Grantor Retained Annuity Trust

(This is the fourth installment in a six-part series of powerful planning strategies that will help you take advantage of a down market and protect wealth.)

With a Grantor Retained Annuity Trust (GRAT), you can avoid gift-tax consequences while temporarily freezing the value of an asset that will be worth more later.

The asset can be shares in a company that is likely to go public or beaten down shares of stock that are likely to appreciate.

Like loans, GRATs mature within a specified number of years and you get back any money you put in when the trust expires.

How Does It Work?

A GRAT is an irrevocable trust and can be designed in a variety of ways to benefit you and your family. In general, it involves transferring an asset, such as stock, with a retained right to receive fixed income, at least annually.

The GRAT permits the value of the grantor’s retained interest to be subtracted from the value of the property transferred in order to arrive at a net gift amount.

While it can be structured in many creative ways, it is typically used in the following way:

1. The grantor has an asset that he believes will appreciate and that he wants to remove from his estate for tax purposes. (With stocks and real estate at a low, this is a powerful tool, assuming the grantor believes that values will appreciate.)
2. The grantor receives a defined income stream, which reduces the value of the principle.
3. The beneficiaries receive the appreciation, whatever that may be.

For example, Dad places $500,000 of company stock into a GRAT. He receives a certain sum in income, pays tax on it, but allows all of the stock’s appreciation to transfer to his children, gift tax free.

What Are the Benefits?

There are many non-tax benefits to a GRAT, as well. For example, if you wants a specific asset to go to one child over another, or you don’t want a former spouse or creditor who might contest your will to obtain it, a GRAT makes it less likely that the asset will be lost if your estate is embroiled in a lawsuit.

Be aware that if you die before the trust ends, then it’s as if the GRAT never existed. The trust’s entire value – including its returns – will be included in your estate and subject to the estate tax.

Another good planning approach is to create separate GRATs for each asset. If you combine two or more unstable assets into one GRAT, then the losses on one might offset the gains on another.

A well-designed GRAT is a powerful way to avoid gift-tax consequences while providing your family a significant portion of an asset’s income.

I hope this information helps you and your family. If you have a specific case or a question, don’t hesitate to call our office.  As always, feel free to call me for further advice or to share your ideas.

This article concludes the 2008 portion of our series on transferring wealth strategies. Our six-part series will continue in 2009 with:  “Sharing the Family Business Without Giving Up Control.”

Intentionally Defective Grantor Trusts

(This is the third installment in a six-part series of powerful planning strategies that will help you take advantage of a down market and protect wealth.)

Here’s another great technique you can use to transfer wealth in an advantageous and unique way: gifting an asset’s appreciation while keeping its income. An Intentionally Defective Grantor Trust (IDGT) is an irrevocable trust designed for the benefit of your children and future descendants.

How Does a Defective Trust Work?

While there are two main strategies, the “pure gift” of the asset or the installment sale, the most common is the installment sale. Typically, you as the trust maker set up an irrevocable trust and then gift cash into the trust. The trust is drafted so that you retain enough control to cause the property conveyance to be “defective” so that you are taxed on the income from the trust, but effective enough to avoid estate and gift tax. You then enter into a sales agreement with the trust to sell appreciated assets in exchange for a promissory note. Interest is paid at the Applicable Federal Rate (AFR). The result is the sale of the appreciate asset “freezes” its value for estate tax purposes.

For example: Mom and Dad create an IDGT into which they wish to transfer $500,000 worth of stock. They can either gift the stock or sell it. If they sell it to the IDGT, they need to convey enough cash into the trust to cover its down payment to them. They enter into an agreement for a monthly amount. The interest rate on the promissory note must at least equal the Applicable Federal Rate (AFR). The logic is that the stock will appreciate at a greater rate than the AFR, so that they kids benefit from the appreciation but Mom and Dad’s value is the $500,000 note they traded for the stock.

What Are the Advantages?

· An “estate tax freeze” of the appreciating asset.
· No gift tax conveyance while shifting future appreciation estate tax free.
· If you (the trust maker) die, only the value of the note is included in your estate.
· Creditor protection for the asset inside the trust.

