Still Undefeated Against Department of Justice

June 27, 2015 in Tax News

In most court cases concerning federal tax matters, the Department of Justice does not represent the Government. That’s because those cases take place in Tax Court, where the IRS represents itself. Only when a taxpayer first pays up, then sues for a refund, or when a case goes up on appeal, does DOJ take over. Those situations don’t arise very frequently. So I may not be alone as a tax lawyer having only had a few cases against DOJ, and even fewer resulting in an actual court opinion.

And, happy to say, I’m still undefeated, a proud 2-0 after a recent victory. In May v. United States, 115 AFTR 2d 2015-827 (D.C. Ariz. 2015), the Federal District Court for the District of Arizona ruled that the assessment of a penalty against the taxpayer was untimely under the applicable statute of limitations. The case was one of first impression. It was decided on a motion for summary judgment

In my humble opinion, the court got this one exactly right, and it would have been a travesty had it gone the other way. The statute of limitation in question, Internal Revenue Code Section 6501(c)(10), extends the otherwise applicable statute of limitations with respect to liabilities arising from certain transactions until one year from the date information related to the transaction is furnished to the IRS. In this case, the IRS agent auditing the taxpayer’s return asked for and received all the necessary information and was fully prepared to make the assessment, but the IRS nonetheless waited about two years to actually assess the penalty. In defending against the suit for a refund, the Department of Justice claimed that the information the IRS requested, received and acted upon should not be considered “furnished” to it because it was not placed on a certain IRS form. Thus, according to DOJ, the one-year period of Section 6501(c)(10) never commenced to run. It was a hollow argument, and the court appropriately rejected it.

When In Doubt Regarding the IRS, Don’t Sign

July 13, 2014 in Tax News

I’ve recently had three different clients ask me for a second opinion on an IRS situation because they had doubts about their tax position. Turned out in all cases their doubts were well founded. In two of the cases, the clients signed with the IRS first, then consulted me. In the third, the client consulted first. Check out how much better the third client fared:

Client 1 had been audited by the IRS. The agent proposed a tax increase of several hundred thousand dollars. Under pressure from a tax return preparer he had hired to assist him in the audit, the client signed off on the changes made by the agent. Did he give up his rights completely? No. He could still seek a refund. But he would have to pay the tax first, which he has not been able to do. Until he can, the IRS can exercise its enforcement power to collect the tax, even though a large portion of it likely isn’t owed. Had he not signed off on the audit, he could be fighting the issue in Tax Court, before having to pay the tax.

Client 2 signed her tax return, as prepared by her return preparer, and filed, even though she was not comfortable with the tax liability reflected. When she mentioned this to me at a meeting on an entirely different matter, I ultimately concluded that she’d failed to claim a substantial loss. She amended her tax return to claim the loss. But amended returns are scrutinized more closely than original returns. Her amended return was audited. Although the IRS allowed the loss, it made unfavorable changes to other items on the return.

Client 3 thought her tax return wasn’t quite correct. Before filing, she asked me to take a look. I found a mistake in the treatment of the foreclosure on her house. The return was corrected, with a substantial tax savings.

The bottom line: If you are in doubt regarding an IRS matter, get your questions answered before you sign.

Tax Planning Never Was the Main Reason to Plan Your Estate

July 11, 2014 in Estate Planning

Most people know by now that unless they are members of the elite group of Americans with a net worth of over $5.3 Million ($10.6 Million for married couples), they likely won’t need an estate planner to manage the potential tax on their estates.

So, far fewer people are planning their estates these days.

That’s unfortunate. You see, tax saving never was the primary reason to engage in estate planning. Consider the benefits that flow from estate planning that have nothing to do with taxation:
First, a carefully planned estate can provide legal protection for your loved ones’ inheritances which they could never achieve themselves after your death. In the absence of this planning, there is an unnecessarily increased risk the inheritance you pass could land in the hands of a claimant or a divorcing spouse of a child, or the future stepchildren of a spouse who survives you.

