San Jose Estate Planning Attorney Blog

One of the best strategies for clients with wealth is to find ways to maximize the value and economic efficiency of that weath in a way that benefits the family without increasing the tax impact on the client's estate.  An intrafamily loan is often an excellent strategy.

Loans to the children and grandchildren can be used to help the kids purchase a home, pay for living expenses, start a business, and many other things.  With short term interest rates less than .25% per year, even loaning funds for investment purposes can be an excellent freezing technique for the client's estate.

Here are 5 tips to avoiding traps when making an intrafamily loan.

1.   Always Have the Loan in Writing

The importance of making the loan in writing cannot be overstated.  How do you prove to the IRS what the terms of the loan were?  What if someone dies before repayment of the loan?  Who gets the future income and payments?  Will other family members be upset that one child got “free” money that they didn't get?  If you need to prove that the loan was a bona fide loan and not a gift (very important for tax purposes) you will need documentation to prove it.

2.   Take Advantage of the Annual Gift Tax Exclusion

Every year, a client can give $13,000 to as many different individuals as they wish.  If the client is married, the couple may give a combined $26,000 per year.  If there is a loan outstanding, the client could potentially forgive the annual exclusion amount of the loan each year until it is paid off.  This is often preferable to an outright gift that use up exemption and may create negative tax consequences.  However, be careful not to merely “loan” the money and then never expect repayment because of future forgiveness of the annual exclusion amounts.  This may impact whether or not you actually make a bona fide loan in the first place.  You will want to work with a qualified attorney to help avoid that pitfall.

3.   Show That You Intended to Collect the Loan

This follows from the comment above.  You must have every intention of collecting according to the terms of the loan.  I think it is important to have some repayment history on the loan. 

4.   What if the Loan is in Default

It is not appropriate to let a loan linger in default.  This goes towards whether or not you have a bona fide loan.  Some attempt at collecting should be made.  If the loan is secured, for example, against a house, you will need to consider whether or not foreclosure is appropriate.

5.   Charge Interest on the Loan

The Treasury Regulations require that interest be paid on the loan at the Applicable Federal Rate (AFR).  The AFR is divided into Short Term (up to 3 years), Mid-Term (3 to 9 years), and Long Term (over 9 years) interest rates.  In any intrafamily loan, you must charge at least the appropriate interest rate.  In most cases this interest is taxable income to the client and should be reported on their 1040 income tax return.  Even if the interest is not paid or is forgiven as a gift, the interest income is still reportable taxable income.

I am often asked why we have recommended making a different state the location for a client's Dynasty Trust, Family Limited Partnership, or LLC.  Since setting a trust or entity up in another jurisdiction is

There are many different reasons for doing so.

Some states allow a trust to last forever.  California, on the other hand, severely limits the length of time the trust may exist.  This can have real negative tax consequences to my clients.

Some states allow for great restrictions on the Limited Partners or LLC Members.  California, on the other hand, is fairly loose.  This means that those entities do not get the best valuation discounts nor the asset protections afforded by other states.

Recently, Tamara Pow of the Structure Law Group, posted on the San Jose Business Lawyers Blog an article on Choice of State for a New Corporation.  In it, she compares California, Nevada, Delaware as places to form your new corporation.  She discusses the pros and cons of each.  I commend her post for your perusal. 

Obviously, these are complex issues that require time and an understanding of the client's goals and objectives.  It is not uncommon, in my practice, for clients to decide to do the more convenient thing rather than the most “tax efficient” thing.  They may a business decision.  Or they make a family decision.

But it is very important that clients be given options… so they can make a decision.  In my experience, most Santa Clara County Estate Planning Lawyers only advise and recommend California trusts and entities.  They often don't know better. 

Make sure you client's get options.  Fill out our Contact Form or call the office to comment or ask questions.  A reminder… our office is in San Jose near the airport with convenient freeway access and free parking.

For many years, the GRAT has been a staple of estate planning strategies. It was something that every high net worth client considered as a freezing technique.

With the new estate tax law that became effective last December, a GRAT may not be the best strategy for many clients going forward.