The ultimate goal is that assets sold to the IDGT will be completed gifts for your children and will not be subject to estate taxes.  Since you are receiving the income, the trust allows the transfer without a negative gift tax consequence.

Transfer Assets at Fair Market Value

It’s important to note that if the IRS believes you sold assets to an IDGT for less than fair market value, it can treat them as gifts or reject the trust altogether and treat the assets as if they were still part of the your taxable estate. To avoid this, assets should be sold to an IDGT at fair market value and the promissory note’s interest rate should at least equal the Applicable Federal Rate (AFR).

Through careful design and a rigorous attention to detail, an IDGT can be a powerful way to reduce estate tax liability while benefitting your family. I hope this information helps you and your family. If you have a specific a question, need further advice or want to share your ideas, don’t hesitate to contact our office.

Stay tuned for Part IV of our series!

Help Relatives With Loans, But Protect the Principal

(This is the second installment in a six-part series of powerful planning strategies that will help you take advantage of a down market and protect wealth.)

In our last installment, we discussed how gifting can reduce your estate tax burden and help your beneficiaries. This time, we’ll explain the opportunities found in making a family loan. Lending is a great way you can help your beneficiaries and possibly garner a greater return on your money than by investing it in a CD or money market account.

Still, many people never approach the subject of lending because they find it awkward to discuss money with relatives. But it doesn’t have to be that way.

The Family Loan
With the nation’s credit crisis and failing capital markets, the appeal of a family loan is evident.  Low interest family loans benefit recipients and are a significant estate-planning tool for families. 

The classic example is Mom and Dad loaning money to a child who is buying his or her first home. Instead of gifting the money, Mom and Dad loan a down payment or the entire purchase price.

If the home is valued above $12,000, which most are (even in this market), then anything above that mark can be considered a gift and be taxed.

To avoid triggering a gift tax, you can provide a low interest loan based on the Applicable Federal Rate (AFR), which the government determines monthly. It’s typically less than a bank rate. In August, the average rate on a 30-year mortgage was 6.5 percent, but the AFR was between 2.5 percent and 4.5 percent.

A New House
Mom and Dad loan $400,000 to a son and daughter-in-law at an AFR of 3 percent.  At the end of the year, Mom and Dad then gift $24,000 to their son, who applies it to the principal of the mortgage. This allows Mom and Dad to avoid a gift tax and enables their son to save a substantial sum.

The stunning advantage of this strategy is that while the child saves hundreds of thousands of dollars in interest that he or she would pay to a bank, Mom and Dad receive a higher rate of return than from a CD or a money market account.

The Investment
In another scenario, the child can take the loan and invest it at a higher rate of return than the loan itself. At the end of the loan, you receive the principal back and have essentially transferred the amount of the investment’s increase to your child free of a gift tax.

Be sure to treat the loan like a formal business arrangement and be willing to enforce any legal claims against a defaulting borrower. If borrowers stop making payments, then you can find yourself in the regrettable position of having to foreclose on your own children. This downside seems remote, but it is one you must consider.

If you can live with this resolve, then this can be a powerful, winning strategy for everyone.

I hope this information helps you and your family. If you have a specific a question, need further advice or want to share your ideas, don’t hesitate to contact our office.

Stay tuned for Part III of our series on Intentionally Defective Grantor Trusts: Gift the Appreciation, But Keep the Income.

The door is locked, the ATM isn’t working and nobody is answering the phone. Banks don’t just close, right?

Yes, they do. But by taking the right steps to safeguard your business assets, a bank failure won’t cost you the value of those deposits.

Many Americans are alarmed by the failure of at least fifteen U.S. banks this year and panicked at not knowing if their money could be saved. In the midst of the nation’s banking crisis, it’s wise to re-examine how you structured your business bank accounts. That’s why we’ve gathered the latest banking rules to help you understand how to protect your money without having to stash it in banks all over town.

Experts in and out of government predict the banking crisis will continue. The markets have priced the odds of banking giant Morgan Stanley defaulting in the next five years at 45 percent and Citigroup failing at 21 percent.

To reassure depositors, the FDIC has made a few policy changes. It simplified rules for revocable trusts, increased the level of insurance coverage per depositor from $100,000 to $250,000 for interest bearing accounts and agreed to insure the full value of non-interest-bearing accounts until Dec. 31, 2009.