Second, you have the ability through an estate plan to nominate the individuals you want to act for you should you become incapacitated and, if you have minor children, the individuals who will act as their guardian should you die before they reach adulthood.

Third, without an estate plan, your estate likely will require a probate upon your death and could require a conservatorship should you become incapacitated.
The bottom line? Estate planning still makes sense, even though it may not save you a dime in taxes.

2012: A Challenging Year for Year-End Tax Planning

November 15, 2012 in Tax News

Year-end tax planning in 2012 will be more difficult than in prior years. Ordinarily, the objective at year-end is to accelerate deductions and postpone income, with the idea being to defer, but probably not avoid, tax.

But 2012 is different, for several reasons. First, there is a likelihood at this point that income tax rates will increase for high-income taxpayers. Second, the preferential rate on long-term capital gains likely will increase and the preferential rate on dividends may disappear entirely. Third, there are tax provisions in the Affordable Care Act that will subject additional income to the Medicare tax. Specifically, wages in excess of $250,000 for a married couple will be subject to an additional .9% Medicare tax and investment income will be subject to a 3.8% Medicare tax to the extent it causes adjusted gross income to exceed a specified threshold ($250,000 for married taxpayers filing jointly).

So, if you’re a high income taxpayer, is the game plan in 2012 to accelerate income and delay deductions? Yes, but not entirely yes. Remember the rules that limited itemized deductions? Those may be returning. In addition, Congress is looking at limitations on the total amount of itemized deductions. Thus, itemized deduction may be worth more in 2012 than it will be in 2013.

As if all that were not complicated enough, there are looming changes in the estate and gift tax rules, the details of which are less predictable than the changes to the income tax rules. Currently, a married couple may pass up to $10 Million free of estate tax to the next generation, with the excess subject to tax at a 35% rate. In the absence of new legislation, the so-called exemption will decrease to $2 Million for a married couple, with the excess subject to tax at a maximum rate of 55%. Ultimately, the exemption amount could land anywhere in between. My guess is that it will land at $7 Million for a married couple, with the excess taxable at 45%. How does all this translate? First, if you have a large estate, see your estate planner immediately to determine whether any action should be taken before 2013.

Second, if you’re not a high income taxpayer ($250,000 of adjusted gross income for a married couple filing jointly, $200,000 of adjusted gross income for a single person), relax. There’s probably just not that much at stake. Yes, there’s a chance that total gridlock in Congress will cause your rates to increase back to pre-2001 levels, but there’s no way to quantify that risk and the effect would not be overwhelming. If you expect to make substantially more in 2013 than 2012, you may want to accelerate income into 2012 to even things out, but going beyond that point could prove to be a bad play. These general rules don’t apply to everyone. For example, if you’re considering converting a traditional IRA to a Roth IRA, 2012 may be the optimal time. If you have unrealized gains in investment assets, it may make sense to accelerate those gains. Even though the increased rates largely are limited to high income taxpayers, the increased rates on capital gains likely will apply to all taxpayers.

Third, if you are a high income taxpayer, you should get together with your tax advisor and consider whether there are opportunities to accelerate income. For example, if you have appreciated stocks, you could sell them and buy them back, thereby triggering the gain (the wash sale rules do not apply to gains). This could you save you 8.8% in tax (15% capital gains rate, as compared to 20% capital gains rate plus 3.8% Medicare tax). There may be various other opportunities to accelerate income (or delay deductions). Among the most common are:

  • Accelerating January bonus compensation to December
  • Maximizing retirement distributions
  • Converting Roth IRAs
  • Triggering unrecognized installment sale income
  • Accelerate billing and collection of business income
  • Declaring special dividends from closely held corporations
  • Postponing mortgage payments
  • Postponing state income tax payments

If your income in 2013 is likely to exceed $380,000, this planning may be especially important. At that level, your marginal income tax rate in 2013 could be 4.6 percentage points higher, and you will be subject to the additional Medicare tax as well. At a minimum, your overall rate increase will exceed 5 percentage points and, on some types of income, it could be exceed 8 percentage points.

