Charitable bailouts can save your C corporation clients big on taxes

This strategy can be a win for donors, C corporations, and charities.

By Patricia M. Annino, J.D.

philanthropyBecause of the accumulated earnings tax, a C corporation with significant accumulated earnings can be a problem for a CPA trusted business adviser. Paying the money out as a dividend leads to a second tax the client probably does not want to pay. On the other hand, the longer the company holds the cash and does not use it, the more likely the IRS will impose the accumulated earnings tax.

But if a C corporation owner client is philanthropically inclined and would like to remove the earnings from the company while still maintaining a controlling position of its stock, it may be time to explore a charitable bailout. That’s because this technique can help the donor achieve his or her charitable objectives, avoid capital gains tax, and distribute excess cash that has been accumulated in the corporation tax-free. If the owner’s succession plan involves transferring ownership of the company to his or her children, the owner can also achieve this goal through a charitable bailout.

In a charitable bailout, a corporation’s owner gifts stock in the corporation to a charity, and the corporation then redeems the stock using the corporation’s retained cash. Both the gift of the stock and its redemption are income-tax-free. If the charity is public and if the donor has held the stock for more than one year, the donor is entitled to an income tax deduction for the fair market value of the stock under Sec. 170(b)(1). If the gift is
made to a charitable organization that is not a public charity, the income tax deduction is limited to the donor’s basis in the stock under Sec. 170(e)(1).

Stockholders may choose to donate the stock to a charitable remainder trust for redemption. Normally, if a charity is a private foundation or a charitable remainder trust, a redemption would violate the self-dealing rules. However, a “corporate adjustment” exception (http://www.irs.gov/Charities-&-Non-Profits/Private- Foundations/Exceptions-Self-Dealing-by-Private-Foundations:-Certain-recapitalization-transactions) of Sec.
4941(d)(2)(F) permits redemptions when all stock of the same class as the donated stock is “subject to the same terms” and the charity receives at least fair market value for the stock. To be “subject to the same terms,” the corporation must make a bona fide redemption offer on a uniform basis to the charity and every other stockholder.

Why use charitable bailouts?

The charitable bailout can be very beneficial to all parties involved. It allows a charity to receive cash and a corporation to bail out its accumulated cash while the donor avoids any built-in capital gains tax on the donated stock. The capital gain on the redeemed stock is considered passive income and, as gain from the sale of property, is exempt from the unrelated business income tax (UBIT) under Sec. 512(b).

Charitable bailouts have far better tax consequences than direct donations by a stockholder. If a corporation paid a dividend to the stockholder that the stockholder then contributed to the charity, the stockholder would then owe income tax on the dividend. But, with a charitable bailout, the stockholder can claim the charitable income tax deduction for the donated stock (subject to the 30% and 50% limits of Sec. 170). Though it is the stockholder, not the corporation, who receives credit for the gift, it is the corporation’s cash, not the stockholder’s cash, that is being used. A corporation that has accumulated significant cash will have less cash after a charitable bailout, and thus be less likely to be subject to the accumulated earnings tax.

The charitable bailout technique can also be useful in succession planning. If parents and children all own stock in a C corporation, the parents could reduce or eliminate their ownership stake by contributing their stock to a charitable remainder trust, which stock the company could then redeem. For this strategy to be effective, the children must be stockholders prior to the redemption and the corporation must have sufficient cash to effectuate the redemption. (See IRS Letter Rulings 200720021 and 9338046. Redemption by a note and not cash is a prohibited act of self-dealing).

Potential trouble spots

Advisers and their clients should be aware of several possible pitfalls when using charitable bailouts. One is the imputed prearranged sale doctrine (Rev. Rul. 78-197; Rauenhorst, 119 T.C. 157 (2002); Letter Ruling
200321010). If a stockholder contributes stock in an arrangement in which the charity is compelled to sell the stock, the IRS could take the position that the shareholder had assigned the sale proceeds to the charity, and tax the transaction as if the stock were sold or proceeds distributed to the stockholder. It is worth noting that Rev. Rul. 78-197 states redemption proceeds are taxable as income to the individual stockholder only if the charitable entity is legally bound or can be compelled by corporation to surrender its shares for redemption.

As always, advisers should review state law before recommending a charitable bailout. Also, if the transaction is occurring between related parties, they should be sure to review the charitable organization’s conflict of interest policy.

