(c) 1997 The Wealth Transfer Group, Inc.
283 Cranes Roost Boulevard, Suite 145, Altamonte Springs, Florida, 32701 (407)
339-5787
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