This post only touches upon some of the tax law changes that will occur at the end of the year. There are others, and it is quite possible new legislation may be enacted late this year or early next. Thus, the analysis in this post is not intended to be exhaustive. It is general in nature and is not intended as legal advice.

The Estate Planning To Do List

October 29, 2012 in Estate Planning

By no means is this list exhaustive, but these items should be on everyone’s estate planning to do list.

Life Insurance

The life insurance most Americans carry is woefully inadequate, especially if they have young children or a dependent spouse. Quite often, the breadwinner in a family carries life insurance with a death benefit equal to only one year’s income. What your family needs is a death benefit that will generate income equal to your annual income, which typically is between ten and twenty times your annual income.

Succession Planning

Too many businesses are lost to unexpected death of the business owner. Succession planning is, no doubt, a challenge. More often than not, the business owner is the heart and soul of a small business. But leaving succession planning unaddressed is not an option. Do you have a child who is active in the business and who could take over? Could your employees take over and buy out your surviving family members? Can the business be sold without tremendous value being lost? Even if there are no “good” options, it’s important to identify the “least bad” option and implement it, as the financial stakes are enormous.

Guardianship Nomination

Couples usually think of where the money will go when they consider the need to execute Wills.  But there’s a more urgent matter addressed in your Will: Who will raise your children? In legal terms, that translates into who will serve as guardian for your children and conservator of their estates? These matters are handled in a Will, and should never be left unaddressed. And they require careful consideration. For example, it may seem sensible to name your 65 year-old parent as guardian of your three-year old child, but doing so means your 80 year old parent could be faced with the task of raising a potentially rebellious teenager.

Structuring Your Children’s Inheritance

Deciding how an estate will be shared among children and others typically is a straightforward decision. Indeed, the intestacy laws of most states usually will vest the estate in those whom the decedent most likely would have named in a Will. But intestacy laws, simple wills and canned living trusts utterly fail to address the critical question of that age at which your children will take control of their inheritance and who will manage the money for them until they reach that age. So, unless you’re comfortable with your eighteen year old child getting a six or seven figure check to spend as he wishes, some planning here is critical.

Asset Protection Planning For Your Children

In today’s litigious society, many people consider their own asset protection planning. Planning to protect your assets from adverse claimants, however, can be complex, costly and often only marginally effective. But protecting your children’s inheritance through basic estate planning is straightforward and cost effective. If your children follow your plan, the likelihood that claimants could reach their inheritance will be remote. And this planning also will protect them from divorcing spouses and estate taxes. This basic planning on your part provides benefits to your children that no amount of planning on their part could achieve.

Positive Developments in the Tax World

July 12, 2012 in Tax News

New IRS Fresh Start Program a Huge Help to Struggling Taxpayers

In May, the IRS rolled out new features to its “Fresh Start” program that will allow thousands of taxpayers to clear up their tax problems and move on. Under the new program, taxpayers who previously could not qualify for relief will be able to resolve their tax debts in two years or less, and often for a fraction of the outstanding liability.

This is an outstanding development for taxpayers struggling with back tax liabilities.

The centerpiece of the new program is a dramatic change in the evaluation of offers in compromise, which essentially are offers by taxpayers to satisfy their tax liabilities in full for an amount based on the income they’ll have available after payment of necessary living expenses. Previously, the IRS sought a payment based on four or five years’ worth of available income. Under the new rules, however, the IRS will seek payments based on only two years’ worth of available income and, if a taxpayer can obtain the funds to pay immediately, only one year’s worth of available income. The new program also increases the amounts allowable for various living expenses in determining a taxpayer’s income available to pay tax, and also allows delinquent state tax liabilities to be taken into account.

Anybody struggling to pay back taxes should explore the possibility of filing an offer in compromise under the IRS Fresh Start program.

All-Time Low IRS Minimum Interest Rates Create Rare Planning Opportunities

Many tax planning strategies, especially estate tax planning strategies, involve loans between family members or trusts for their benefit. Such loans typically must carry an interest rate at least equal to the “applicable federal rate,” or AFR, to be respected for tax purposes. Often, the benefit the strategy offers increases as the AFR decreases.