Note that donor-advised funds, private foundations, and supporting organizations must be mindful of the excess business holdings prohibition and 10% tax under Sec. 4943. This prohibition and tax do not apply to public charities.

In summary, if a client has significant retained earnings in his C corporation and has philanthropic intent, the charitable bailout is a strategy well worth considering.

Patricia Annino is a sought after speaker and nationally recognized authority on women and estate planning. She educates and empowers women to value themselves and their contributions in order to ACCOMPLISH GREAT THINGS in the world – and in so doing PROTECT THEMSELVES, those they love, and the organizations they care about. Annino recently released an updated version of her successful book, Women and Money: A Practical Guide to Estate Planning to include recent changes in the laws that govern how we protect our assets during and beyond our lifetime. To download Annino’s FREE eBook, Estate Planning 101 visit, http://www.patriciaannino.com.

Beyond the $5 Million Federal Exemption: Today’s Estate Planning Trends

Family estate planning document image, estate planningAs 2015 continues to unfold, estate planning advisors should take note of the latest trends, which appear to be here to stay:

 

  1. Simplify, Simplify, Simplify (and get back to the basics) – The federal gift, estate, and generation-skipping tax exemptions are, for now, remaining at $5 million (adjusted for inflation). The trend, therefore, will be to simplify and unwind complicated structures, including trusts, which no longer have any estate tax benefit.

    Clients under the tax threshold will not want to pay to establish traditional, revocable bypass trusts, so there will be a trend back to creating simple wills. Managing the complexity and the administrative burden of numerous entities would be frustrating for many of these clients.

    Although the sentiment that “the law may change” will encourage some clients to cling to those structures, the move will be toward simplicity. Clients want transparent, understandable planning tools and no longer believe they need anything complex to accomplish their overall goals. Post-mortem techniques will allow advisors and families to have a “second look” nine months after the date of the decedent’s death to correct any factual mistakes or changes in the law that may have happened since the documents were established.
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  3. Increase in Emphasis on State Estate Tax Planning. – For many families, federal estate tax planning will no longer be the main driver – state estate taxes will now be in the spotlight. In some states, there is a minimal $1 million exemption and the state estate tax rates reach 16 percent. For a $10 million estate that may not pay any federal estate taxes, the state estate taxes could be as high as $1.44 million.

    Although the state in which a family is domiciled controls the bulk of the tax, it becomes complicated to calculate the state inheritance taxes when families own property in several different states. If a husband and wife are domiciled in Florida (which does not currently have a separate state death tax), owns a vacation home on Cape Cod, and has commercial real estate in Greenwich, they would have to pay state estate taxes to both Massachusetts and Connecticut because they owned real property in both states. The state that claims estate tax domicile will prevail in assessing the estate tax on more than the real property and tangible personal property physically located in that state – it will reap the tax on the decedent’s intangible assets too, including investments and stock in the family business no matter where it is located. The determination of domicile for state estate tax purposes is fact-driven and differs from the determination of domicile for state income tax purposes. Estate planning professionals need to pay particular attention to these points.
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  5. Increased Focus on Intergenerational Planning – As greater wealth passes down unhampered by federal estate taxes, it will become easier to hold broad discussions on family wealth that cut across generational lines. Insurance professionals must shift gears from the old goal – preserving the wealth by making sure that the government interferes as little as possible – to emphasizing the capture, preservation, and management of the assets for the good of a family system for generations to come. This requires a candid and thoughtful conversation with the family to discuss their common goals, their visions for the future, and how the family business will be managed in subsequent generations.
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  7. Investment Choices on Dynasty Trusts Established to take Advantage of the Federal Gift Exemption. At the end of 2012, many high net worth families took advantage of their ability to gift $5 million, adjusted for inflation, and transferred assets to trusts. In the year-end rush, many of those trusts now have investments but no investment strategy. Now that this increased exemption has become permanent, many families will continue to implement and fund these trusts. From a leverage point of view, current law dictates that those assets, no matter how much they appreciate, will bypass estate tax for subsequent generations and will do so until the trust terminates. From an estate planning point of view, advisors should consider investment leverage and with their fiduciary duty in mind, contemplate investing those assets for future growth. Many families are also purchasing life insurance as part of this investment strategy, as it provides additional leverage and the funds used to purchase the insurance have already been moved out of the federal transfer tax system.
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  9. Understanding the Impact and Influence of Double Inheritors. Many baby boomer women in this country will be double inheritors – they will inherit wealth from their parents and from their spouse. Over the next 20 years, the amount of wealth that will pass through and be controlled by baby boomer women will be staggering. As advisors, it is imperative that we understand the enormity of this market and acknowledge that reaching the woman client is different from reaching the male client. That woman client may be happily married now (and widowed later), single, divorced, widowed or remarried.
     