Some Good News

It’s worth noting that since the Federal Deposit Insurance Corporation (FDIC) began insuring banks in January 1934 no depositor has lost a single cent of insured funds as a result of a bank failure.

To reassure depositors in today’s financial climate, the FDIC has made a few policy changes. It simplified rules for revocable trusts, increased the level of insurance coverage per depositor from $100,000 to $250,000 for interest bearing accounts and agreed to insure the full value of non-interest-bearing accounts until Dec. 31, 2009.

Something you might not realize is that FDIC coverage on interest-bearing accounts can be increased – if the accounts are held in different ownership categories. These include single accounts, certain retirement accounts, joint accounts and revocable trust accounts.

Separate Personal and Business Accounts

It’s important to understand that when calculating insurance coverage the FDIC adds together the deposits in all “single” accounts owned by the same person.

Let’s assume coffee shop owner Jane Jones, the sole proprietor of Jane’s Java, has opened several accounts at the same bank.

1. Account A ($15,000) is Jane’s personal checking account.
2. Account B ($20,000) is Jane’s savings account.
3. Account C ($190,000) is Jane’s CD account.
4. Account D ($25,000) is a business checking account for Jane’s Java.

So far, Jane’s deposits area securely covered because the total of her deposits does not exceed $250,000

But what if Jane put an additional $10,000 into her savings account? The additional deposit would not be covered because it exceeds the FDIC’s $250,000 limit.

To keep her deposits fully covered, Jane can transfer the business account for Jane’s Java to another bank so that the her deposits at the original bank do not exceed $250,000 or place her personal accounts into a living trust.

You can deposit more than $250,000 into a revocable trust account and it can still be fully insured. You just need to name more than one beneficiary. Each beneficiary’s share would be insured for up to $250,000.

You can learn more about the FDIC and how it protects your deposits by visiting www.fdic.gov.

If you’ve got further questions, don’t hesitate to contact us. We’re here to help.

Business owners try their best to avoid having any problems with tax authorities. They usually try to solve the problem right away so that they do not encounter any more problems later. But what happens when there is a tax authority with a vendetta against you? I recently read an article where this happened. A 70-year-old inventor claimed California tax authorities hounded him for the past 15 years for income tax and fraud penalties. He argued that he owed nothing and this was a personal vendetta.

Through his persistence and motivation, he was able to win a lawsuit against a government for $388 million for compensatory damages and punitive damages. This jury found the tax agency acted with oppression, fraud and malice. Those of you who like David vs. Goliath type stories will enjoy it. I have attached the article below if you would like to read the whole story.

http://www.thestrategiccounsel.net/downloads/2008_california_scheming_nets_388_million.pdf

This is a fantastic editorial from Andy Kessler in September 25th Wall Street Journal. Mr. Kessler is a former hedge-fund manager who wrote a great book called “Running Money”.

His book argues that all the paradigms for evaluating the economy don’t work anymore. I have given out copies of “Running Money” and encourage everyone I know to read it. Mr. Kessler’s editorial was so wonderfully contrarian and insightful, I had to share this article.

http://online.wsj.com/article/SB122230704116773989.html#printMode
 

I watched Paulson testify in front of Congress yesterday. He has a lot of patience and courage. I personally think I would have politely told some of the self righteous grandstanding Senators to politely take the job if they thought they could do it better.
Paulson’s plan is less than perfect, but he is right. As tax payers, we are the hook anyhow. I am attaching an editorial from the Wall Street Journal that provides interesting criticism. Let me know your thoughts.
http://www.thestrategiccounsel.net/downloads/2008September24_The%20Paulson%20Sale.pdf

One of my fiscal beliefs is that you can’t be taxed into prosperity. The U.S. dollar, our interest rate, legal system, and entrepreneurial attitude make us a wonderful country to attract global companies.

However, our corporate tax rates are second highest in the world. If you want to stimulate the U.S. economy, provide tax credits for research and development, clean energy ventures, and investment in infrastructure. Apply the credit to our corporate tax rates and stand back. (This of course is just my humble opinion.)