The AFR just reached an all-time low. For example, on a nine year loan, the minimum interest rate is less than one percent per year — .92%.

Because the AFR currently is so low, several estate tax planning strategies could work exceptionally well if you’re concerned about the future of the estate tax after the 2012 election. If you’re seeking to fulfill charitable objectives in a tax-advantaged manner, this might be your golden opportunity to do so.


November 13, 2010 in Tax News

As a business and tax attorney serving Arizona for over 30 years, the philosophy behind my legal practice has remained constant. I maintain the highest level of responsiveness to my clients’ needs, solve legal problems in the most cost-effective, yet creative manner and take on no more work than I can do well.

My practice emphasizes:

  • Tax Disputes
  • Estate Planning
  • Business Planning and Transactions
  • Business succession planning
  • Formations of corporations, partnerships and limited liability companies
  • Business acquisitions and sales
  • Taxation of real estate transactions
  • Probate
  • Individual, partnership, limited liability company and corporate taxation
  • Tax exempt organizations

Although I’m a solo practitioner, my network of lawyers with complimentary areas of expertise is extensive. Through those affiliations, my clients often are able to obtain the same breadth of expertise as they would with a large firm, but with the personal touch and attentiveness of a small firm with a client-centered environment.

Lawyer Robert Lord | Lawyer Tax

The Buy-Sell Agreement: Every Business Owner Should Have One

November 12, 2010 in Contracts

What happens if a business owner dies, withdraws from the business, or wants to sell his or her shares? Without a buy-sell agreement, the remaining owners can lose control of the business. The implementation of a buy-sell agreement, however, should be handled carefully. Having an improperly structured buy-sell agreement could be worse than having no buy-sell agreement at all.

A buy-sell agreement permits (or requires) the company or the remaining shareholders to buy back a departing shareholder’s stock. In addition to controlling ownership, a buy-sell agreement:

  • Creates liquidity for a deceased shareholder’s heirs.
  • Provides an “exit strategy” under which owners can withdraw from the business and dispose of their interests.
  • Helps avoid disputes over the value of stock by setting the price or a formula for determining the price.
  • Provides for an orderly succession of the business to family members or others.
  • Helps establish the value of the business for estate and gift tax purposes.

Buy-Sell Events

The obligation to buy or sell shares of a company typically is triggered by any one of the following events:

  • Death
  • Disability
  • Termination of Employment

In structuring a buy-sell agreement, careful consideration should be given to the circumstances under which a shareholder’s employment is terminated. A shareholder’s employment may be terminated by the company or by the shareholder. If the company terminates the employment, the termination shall may be “for cause” or “not for cause.” If the shareholder terminates his own employment voluntarily, the termination may be in the prime of his career or may be a termination in the nature of retirement. In most cases, each of the foregoing situations will call for a different set of buy-sell requirements.

In addition to the ordinary triggering events, a well-drafted buy-sell agreement also should address the bankruptcy or divorce of a shareholder.

Optional or Mandatory Purchase Requirement

For each triggering event under a buy-sell agreement, the agreement should specify whether the purchase of the departing shareholders shares is mandatory or optional. Many buy-sell agreements provide for a mandatory purchase in every situation. Quite often, however, that is not appropriate. For example, if a shareholder’s employment is terminated for cause, should the company or the remaining shareholders be forced to fund a large stock purchase? If the bankruptcy of a shareholder is addressed in a buy-sell agreement, the purchase of the bankrupt shareholder’s shares ordinarily should be optional.

Valuation of a Departing Shareholder’s Shares

Valuation of a departing shareholder’s shares is perhaps the most difficult part of structuring a buy-sell agreement. There are several options to consider. The buy-sell agreement can provide for an appraisal of the departing shareholder’s shares at the time of his or her departure. Alternatively, the buy-sell agreement can specify a formula for valuing a departing shareholder’s shares. A third option is to require the company and shareholders to agree on an annual basis what the value of a departing shareholder’s shares will be for the following year. Each valuation method has its advantages and disadvantages. For example, an appraisal requirement probably best ensures that both the remaining shareholders and the departing shareholder will be treated fairly. Appraisals, however, are expensive and the appraisal process is time consuming.