    Author Tom Peters, who has written extensively about organizations, leadership, and trends in the marketplace, is convinced that women represent the number one economy – and he believes that the impact of the women’s market on our global economy may be even bigger than the impact of the Internet. Understanding and reaching the double inheritor market is an important client service and an increasingly important business opportunity for estate planning advisors.

 
Now that the $5 million federal exemption appears to be permanent, estate planners need to refocus their energies – and their clients – to creating estate plans that are less concerned with avoiding federal taxes, and more concerned with managing and maintaining wealth for current and future generations.

Patricia Annino is a sought after speaker and nationally recognized authority on women and estate planning. She educates and empowers women to value themselves and their contributions in order to ACCOMPLISH GREAT THINGS in the world – and in so doing PROTECT THEMSELVES, those they love, and the organizations they care about. Annino recently released her new book, “It’s More Than Money, Protect Your Legacy” available at Amazon.com. To download Annino’s FREE eBook, Estate Planning 101 visit, http://www.patriciaannino.com.

3 Tips to Planning at the Intersection of Income and Estate Taxes

The American Taxpayer Relief Act (ATRA) significantly increased the federal estate tax exemption in 2013 to Estate Taxes$5,250,000 (adjusted for inflation). For estate planners that have traditionally overlooked the income tax during planning discussions, it’s time to take another look at that tax and how and where it intersects with estate taxes.

  1. A refresher course on the relationship between the federal estate tax and the federal income tax.
  2. If there is no federal estate tax, giving the asset away during lifetime can result in overall higher taxes paid by the family. Under the ATRA federal income tax rules, capital gains on appreciated assets will be taxed at a 20% rate for taxpayers with taxable income over $450,000 (joint filers), $400,000 (single filers), $425,000 (heads of households) and $225,000 (married taxpayers filing separately). The capital gains tax is 15% for taxpayers that are below those thresholds. Also under ATRA, there is a 3.8% investment tax that may apply, with a significantly lower threshold. The investment tax is based on modified adjusted gross income (adjusted gross income plus any excluded foreign income) and is $250,000 for joint filers, $200,000 for single filers, $200,000 for heads of households and $125,000 for married filing separately.

    When the asset is given during lifetime, the recipient inherits the income tax basis of the donor if that basis is appreciated (IRC Section 1015(a)). The result may be a significantly higher overall tax paid than if the asset transferred at death. In other words, if the gross estate of the donor is less than the federal estate tax exemption, and there is significant built-in gain in the asset, then giving it during lifetime will trigger the gain when that asset is disposed of or sold.

    When evaluating the tax cost to a lifetime gift, look at the state inheritance and estate taxes too. For states with an estate tax, the exemption is lower than the federal estate tax exemption level, so there may be a state estate tax due even if there is no federal estate tax due. Retaining the asset until death may result in no federal estate tax, a state estate tax, and a fresh start income tax basis for income tax purposes. It is important to run the numbers and determine the lowest combination of those three taxes to make an informed planning decision.

    If property given during lifetime is depreciated at the time of the gift, the donee takes as the income tax basis the fair market value of the property at the time of the gift – but only for the purpose of taking losses. (IRC Section 1015(a)). The donee’s basis is increased by the portion of the gift taxes paid on the gift transfer. (IRS Section 1015(d)(6)).

    When the bequest occurs at death time, the income tax basis receives a fresh start and is stepped up to the date of death value, or the alternate valuation date, if that was elected. (IRC Section 1014). This occurs even if no federal estate taxes are due, meaning that any gain accrued prior to the date of death disappears. On the other hand, if the asset was depreciated for loss recognition purposes, the basis steps down at the time of death and loss cannot be recognized.

