The Strategist
1st Quarter 1998 - Volume 5 Issue 1
Unless legislation is enacted quickly, an
important charitable tax break could be expiring for our clients. As part of
the 1997 Tax Reform Act, full tax deductions for gifts of appreciated public securities
to private foundations was extended through June 30, 1998. The law had
technically expired on May 31, 1997 but was retroactively reinstated from June
1, 1997. However, this tax break will expire on June 30, 1998. If the tax break
is not extended, any gifts of public securities to a private foundation will be
limited in the tax deduction to the donor's basis in the stock or the fair
market value of the stock if less than the basis. This limitation would also
apply to gifts to charitable remainder trusts if the remainder beneficiary of
the charitable remainder trust were a private foundation. Generally, this will
not affect gifts to public charities which includes most universities,
hospitals, and public good foundations.
It is unfortunate that this law could expire
especially in light of recent published reports that indicate charitable giving
increased to its highest levels ever in 1997 and by some reports, increased
over 20% from the prior year.
In January, President Clinton submitted his
proposed budget for the fiscal year 1999 which begins October 1, 1998. In his
proposal were several items that could impact estate planning. These items are
proposals only and have not been approved by the House Ways and Means Committee
or the Senate Finance Committee. Two specific proposals are (1) the elimination
of Crummey gifts qualifying as annual exclusion gifts, and (2) prohibiting
discounts for family partnerships.
Crummey gifts are gifts to an irrevocable trust
where certain designated beneficiaries have a right to withdraw the gift from
the trust generally within 30 days of the gift. Since the beneficiaries have
the right to withdraw the gift, the courts have ruled that this gift qualifies
as a gift of present interest and can qualify for the annual gift tax exclusion
(the $10,000 that an individual can gift to anyone each year). If the
beneficiary does not withdraw the gift within the 30 days, then the amount
gifted to the trust stays in the trust under the trust terms. Most often these
types of gifts are used to fund life insurance trusts, however, that is not
always the case.
More and more today we see people
establishing Crummey trusts that have nothing to do with Life Insurance Trusts.
People make gifts to a Crummey trust under this type of arrangement so that the
gifts to the trust, although generally subject to a 30 day right of withdrawal,
will not vest ownership with the intended beneficiary if no withdrawal is made.
In today's litigious society, an asset that is not owned by an individual
generally cannot be claimed by a creditor or by legal judgment. Additionally,
people use non-insurance Crummey Trusts for spendthrifts.
President Clinton's budget also proposes
eliminating any potential discount for most Family Limited Partnerships. You
have probably heard a great deal about Family Limited Partnerships but what you
have heard is probably inaccurate. Many people are claiming that forming a
family limited partnership enables you to discount the value of the partnership
from its real value by 35% to 80%. This is not the case. Limited partnerships
can be used very effectively for estate planning, however, there are many rules
to follow. Let me cite you an example of what not to do.
Assume Dad forms a partnership with a number
of his assets and is the original 1% general partner and the 99% limited
partner. Dad thinks that he will save between 35% and 80% on his estate taxes
because he has formed a limited partnership. Unfortunately in this example, the
state where Dad formed the partnership has provisions that state upon the death
of a general partner, the partnership is deemed to liquidate within 6 months.
Dad never gives away any limited partnership units and, at Dad's eventual
death, he will probably receive no discount.
State law is very important in determining
the effectiveness of partnership use.
Taxpayers who file a joint return can
exclude from income up to $500,000 in gains from the sale or exchange of their
principal residence under the 1997 Tax Reform Act. This is a permanent
exclusion and not a deferral or rollover of gain until a later time.
Additionally, there is no reinvestment required. This replaces the old one-time
$125,000 exclusion available to eligible individuals that were age 55 or more.
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 may be
claimed once every 2 years. The old rule concerning rollover in which a
taxpayer sold his home at a gain and purchased a new home at least equal to the
selling price of the old home in no longer in effect.
There is a new type of individual retirement
account called a Roth IRA. Contributions to a Roth IRA are not deductible,
however, if certain conditions are met, they are forever tax-free including all
earnings. The contribution limit per Roth IRA per year is $2,000 per
individual. The old type of IRA is still available however, the maximum
contributions between all IRAs per individual is $2,000. Careful consideration
must be given to which type of IRA you choose. The Roth IRA is phased out for
single taxpayers with adjusted gross income between $95,000 and $110,000 and
for joint filers with an adjusted gross income between $150,000 and $160,000.