Dispute Resolution

Buy-Sell agreements can be used to implement an effective dispute resolution mechanism commonly known as a “forced buy-sell” or “shotgun buy-sell” arrangement. Under this arrangement, a shareholder may provide notice to another shareholder and state the price per share at which one will be required to buy the other’s stock. The other shareholder then is required to choose whether to be the buyer or seller at the stated price. This mechanism often allows co-shareholders who no longer get along with one another to sever their relationship in an efficient and fair manner, without the need for expensive appraisal or litigation.

Types of Buy-Sell Agreements

There are generally two types of buy-sell agreements: the cross-purchase agreement and the redemption agreement. Under a cross-purchase agreement, a departing shareholder’s stock is purchased by one or more of the other shareholders. Under a redemption agreement, the corporation purchases the stock. Often, buy-sell agreements are funded with insurance on the shareholders’ lives. If a redemption agreement is used, the corporation is the owner and beneficiary of the policy. Under a cross-purchase agreement, each shareholder purchases insurance on the lives of the other shareholders.

Although cross-purchase agreements are more difficult to administer, they may be advantageous tax wise, in two respects. First, if insurance is used to fund the purchase obligation, the purchasing shareholders essentially receive a stepped-up basis in the stock, which reduces the amount of capital gains tax they must pay if they sell the stock.

Suppose, for example, that Smith and Jones are the cofounders of ABC, Inc. Each contributes $10,000 to ABC in exchange for 50% of ABC’s stock. If ABC, Smith and Jones enter into a stock redemption agreement funded by $1,000,000 insurance policies on the lives of Smith and Jones and Smith dies when the value of the business is $2,000,000, ABC will collect the insurance proceeds and buy back Smith’s stock for $1,000,000. Jones then will own 100% of ABC’s outstanding stock, but his basis only will be $10,000. If Jones then sells his stock for $2,000,000, he will realize $1,990,000 in taxable gain.

If, instead, Smith and Jones enter into a cross purchase agreement, Jones will collect the insurance proceeds and purchase Smith’s shares, thereby increasing his tax basis to $1,010,000 (the purchase price plus his original capital contribution). If Jones sells his stock, his taxable gain will be only $990,000 rather than $1,990,000.

Second, cross-purchase agreements avoid alternative minimum tax (AMT) problems that sometime arise under redemption agreements. Life insurance proceeds generally are tax-free to the recipient, but a corporation may incur AMT liability as a result of receiving life insurance proceeds.

This article contains only general information and is not to be relied on as legal advice. For advice on your individual situation, consult a lawyer in your jurisdiction. No attorney/client relationship arises from use of this article.

Estate Planning for Perfectionists and Social Engineers

November 3, 2010 in Estate Planning

The ordinary estate plan does what it is supposed to do. It provides for the distribution of wealth in a tax-efficient manner, taking into account planning for special needs, asset protection and perhaps divorce protection. Some people, however, like to take things a step further. Their attempts to achieve perfection and desired social objectives for their children have given rise to some interesting (and somewhat amusing) provisions in their estate plans. This article provides a few examples of those provisions. My purpose in writing this is not to suggest that you should incorporate such provisions in your own estate plan, but rather to provide food for thought and perhaps a chuckle or two. There is a fine line here between planning on the one hand, and obsessing, on the other. You’ll never achieve the perfect estate plan, but sometimes you can come a little closer to your goal.

