By: John P. Dedon1775 Wiehle Avenue, Suite 400

Reston, Virginia 20190(703) 218-2131

John.Dedon@ofplaw.com

2013 VADA Family 2013 VADA Family ConventionConvention

GreenbrierGreenbrier

FINANCIAL PLANNING FINANCIAL PLANNING ASSOCIATION – NATIONAL ASSOCIATION – NATIONAL

CAPITALCAPITAL

Year End Tax Planning UpdateYear End Tax Planning Update

1

Virginia Business Virginia Business MagazineMagazine

January 4, 2013January 4, 2013

Congress Provides Business Congress Provides Business Owners A Grappling HookOwners A Grappling Hook

By: John P. DedonBy: John P. DedonYes Virginia, there is a Santa Claus, and Yes Virginia, there is a Santa Claus, and

yes Virginia business owners, Congress did yes Virginia business owners, Congress did provide estate tax relief by enacting the provide estate tax relief by enacting the American Taxpayer Relief Act of 2012. The American Taxpayer Relief Act of 2012. The relief is not a first class ticket off the cliff, as relief is not a first class ticket off the cliff, as that would have been estate tax elimination, that would have been estate tax elimination, but considering the alternatives, it is a soft but considering the alternatives, it is a soft descent down the cliff.descent down the cliff.

2

2012 Law Highlights2012 Law Highlights

• $5 million exemption indexed for inflation

• 40% estate tax rate• Gift opportunities remain…for now

• Discounting• Dynasty Trusts• GRATs and Intentionally Defective

Trusts

3

Estate TaxEstate Tax : :

2013 Forward:2013 Forward: $5 Million gift and estate $5 Million gift and estate exemption: 40% tax rateexemption: 40% tax rate

President’s Proposal President’s Proposal Reversion to 2009: 45% Reversion to 2009: 45% rate & $3.5 M exemption rate & $3.5 M exemption beginning in 2018beginning in 2018

Exemption AmountYear

Permanent?Permanent?

President Obama’s Budget President Obama’s Budget Proposal: ContinuedProposal: Continued

• Limit GRATs: 10 year minimum term Limit GRATs: 10 year minimum term and remainder have some value.and remainder have some value.

• Limit dynasty trusts to 90 years Limit dynasty trusts to 90 years protection from GST taxprotection from GST tax

• Eliminate stretch IRAs for non-spouse Eliminate stretch IRAs for non-spouse beneficiaries. 5 year requirement.beneficiaries. 5 year requirement.

• Limit sales to grantor trusts (estate tax Limit sales to grantor trusts (estate tax inclusion on assets sold to grantor trusts)inclusion on assets sold to grantor trusts)

4

Annual ExclusionAnnual Exclusion

1)1) Make $14,000 annual exclusion Make $14,000 annual exclusion gifts (Outright; Crummey Trusts)gifts (Outright; Crummey Trusts)

2)2) Pay Tuition for educationPay Tuition for education

3)3) Pay Medical ExpensesPay Medical Expenses

5

Power of the Annual Power of the Annual ExclusionExclusion

$14,000 per year, “use it or lose $14,000 per year, “use it or lose it”it”

Example: Mom and Dad have three Example: Mom and Dad have three kids and 5 grandchildrenkids and 5 grandchildren

$14,000 x Two x Eight x 20 years = $14,000 x Two x Eight x 20 years = $4,480,000$4,480,000

Potential estimated estate tax Potential estimated estate tax savingssavings

$1,792,000$1,792,000

6

Interplay of Estate and Interplay of Estate and Income Tax Planning Post-Income Tax Planning Post-

ATRAATRA Decision between gifts and bequests more complexDecision between gifts and bequests more complex

- Income tax basis of property received by gift versus bequest:Income tax basis of property received by gift versus bequest: Gifts – “carry-over” basisGifts – “carry-over” basis Bequests – “step-up” in basis to fair market value at deathBequests – “step-up” in basis to fair market value at death