While the GRAT is an excellent method for shifting the future growth of an asset to the children, there are a number of risks associated with this strategy. For example, the trust maker must survive the entire GRAT term for there to be any benefit. In addition, payouts from the GRAT must be done on a regular basis (monthly, quarterly, annually, ect.) and each payment must be basically the same amount (no more than a 20% increase) as the previous payment.

For many client’s, there is a better technique available to accomplish the same goals but without these risks. This technique is an installment sale to a grantor trust (IDGT).

How does the installment sale work? The trust maker sells the property to a grantor trust at its fair market value in exchange for a note. There are two important aspects to this strategy. First, the trust must be structured as a grantor trust so it can be disregarded as a separate taxpaying entity for income tax purposes. Second, the transfer for fair market value must be a bona fide sale for full and adequate consideration to avoid any gift tax issues. After the note has been paid in full, whatever remains in the trust may be distributed to the beneficiaries (usually the trustmaker's children and/or grandchildren) free of estate and gift taxes, and if appropriately structured, generation-skipping transfer taxes as well.

If the assets in the trust appreciate at a rate greater than the interest rate due on the note, there will be assets remaining in the trust at the end of the note term to pass to the beneficiaries. Ideally, we would like the income produced by the assets to be greater than the interest only payment due on the note. This allows for maximum compounded growth of the principal. The trustee, however, may use the trust's capital assets to pay the note if necessary.

Generally, any assets with appreciation potential or yield in excess of the note interest rate are candidates for this installment sale strategy. Assets that can be valued at a discount, such as a minority interest in a family business or a fractional interest in real estate produce significant savings because the face amount of the note will be based on the discounted value of the assets sold rather than on the full economic value. At some point in the future, however, when the assets are sold, the discount is recaptured and the discounted benefit fully realized.

In the coming weeks we will continue to blog further about GRAT's and Installment Sales.

Make sure your client's are working with an Excellent Estate Planning Attorney who understands both planning and tax.

6 ARGUMENTS AGAINST PLANNING FOR PORTABILITY

It seems like all I hear or read from other lawyers are all of the problems and uncertainties that exist in Portability Planning in the client's estate plan. Last week I listened to another attorney go on and on about the best course of action to take: "Keep Doing Things The Way We Have Always Done Them! Portability has problems!!!"

Living in the past is not usually the best solution for our clients. It is true that there are unknowns in Portability Planning. There are also some situations where it is not appropriate for that particular client. However, for most clients who have non-taxable estates, planning to use the deceased spouse portability exemption is the BEST planning available to them. At a minimum, it ought to be actively considered in the planning process.

Over the next couple of weeks, I will examine the potential problems of portability planning and the advantages and benefits as well.

Problems of Portability Planning

There are six primary arguments I hear attorney's make when they speak against planning for the surviving spouse to use Portability.

1. "It is only a two year law. Portability is only possible if the client dies in 2011 or 2012. Since that is not likely, why spend much time on it. Who knows what the law will be in 2013."

While it is certainly true that the law may change in 2013, not everyone will live to see that day. But we create estate plans to be in place when client's die. They need to be accurate and subject to the best information we have available at the time. It is not a good response to say, “I did not think you were going to die today?

2. "The law is ambiguous and there are no regulations and cases to help us interpret the law."

This one really upsets me because it is one of the reasons lawyers have such a bad reputation among the general public. Attorneys are generally perceived as being too conservative. In this case, however, the attorney, along with the rest of the client team of advisors, needs to weigh the risks and rewards of the strategy. As we will discuss in later posts, the benefits for some clients, clearly outweigh the risks.

3. "Use of the Portability Exemption is not automatic. It requires you to file an estate tax return."

True again. But at what cost? The cost of filing the return may be very small compared to the taxes lost for failing to tax advantage of Portability. In addition, there is the possibility the IRS will create a 706A short form as an alternative to the standard 706 Estate Tax Return currently required.

4. "There is no statute of limitations for examining the estate tax return."

There is also no statute of limitations if you don't file a return at all. However, if a return is filed, the IRS may only examine it after three years for a limited purpose and not to assess taxes. There are no limitations for an unfiled return."

5. "Although the surviving spouse estate tax exemption is indexed for inflation (also only for the next two years), there is no inflation adjustment for the deceased spouse Portability Exemption."