“Fairness” Provisions. In most, but not all, estate plans, parents want to treat their children equally. Ordinarily, that simply means dividing their estate into equal shares when both parents have passed away. Some parents, however, question whether that is entirely fair. For example, if they die when Johnny is 23 years old and has completed his college education (funded by mom and dad, of course) and Susie is 18 and a senior in high school, is Susie getting cheated? After all, she will have to pay for her education out of her inheritance, while Johnny has already had his paid for. So what is a fair-minded perfectionist to do? The most common solution to this perceived problem is to hold the entire estate until all children are through college, making distributions only for the college and support expenses of the younger children. When the youngest child graduates, the remaining estate is split into equal shares.

The thinking does not always stop there. For example, what if one daughter’s wedding has been paid for and the other’s has not at the time both parents die? The thinking can even go the other way – that the older child is being treated unfairly. For example, suppose Johnny and Susie each inherit $1 million when Johnny is 35 and Susie is 30. If Susie then invests her inheritance for five years, she will have perhaps $1,500,000 when she turns 35, whereas Johnny only had $1 million. Believe it or not, I have had clients actually take this into account. In simple terms, they reduced Susie’s share so it would grow to equal Johnny’s share by the time she reached age 35. This is an area where the fine line between planning and obsession perhaps has been crossed.

Obviously, you do not want to over-think this issue, but there may be circumstances where equal shares of an estate are not necessarily equivalent treatment of children. But do not obsess here. It is impossible to achieve perfection.

“Anti-Laziness” Provisions. Many people are concerned that the receipt of an inheritance by a child will destroy that child’s ambition. Indeed, charities prey on this fear in people. In some cases, they convince them to leave all or substantially all their wealth to charity in order to avoid destroying their children.

Some parents are not that gullible, but they do fear the effect a large inheritance might have on their children, so they create mechanisms to make sure that their children do not rely on their inheritance as a means of avoiding hard work. My favorite provision in this area is elegant in its simplicity, although perhaps somewhat narrow-minded. My client provided that each child would have an equal share of his trust, but that the distribution paid to each child in any year would be limited to the income that child earned himself or herself. In other words, the more you work, the more you get. Of course, this mechanism may unfairly penalize a child who chooses a lower paying career, such as teaching, but it certainly does discourage laziness. I am not sure I would include such a provision in my own trust, but I do applaud the creativity.

The “Don’t Let My Siblings Cheat My Kids” Provision. This is one of my favorites. Here is the situation: My client wants to make sure his elderly parent is provided for in the event he dies prematurely. But he also wants to make sure his siblings contribute their fair shares to mom’s cause, so that his kids’ ultimate inheritance is not depleted any more than is appropriate. So, he establishes a trust for his mom’s health, support and maintenance after his death. That, by itself, is not the least bit unusual. Included in the trust, however, is a provision which conditions any distributions from the trust on equal contributions being made by his siblings to mom’s cause. So, if bro and sis don’t kick in their fair shares, mom doesn’t eat. Clever, huh?

Conclusion. There are numerous other concerns that I have seen addressed through unusual estate plan provisions – divorce, education of grandchildren, hurt feelings over selection of trustees. Although you may conclude that these concerns are better left unaddressed in your estate plan, they’re worth a passing thought.

This article contains only general information and is not to be relied on as legal advice. For advice on your individual situation, consult a lawyer in your jurisdiction. No attorney/client relationship arises from use of this article.

Coping with Changes and Uncertainty in the Estate Tax

November 3, 2010 in Tax News

As most people have heard, the Federal Estate and Gift Tax Code is scheduled to change dramatically over the next several years. Under current law, each individual may pass up to $1,000,000 of wealth free of federal estate or gift tax to the next generation. That amount, the “exemption equivalent,” is scheduled to increase to $1,500,000 in 2004, then gradually increase further to $3,500,000 in 2009. In the year 2010, the estate tax is scheduled to be repealed, only to return in 2011, with an exemption equivalent of only $1,000,000. Undoubtedly, further changes will be made. Without further changes, the dilemma facing wealthy octogenarians in the year 2010 would be too unpleasant even for Congress to tolerate.