As further evidence, I am attaching an editorial called “America the Uncompetitive” from the Wall Street Journal. By the way, read about the Irish tax rate of 12.5% that actually collects more than the U.S.!!! If you find this interesting, pass it on.

http://online.wsj.com/article/SB121875570585042551.html

One of the maxims in journalism is “never bury the lead,” which means, put the most important point of your article at the beginning. This is always a challenge for us for a variety of reasons, but based on the questions and feedback we received for the
blog called Tax Proposals of the Presidential Candidates, we buried the lead. We humbly apologize. We will try again; here is the lead:

The Estate Tax Is Here To Stay!
Both presidential candidates are behind keeping the estate tax; neither supports its repeal.

Senator Obama
Senator Obama is proposing a $3.5 Million Exemption and a 45% Estate Tax Rate. His position is basically the Democratic Party’s position on this issue.

Senator McCain
Senator McCain is proposing a $5 Million Exemption and a 15% Estate Tax Rate. This is more generous than his opponent’s plan, but it’s obviously not a repeal.

What Does This Mean?
Like everything involving politics, this is only conjecture until it becomes law. For the sake of discussion, let’s make some assumptions. First, one of these two presidential candidates wins (safe assumption). Second, the first item on the new President’s agenda is the repeal of the Estate Tax (not so safe of an assumption, as it will probably not be an issue until 2010). Third, Congress passes the new President’s tax position. Now all of these
assumptions may get us in trouble, so the only conclusion we can truly reach is that there will be an Estate Tax.

What does this mean to us?
Certainty. Well, maybe not certainty, but at the very least it means some direction. We need to be educating our clients that the Estate Tax repeal is probably not going to happen. If they are waiting to see what the law will look like, both candidates have
provided their direction. The question is what can be done now to take advantage of the current law.

It’s Not Law (We Know)
We realize that it’s not law, but it is a prediction of what may become law. This is the reason we “accidentally” buried the lead. The candidates are clear, but the future is not. Therefore, the only conclusion we can reach is that if either becomes President, the Estate Tax in some form will be with us beyond 2010. Both candidates are already telling
us their positions; the only question is how do we help our clients to act now?

Fall will be here before you know it, and in 2008 that can only mean one thing (besides the return of a promising football season) - the Presidential Election. There are an amazing number of issues for the candidates to wrestle with. One of the issues we’ll be
watching is taxation. Both candidates have a plan as to how the United States would run under his term. While each one of us and our respective clients will be impacted differently, we wanted to provide you with a short summary of each candidate’s position.
The key tax issues on which we are focusing are Estate, Capital Gains, and Income Taxes. I have tried to dissect these categories so that you may gain a better understanding of what each candidate is proposing.
 

Estate Taxes – Not Repealed!
This first one is intriguing. We all know that the estate tax is scheduled to be repealed in 2010. However, neither candidate is supporting its repeal. Adjustments yes, but repeal no. As of January 1, 2009, the current Federal Estate Tax exclusion is scheduled to jump from $2 million to $3.5 million, thus affecting about 0.3% of households. Senator Obama has adopted the Democratic Party’s platform to “defer” or freeze the exemption by proposing a $3.5 million exclusion in 2009 and thereafter, with a top rate at 45%. He would like to make these tax parameters permanent in an attempt to “restore fairness” to the tax system. Senator McCain’s plan proposes raising the exclusion to $5 million per
person and cutting the top federal estate tax rate to 15%.
Also, both Senators support retaining the current system for valuing inherited property that has increased in value over the years, referred to as the “stepped-up basis.” This is good news for our CPA colleagues, who are concerned about the repeal of the “stepped-up basis” under current law.

Capital Gains
Senator McCain would like to keep the current structure of tax rates on capital gains and dividends.Senator Obama, on the other hand, would like to raise the long-term capital gains rate to 20% if your income is over $250,000.

Income Taxes
Last but not least is a comparison of how each candidate would handle your income taxes. Senator McCain would not change much from the current system. He favors giving us a 35% income tax rate and keeping Social Security taxes at the current level. On the other hand, Senator Obama wants to increase the income tax rate to 39.6%. He also proposes
higher Social Security taxes for those with incomes over $250,000.

Election 2008
We don’t know which candidate will be our next President. However, their tax policies are influential with many voters. None of these proposals will be signed into law without debate, and of course, Congressional approval. Make your vote count.