This is a risk to be considered in implementing Portability after the first spouse dies. It is not a reason not to plan. For many clients, this will not matter. It is good information to know, but it does not stop us from planning to use Portability.

6. "Portability only applies to Estate and Gift Taxes.. It does not apply to Generation Skipping Transfer Taxes."

Finally, an argument that makes sense! Therefore, if GST planning is important to the client, you should not use Portability as a planning option.

In our next post, we will discuss the many positive benefits for Portability Planning for clients.

The Qualified Personal Residence Trust (QPRT) is an important and valuable estate tax planning technique for efficiently transfering the value of your primary residence or vacation home to your children on a tax advantaged basis.

The QPRT is an Irrevocable Trust which takes advantage of certain provisions in the tax code to allow you to leverage your gift of your home using a discounted value. Because it take advantage of provisions in the Treasury Regulations, it is a safe and secure way to accomplish your goal without any legal or tax risks.

To create a QPRT, the homeowner transfers his or her residence to a trust for a set period of time (4, 7, 11 or 15 years). You pick any number of years for the term. You continue to reside or use the home as you see fit during this time.

At the end of the term, the property is transfered to the beneficiaries you have named in the trust (usually your children).

Hugh Hefner is purchasing the 30% of Playboy Enterprizes he doesn't own for an 18% premium. The media is focusing on his age and the poor future propects for the company. They seem to be ignoring the tax aspects of this deal for Mr. Hefner's family.

A publicly traded company is easy to value for estate and gift tax purposes. The publicly traded price is the valuation price for the stock. There is no discount. Not only that, but publicly traded companies generally trade at higher multiples of earnings than their closely held counterparts.

When a company is closely held, the value as a percentage of earnings is generally lower than corresponding publicly held companies and the shares are discountable as well.

Assuming Mr. Hefner is not going to live for another 20 years, this tranaction makes perfect sense from an estate and gift tax perspective. The cash he puts out to purchase the shares will reduce the value of his estate since the overall value of the company, now privately held, will go down.

The reduction in value for estate tax purposes will save the estate taxes on Mr. Hefner's death.
Later, when the economy is better, the family can sell the company back to the public for a premium to generate and realize the value that has been there all along.

This type of strategy works in reverse as well.

If your client has stock in a privately held company that may go public (i.e. Facebook, etc.), they should see a qualified estate tax planning attorney to create strategies for them while the valuation of the stock is still relatively low. As the day of going public nears, the value of the shares is increasing for tax purposes and the less tax savings your client will realize.

We have a new law!

President Obama signed the new tax law on Friday extending the Bush tax cuts for two years. Included in this new law are significant estate tax ramifications. While the overall impact on advisors remains to be seen, there is no doubt that this is bad news for some and good news for others. As a general rule, however, this is good news for the rich.

Here is a quick summary of the estate tax provisions of the new law:

1. $5 million exemption: There is now a $5 million estate tax exemption for each individual. This means $10 million can be exempted from estate taxes for a married couple.

2. Reunification: The estate, gift, and GST tax exemptions have been unified to the $5 million amount. This means that a client can gift $5 million into a dynasty trust while they're alive, using up their estate tax exemption, and not have to wait until they die to take advantage of the increased exemption.

3. Portability: clients who no longer plan for their estate tax exemptions me transfer their unused portion of that exemption to their spouse when they die. If husband dies, he can transfer his $5 million exemption to his wife, and she will now have a $10 million exemption upon her death as she leaves the property to her kids.

4. 2010 election: for clients dying in 2010, they have a choice of law. The client may elect to have a $5 million estate tax exemption with a full step up in basis on all of the decedents property. The client could also choose an unlimited estate tax exemption, but they would only get carryover basis with the additional allocated basis maxing out at $4.3 million.

This law is going to create huge planning opportunities. But there is no doubt, that planning options will change. For many, this means simpler plans which are also less expensive. However, the opportunities for the wealthy to plan and avoid estate taxation have never been better.

We will be conducting a couple of workshops in San Jose, at the end of January or the beginning of February to better help the advisors that we work with understand the details and planning options more fully.

I will post the details in the future.