In light of the recent changes, and the uncertainties regarding the future direction of the federal estate and gift tax system, the question arises which estate and gift tax planning vehicles should you still consider and which vehicles no longer are viable? Do irrevocable life insurance trusts still make sense? How about family limited partnerships and limited liability companies? Are charitable remainder trusts as tax efficient as they used to be? This article discusses the ongoing viability of the traditional various tools used in the estate and gift tax planning process. As discussed below, the viability of some of those tools is unchanged by modifications in the tax law. The effectiveness of some of those tools, however, has been reduced sharply. In some circumstances, tools used for years by estate planners actually could result in increased tax liability.

The Traditional “A-B” or “Credit Shelter” Trust. The good news here is that the A-B or credit shelter trust generally still works, although it could prove unnecessary if the repeal of the estate tax scheduled for the year 2010 is made permanent. Prior to repeal of the estate tax, however, your use of an A-B trust to allow you to double up on your and your spouse’s exemption equivalents remains an important objective in the estate planning process.

If you have an A-B living trust from several years ago, it likely still works. It is important, however, to review the language of older A-B trusts. Some of those trusts refer to the dollar amount of the exemption equivalent at the time the trust was drafted. Trusts drafted in that manner may be deficient and they may prevent you from fully using the recent increase in the exemption equivalent.

Note also that the increase in the exemption equivalent could interfere with your non-tax concerns. For example, if you have structured your plan to allow children from a prior marriage to inherit the exemption equivalent immediately from you upon your death, rather than at the time of your spouse’s death, the scheduled increase in the exemption equivalent could cause a much larger share of your estate to pass to those children and a correspondingly smaller share of your estate to your spouse.

Charitable Remainder Trusts. The attractiveness of charitable remainder trusts certainly has diminished as a result of recent changes in the tax law. In the typical charitable remainder trust, you would contribute appreciated assets to a trust, retaining a lifetime interest in the trust and assigning the remainder interest in the trust to your children. The principal tax advantage to you would be the avoidance of capital gains tax upon the sale of appreciated assets contributed to the trust. The economic disadvantage of the charitable remainder trust to you would be the gifting of a remainder interest in the contributed assets to charity. Under current law, that disadvantage would be mitigated by the reduction in your estate tax liability resulting from the removal of the contributed assets from your estate.

Recent changes in the tax law have reduced the tax advantage of the charitable remainder trust and, at the same time, increased, or at least potentially increased, the economic disadvantage. Because the maximum rate for long-term capital gains has decreased, the value of avoiding tax on the sale of appreciated assets by a charitable remainder trust also has decreased. Because the exemption equivalent is scheduled to increase in future years and because the estate tax may be repealed entirely, the after tax “cost” of leaving a remainder interest to charity has increased.

Prior to the changes in the tax law, the tax benefit would be sufficient to warrant your consideration of a charitable remainder trust even if you had only modest charitable intent. In other words, the decision to establish a charitable remainder trust often had both a tax avoidance and a philanthropic component. Now, the charitable remainder trust should be considered only if philanthropy is your overriding objective. In other words, if you plan to leave money to charity anyhow, the charitable remainder trust may still be worthy of consideration. Otherwise, it probably is not.

Irrevocable Life Insurance Trusts. The irrevocable life insurance trust remains a viable tax planning vehicle. By having a life insurance policy held in an irrevocable trust, you are able to exclude the death benefit on the policy from your taxable estate. If the estate tax remains in place, the irrevocable life insurance trust may serve to reduce your ultimate estate tax liability. If the estate tax is repealed or if the exemption equivalent is raised to the point where your estate will not be taxable, the irrevocable life insurance trust would prove unnecessary. However, it would not result in any detriment to your situation. Thus, the only real factor to consider before establishing an irrevocable life insurance trust is cost. Any potential tax savings, however, is likely to outweigh the cost of establishing an irrevocable life insurance trust.