Contributions may be made to a Roth IRA even after the individual reaches age
70. Distributions from a Roth IRA are income tax-free if (1) the Roth IRA has
existed for 5 years, (2) the individual has obtained the age of 59 1/2, (3)
payments are made to a beneficiary or the individual's estate after his death,
(4) if the individual is disabled, or (5) for first time home buyer's expenses.
If distributions do not qualify, they are included in income to the extent
attributable to earnings and are subject to the 10% early withdrawal tax.
Fortunately, distributions in this situation are deemed to be made first from
your after-tax contributions. The Roth IRA is not subject to mandatory
distribution rules.
You can convert a regular IRA to a Roth IRA
but there are income tax consequences. In 1998, and only 1998, an individual
can convert their regular IRA to a Roth IRA without having to pay all of the
income tax due on the regular IRA in one year. You can elect to spread the tax
liability over 4 years. However, to convert to a Roth IRA this year, you must
have Adjusted Gross Income (AGI) of less than $100,000. If you convert your
regular IRA to a Roth IRA after 1998, the entire income tax liability is due in
one year.
Since Roth IRAs are not subject to income
tax at death, there is an estate planning opportunity. If you name your
children the beneficiary of your Roth IRA, they will receive the same favorable
income tax treatment. Although the Roth IRA will be included in your estate for
estate tax purposes, no income tax is owed. Additionally as your children
receive distributions from the inherited Roth IRA, the distributions will also
be income tax free to your children. Your children are required to take minimum
annual distributions each year based on their life expectancy. However, the
funds not distributed from the Roth IRA can continue to grow tax free.
In each issue we try to devote space to
questions from our readers and clients. In this issue we are going to address
some very questionable techniques.
You may have heard about a type of trust
that allows you to legally avoid paying any income taxes. These are commonly
referred to as "Constitutional Trusts", "Pure Trusts", or
"Business Trusts". I have never personally met any attorney or accountant
that approves of these types of trusts. Generally promoters of these
arrangements refer to or quote The Constitution, refer to famous wealthy
families, and explain how the IRS will elect not to comment on this arrangement
because they (the IRS) don't want everyone using these arrangements. Plain and
simply, these are shams! If you are approached by a promoter of these trusts,
ask them to provide you proof that the concept works or better yet, have them
provide you a letter ruling from the IRS.
The next technique is known as charitable
split dollar. You may remember that a split dollar agreement is generally an
agreement between an employee or a trust that the employee establishes and the
employer where the two parties agree to split the premium payments on a life
insurance policy insuring the employee. There have been recent private letter
rulings that approved of a split dollar arrangement between the insured's
spouse and an irrevocable trust. In this circumstance, the spouse provided most
of the premium payment while the trust paid the term cost.
The charitable split dollar has taken to
this a new level. The concept is that the insured makes tax deductible cash
contributions to a charity. The charity then agrees to split premium payments
with the insured's irrevocable trust. This time, the charity pays the majority
of the premium instead of the employer or the spouse under the previous
descriptions. The implication is that the insured has effectively made his
insurance income tax deductible.
I do not put this in the same category as a
"Constitutional Trust", but I have serious concerns on this
technique. First, why would a charity agree to provide premium payments from a
cash gift that must have no "strings attached"? The arguments I have
heard are that the charity receives a return of more than just the premiums
advanced, and in fact can receive a very large return if death occurs in the
first few years. Generally however, I am more concerned with the net result to
the charity if death occurs according to normal mortality tables. What type of
return does the charity receive for their premium advances? Secondly, to my
knowledge, the IRS has not ruled on this technique. Finally, several planned
giving organizations have refused to endorse this technique. Personally, I am
staying clear of this technique, at least for now.
Have you looked at your will or revocable
trust lately? As you know the Tax Reform Act of 1997 had numerous estate
planning changes included. Three specific items should be reviewed. First, does
your will or trust leave the maximum tax free amount to your children or a
trust for their benefit? Many documents contained language that specified
$600,000 (unified credit equivalent amount). This amount is now $625,000 and is
scheduled to increase to $1,000,000 by 2006. Newer language most attorneys are
now using is a non-specific dollar clause that incorporates the scheduled
increases. The same is true for your generation skipping transfer tax
exemption. This was previously $1,000,000 but is now indexed for inflation. Finally,
make sure your documents contain the necessary required language that takes
advantage of the small business tax exclusion amount. This can, if your estate
qualifies, avoid estate taxes on the first $1,300,000 of business value. Ask
your attorney if your documents need updating.
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) 1998 The Wealth Transfer Group, Inc.
283 Cranes Roost Boulevard, Suite 145, Altamonte Springs, Florida, 32701 (407)
339-5787
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