- Effect of large, inflation adjusted federal estate tax exemptionEffect of large, inflation adjusted federal estate tax exemption Can shelter more property from federal estate taxesCan shelter more property from federal estate taxes Heirs receive basis step-upHeirs receive basis step-up Benefit magnified in states with income taxes but not estate Benefit magnified in states with income taxes but not estate

taxestaxes- Must compare total income/capital gains taxes on later sale of Must compare total income/capital gains taxes on later sale of

gifted property vs. estate taxes on inherited propertygifted property vs. estate taxes on inherited property

7

Income Tax Planning Post-Income Tax Planning Post-ATRAATRA

8

Individuals now face much higher income tax exposure:Individuals now face much higher income tax exposure:- Maximum federal individual tax ratesMaximum federal individual tax rates

39.6% income ($400,000 (single) / $450,000 (married))39.6% income ($400,000 (single) / $450,000 (married)) 20% capital gain ($400,000 / $450,000)20% capital gain ($400,000 / $450,000) 40% estate and gift tax rate ($5.25MM exemption in 2013)40% estate and gift tax rate ($5.25MM exemption in 2013)

- ““Pease limitation” on itemized deductions for adjusted gross Pease limitation” on itemized deductions for adjusted gross income (income (AGIAGI) over $250,000 / $300,000) over $250,000 / $300,000 Effectively raises federal income tax rates by 1.2%Effectively raises federal income tax rates by 1.2%

- State income and/or estate tax exposure can increase rate to State income and/or estate tax exposure can increase rate to 50%:50%: E.g., VA – 5.75% income & no estate / MD – 5.5% income & E.g., VA – 5.75% income & no estate / MD – 5.5% income &

16% estate / DC 8.95% income & 16% estate / CA – 13.3% 16% estate / DC 8.95% income & 16% estate / CA – 13.3% income & no estate / NY – 9% income & 16% estateincome & no estate / NY – 9% income & 16% estate

Planning for the Couple Planning for the Couple with Assets under $10.5 with Assets under $10.5

MillionMillion

• Focus on asset management and Focus on asset management and income tax planningincome tax planning

• Trusts to protect and manage Trusts to protect and manage inheritanceinheritance

• Income tax planning may be more Income tax planning may be more important than transfer tax planningimportant than transfer tax planning

• Portability v. Traditional Credit Portability v. Traditional Credit Shelter TrustShelter Trust

9

Planning for the Couple with Planning for the Couple with Assets in Excess of $10.5 Assets in Excess of $10.5

MillionMillion

• Continue to use transfer tax Continue to use transfer tax planning techniquesplanning techniques- Gifts to GST trustsGifts to GST trusts- Sales to grantor trustsSales to grantor trusts- GRATsGRATs- Charitable lead trustsCharitable lead trusts

• Watch basis of gifted assetsWatch basis of gifted assets

10

11

Remaining Threats To Family Remaining Threats To Family AssetsAssets

Potential Creditors

3-6% Probate & Legal Expenses40%

39.6% Income Tax

IRS

12

TAKE CARE OF BASICSTAKE CARE OF BASICS

WillsWills Revocable Living TrustsRevocable Living Trusts Advanced Medical Directives Advanced Medical Directives

(Living Wills)(Living Wills) Powers of AttorneyPowers of Attorney

13

Proper Planning Will Allow You to . Proper Planning Will Allow You to . . .. .

Give what you have,Give what you have,To whom you want,To whom you want,

When you want, andWhen you want, andIn the way you wantIn the way you want

And Pay Less for:And Pay Less for: Court CostsCourt Costs

Attorney’s fees Attorney’s fees Estate TaxesEstate Taxes

Other Fundamental Planning Issues

• Children with creditor, financial, or marital problems

• Children from a previous marriage and second spouse

• Children with special needs (parents)• Spouse who would need help

managing and investing funds – now or later

14

15

ProbateProbate

CostTime DelaysPublicityProperty In Multiple StatesHassleAvoid Probate With Revocable