Qualified Personal Residence Trusts and Grantor Retained Annuity Trusts. The qualified personal residence trust and the grantor retained annuity trust both involve the use of the time value of money to generate a tax benefit. In a qualified personal residence trust, you contribute your personal residence to a trust and retain the right to use the residence for a period of years, with the remainder interest in the trust ultimately passing to your children. The grantor retained annuity trust is similarly structured except the asset contributed to the trust is something other than your personal residence and, instead of the right to use a residence, you retain an annuity payout over a term of years, with the remainder interest passing to your children after the expiration of that term. Under both structures, you are treated as having made a gift of the present value of the remainder interest. So, for example, if your house were worth $500,000 and you retained the right to live in the house for twenty years, the value of the amount of the gift would be the amount which, if invested for twenty years at the current market rate of return, would be worth $500,000.

Prior to the recent change in the tax law, the principal disadvantage of charitable remainder trusts and grantor retained annuity trusts was their complexity. Otherwise, if your estate were large enough, they represented powerful estate tax planning vehicles, with limited downside risk.

The potential repeal of the estate tax dramatically alters the equation regarding qualified personal residence trusts and grantor retained annuity trusts. If the estate tax is repealed, qualified personal residence trusts and grantor retained annuity trusts will not give rise to any tax benefit. However, they may give rise to an income tax detriment. Generally, your children may sell assets you leave to them in your estate without paying capital gains tax on the appreciation that occurred prior to the date of your death. That is because the cost basis of those assets is “stepped-up” to their fair market values as of the date of your death. If assets are contributed to a qualified personal residence trust or a grantor retained annuity trust, however, your death will not eliminate the capital gains tax to be paid upon the sale of those assets. Thus, qualified personal residence trusts and grantor retained annuity trusts have an income tax disadvantage associated with them. Prior to the recent changes in the tax law, that income tax disadvantage was more than overcome by an estate tax savings. With the possibility that the estate tax will be repealed entirely, however, that no longer is the case. Thus, it is quite possible that the establishment of a qualified personal residence trust or grantor retained annuity trust ultimately could result in a net tax disadvantage to you.

This is not to suggest that there will be no situations that warrant the use of a qualified personal residence trust or grantor retained annuity trust. However, there now is a real risk that such a trust could cost you tax-wise depending on how the estate tax ultimately is resolved. Thus, you should carefully consider this before going forward.

Family Limited Partnerships and Limited Liability Companies. The family limited partnership or limited liability company uses the illiquidity and lack of control associated with a limited partnership or limited liability company interest to create a discount in the value of stated assets, thereby reducing the ultimate estate tax liability. For example, if you contribute $1,000,000 worth of real estate to a family limited partnership and take back a 99% limited partnership interest along with a 1% general partnership interest, the limited partnership may be valued as low as $500,000 for estate tax purposes. Recently, however, the IRS has had several court victories in which they have challenged the tax treatment of family limited partnerships and limited liability companies. Nevertheless, they remain as viable planning vehicles under today’s tax law.

Family limited partnerships and limited liability companies have the same potential disadvantage associated with them as qualified personal residence trusts and grantor retained annuity trusts. That is, if the estate tax is repealed, the estate tax benefit associated with family limited partnerships and limited liability companies will be lost. At that point, it will be the IRS that will be arguing for a discount in the value of family limited partnership and limited liability company interests, in order to limit the step up in basis. The greater the discount, the more capital gains tax that ultimately will be paid upon the sale of assets contributed to a family limited partnership or limited liability company.

The downside risk associated with the family limited partnership or limited liability company, however, is not nearly as great as the downside risk associated with the qualified personal residence trust or grantor retained annuity trust. That is because the establishment of a family limited partnership or a limited liability company essentially can be reversed simply by liquidating the entity, whereas the qualified personal residence trust or grantor retained annuity trust, once created, cannot easily be undone. Thus, if a family limited partnership or limited liability company could save you significant estate tax dollars under today’s law, it still makes sense to move forward with your planning. If the repeal of the estate tax is made permanent, you may have to liquidate the partnership or limited liability company. You will have been inconvenienced and have paid some unnecessary costs, but will not have lost out tax-wise.

This article contains only general information and is not to be relied on as legal advice. For advice on your individual situation, consult a lawyer in your jurisdiction. No attorney/client relationship arises from use of this article.