What tax loopholes can you take advantage of the next two years thanks to the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act signed into law December 17, 2010 (2010 Act)? If you simply wait until the end of next year, unprecedented benefits may be lost. So, what should be done now before higher taxes confront you? In short, shift wealth to your heirs! Yes, gift certain assets to take advantage of the two-year tax loopholes of the Act. The most advantageous areas of gifting are now with real estate, business assets and whole, universal and variable life insurance policies with high cash values.

Real Estate

Prior to the 2010 Act you could not gift more than $1 million during your lifetime. According to present law, the gift exemption returns to $1 million again in year 2013 and there may be much political and economic pressure to keep the gift exemption at the $1 million level. But, for this and next year that figure has jumped five-fold to $5 million. At the same time present values of real estate and family-owned businesses are now at or near all time lows. What does this mean – in plain language? It means that for this year and next year only, you can put more of your residential, no-rental real estate into trusts (called QPRTs) while the real estate values are low and gifting threshold is high. Properly drafted, the transfer will not diminish your control over the use of the home transferred to the trust. The reason to make the transfer into a trust is to eliminate its present value – and appreciation – from your estate to avoid estate taxes. This move could avoid likely estate taxes of anywhere from 35% to 60%, depending upon the estate taxes Congress will likely adopt at the end of next year.

Businesses

Likewise, it is a perfect time to finally make the move to form and implement a thorough review of your business’s succession plan and to gift closely-held business interests to the next generation(s) of family members. Values are low, interest rates that determine the “gift” amount of the transferred interest are low and the gift threshold is temporarily high. Thus, you now can transfer more business interests, and thus more taxable wealth, to other family members to avoid estate taxes. Properly drafted, the transfer will not diminish your control over the business.

Besides gifting business interests to family members, the review of your business plan should include a look at buy-sell provisions and their valuation formulas in case of your or a co-owner’s departure from the business, either voluntarily, by death or disability. It is a good opportunity to integrate business assets into your estate plan using family generational (or dynasty) trusts. While the gift threshold is temporarily high you may put more assets into such trusts for the benefit of your descendents and simultaneously further reduce your taxable estate. In addition, the trusts will provide asset protection for your descendents. Remember too, business entities must adhere to the statutory mandates of operating a business – proper records, timely meetings and their minutes, etc. All of these matters should be reviewed to lower taxes, provide a smooth transition of management/ownership and protect assets.

Consider a couple, both age 65, with a taxable estate. They own their own business and a second home in Florida worth $1 million. Presently, they each own fifty (50%) percent of their business estimated to be valued at $5 million. They have two adult children. How can they avoid or limit estate taxes?

Real Estate Example using QPRT

1.  A February, 2011 transfer of the $1 million Florida home into a trust (QPRT) yields the following:

Value of gift, which is

Value of gift, which is subtracted from the $5 million gift threshold: $241,320

Value that passes outside of their estate with no gift tax consequences: $758,680

Appreciation also avoiding estate taxes assuming a 5% growth over 20 years: $1,653,298

Tax savings – assuming death at age 85 (after 20 years) and a 35% estate tax: $844,192

Tax savings – assuming death at age 85 (after 20 years) and a 55% estate tax: $1,326,588

Gift of Business Example

2.  They could also shift some of their business interest to their children.

A gift of ten percent of the business stock to each child would be worth $500,000 each. However, under present law, one could apply a discount to that value for lack of marketability by about twenty-five (25%) percent, and lack of control for another twenty-five (25%) percent, thus reducing the gifted value for tax purposes further to $250,000 to each child. This gifted value is removed from the parents’ gross taxable estate upon death. Remember, this includes ten percent of the appreciated value of the business over the next twenty years too. Also, consider that Congress now must have revenue offsets with every enacted tax savings provision, so discounts for lack of marketability and lack of control – perceived “loopholes” – may become old law com the end of next year.

People who have had their estate and business estate planning intentions limited by the previous $1 million gift tax exemption, definitely should consult their estate planning attorney to consider gifting this and next year before these benefits become lost opportunities. People with real estate, business interests and multi-generational gifting desires will benefit the most.

Trustees of Life Insurance Trusts Beware

After the decision of the case In Re Stuart Cochran Irrevocable Trust (“Cochran “), trustees of a life insurance trust (ILIT) have clear notice of their fiduciary responsibilities in managing trust assets even if it is only the life insurance policy on the maker’s life. After this first-of-its-kind case, beneficiaries may now sue trustees for failing to employ a “prudent process” in managing the trust assets.

Too many of us do not consider our life insurance policy after purchasing it. However, life insurance is an asset class like any other in our client’s portfolio that needs to be reviewed and monitored. Substantial premiums may be preserved as a result. Having policies reviewed by an outside, independent entity, that has no financial stake in the review process may be the best means to prevent a court decision that a trustee did not fully and adequately manage and protect trust assets. A trustee’s duty to manage trust assets includes determining if an existing life insurance policy that minimizes costs and maximizes benefits.

For example, one of our clients recently engaged a life insurance advisory firm that does not make in-house determinations of suitability (as we have found to be the case with many agents/brokers), but instead buys independent pricing and performance research reports from theinsuranceadvisor.com. One of the holdings in this client’s portfolio was a $30,000,000 policy from an A++ rated insurer. We asked local agents of the advisory firm, Steven Zeiger and David Buckwald, who both subscribe to a “prudent process” that includes suitability determinations from this outside, independent entity and who had no financial stake in the review process, to help our client understand these pricing and performance research reports.

Based on the independent research from theinsuranceadvisor.com the agents helped our client understand for the first time what he was actually being charged relative to both an industry average pricing and best-available rates and terms. Because the original selling agent who placed this policy provided the client with ONLY an illustration of hypothetical policy performance, thus a comingling of actual policy charges and assumed investment performance, the client was oblivious to being overcharged by almost 40%. As a result of this review, our client not only understood the true costs of his old policy but learned that he could exchange his old policy for a new one with either $12,000,000 of additional coverage for the same premium, or reduce his premium by over $100,000 for the same coverage.

With mortality tables and interest rates recently modified and the message of Cochran, it is critical for trustees and life insurance owners to routinely review life insurance policies. How may a trustee pursue an independent review of the insurance policies of an ILIT? Contact me to suggest agents that really conduct independent reviews and who can compare your existing policies and their costs across the entire industry.

The tax advantages discussed in this newsletter are probable targets for Congressional change/elimination, which Congress does not have to wait until the end of next year to make. Even without Congressional action the gift tax exemptions automatically decrease back to $1 million in the year 2013. Thus, the prudent course is to take action now to investigate estate and business options that may soon no longer exist.