Trust

Closely Held Business

16

Assets

Retirement

Liquid

Insurance

Total

17

Two Case Studies

Mom

Dad

2 Children

Mr. and Mrs. Rich E. Couples

18

ProfileProfile

• Married• $10 Million +• Real estate, retirement plans,

other liquid assets, life insurance

19

Assets

$ 450,000 $100,000

$ 2,500,000

Retirement

$ 4,000,000

Liquid

Insurance

$15,000,000

$ 2,000,000 $250,000

Total $ 2,450,000 $350,000 $21,500,000

Grand Total = $24,300,000

20

Objectives

• Provide for surviving spouse• Provide for children at second death• Eliminate probate• Eliminate or avoid estate tax• Eliminate or avoid estate tax in

perpetuity• Asset protection to protect

children from divorce, creditors

21

Solutions – Case Study I Step I

• Wills, Revocable Trusts with credit trust and marital trust for surviving spouse, Powers of Attorney and Medical Directives.

22

Solutions Step II

• Focus on $4 million Property• Husband creates LLC and transfers

house to LLC• Use $5,250,000 exemption amount

23

Trust $3,960,000

Before Discount

Grantor

Beneficiaries =Wife and Children

Trustee

$4 Million1% Equity100% Voting = 100% Control

99% of Equity

WhWhyy

• Estate and GST Exemption Applied - $5,250,000 + Appreciation Estate Tax Free

• Asset Protection• Spouse• Children

• Access• Husband has control through LLC

voting interest and access through Trust during marriage

• Wife is Trust beneficiary• Keep it in Family

24

Problems (and Problems (and Solutions)Solutions)

25

• Divorce• Death

•Life Insurance (for protection and as an investment)

• Section 2036•Pay Rent

Same Plan – Different Same Plan – Different AssetsAssets

• Corporation or LLCCorporation or LLC• Gift/SaleGift/Sale• Private AnnuityPrivate Annuity

26

27

Solutions – Case Study II Step I

• Wills, Revocable Trusts with credit trust and marital trust for surviving spouse, Powers of Attorney and Medical Directives.

28

Solutions Step II

• Focus on $10 million of marketable securities

• Spousal access Trusts• Each spouse transfers his and her

own assets to the other’s Trust• Use exemption amount and file gift

tax return

29

Husband’s Trust

$5 Million

Grantor

Beneficiaries =Wife and Children

Trustee

30

Wife’s Trust $5 Million

Grantor

Beneficiaries =Husband and Children

Trustee

WhWhyy

31

• Estate and GST Exemption Applied - $10 Million + Appreciation Estate Tax Free

• Asset Protection• Each Other• Children

• Access

Problems (and Problems (and Solutions)Solutions)

32

• Legal Issues• Support• Reciprocal Trust

• Divorce• Death

•Life Insurance (for protection and as an investment)

33

Why Not a GRAT?Why Not a GRAT?

Rethinking Life Insurance Rethinking Life Insurance after ATRAafter ATRA

• What are the reasons for buying the What are the reasons for buying the existing amounts and types of life existing amounts and types of life insurance? Are they still valid?insurance? Are they still valid?

• If to create estate liquidity, does it still If to create estate liquidity, does it still make sense with a $10+ million make sense with a $10+ million exemption between spouses?exemption between spouses?

• If in a trust, how best to deal with If in a trust, how best to deal with policies that exceed current needs?policies that exceed current needs?

34

Rethinking Life Insurance Rethinking Life Insurance after ATRAafter ATRA

• Should high net worth clients use some or Should high net worth clients use some or all of their transfer tax exemption to all of their transfer tax exemption to purchase a single pay policy?purchase a single pay policy?

• Consider the income tax advantages of life Consider the income tax advantages of life insurance for those in the 39.6% bracket insurance for those in the 39.6% bracket and subject to the 3.8% Medicare surtax.and subject to the 3.8% Medicare surtax.

• If held individually, should whole life If held individually, should whole life policies be retained to provide tax-free policies be retained to provide tax-free borrowing or to supplement retirement borrowing or to supplement retirement funding?funding?

35