    If the taxpayer is domiciled in a community property state, then the surviving spouse’s share of community property is treated as acquired from the decedent and receives the stepped up or stepped down basis even if it was not included in the taxpayer’s federal gross estate. (IRC Section 1014(b)(6)).

    There is a glitch if the decedent had acquired the asset within one year of death and if at the taxpayer’s death the asset passes back to the donor or the taxpayer’s spouse. In that case the basis does not step up (Section 1014(c)). From a planning point of view, if the taxpayer’s health is declining, it makes sense, if possible, to make the gift more than one year prior to death and to someone other than the donor or the taxpayer’s spouse.

    Another exception to the stepped-up basis rules pertains to what is known as “income in respect of decedent” under Code Section 691.  Section 1014(c) provides that these items are to be included in full in the decedent’s gross estate and treated as gross income when realized. Essentially, these assets are taxed at twice – once for the estate tax and once for the income tax. There is an estate tax deduction under Section 691(c) for the estate tax attributable to the inclusion of income in respect of decedent on the decedent’s federal estate tax return.

    Examples of assets subject to both taxes include certain salary and fringe benefits accrued at death, fees and commissions performed during lifetime and paid after death, and retirement plan assets and dividends. If the taxpayer’s intention is philanthropic, however, donating these assets to a qualified charity qualifies for both the estate and income tax deductions.

    In light of the significantly increased federal estate tax exemption, take into account these income tax considerations in determining which assets should be transferred during lifetime, at death, to individuals, and to charities.

  3. Carefully Consider the Tax Consequences of Installment Sales
  4. The older generation may decide to sell the family business or commercial real estate to the next generation on an installment basis, which freezes the value of the asset for estate planning purposes. With the significantly increased federal estate tax exemptions, however, this may no longer be important. For federal income tax purposes, installment sales allow the taxation to be proportionately spread out during the years that the principal payments are made. Since this is a lifetime sale, there is no fresh start basis in the underlying asset and the heir who inherits the note continues to pay income taxes on the payments as they are received.

  5. Determine if Charitable Gifts Should be Made Lifetime or Death Time.

For clients who wish to leave a death time bequest to a charity, if the estate is not subject to federal estate tax then there is no deduction.  If the estate taxes are deferred until the death of the surviving spouse, and the charitable bequest occurs through the estate of the first spouse upon their death, in all likelihood there will be no federal estate tax and therefore no estate tax charitable deduction. Alternatively, the client may decide to make the gift during his lifetime and obtain the charitable income tax deduction, or he may ask his spouse to voluntarily make it during her lifetime if she survives him and take the income tax deduction. His estate planning documents could provide that if that is not done then the charitable bequest is to be paid when they both die.

With the significantly increased federal estate tax exemption, it is increasingly important for advisors to understand and focus on the income tax consequences of estate planning.


Patricia Annino
is a sought after speaker and nationally recognized authority on women and estate planning.  She educates and empowers women to value themselves and their contributions in order to ACCOMPLISH GREAT THINGS in the world – and in so doing PROTECT THEMSELVES, those they love, and the organizations they care about.  Annino recently released an updated version of her successful book, Women and Money: A Practical Guide to Estate Planning to include recent changes in the laws that govern how we protect our assets during and beyond our lifetime.  To download Annino’s FREE eBook, Estate Planning 101 visit, http://www.patriciaannino.com.

Estate planning for valuable art (Part Two)

Lessons Brooke Astor could have used.

To continue our discussion from May 22.  Here are several additional options and considerations you may find appealing.

CRATs and CRUTs

The donor may determine how the income interest will be calculated with a CRT. There are two types of CRTs: the charitable remainder annuity trust (CRAT) and the charitable remainder unitrust (CRUT). The CRAT is designed so that the actual dollar amount distributed to the donor (and/or the other persons the donor designates) are fixed when the trust is created and funded. Generally the predetermined annuity amount will not change no matter how the trust assets fluctuate in value. A CRAT can be appealing to the donor who needs a specific amount of income and who is concerned about a change in income payments.

A CRUT is designed so that the amount distributed to the donor is recalculated each year based on a fixed percentage of the trust’s fair market value for that year. Unlike the CRAT, the CRUT is not a fixed annuity payment. The fixed percentage will not change; however, the amount that the donor receives can fluctuate. If the CRT performs well and the trust assets increase in value, so will the income interest payment, which is calculated as a fixed percentage of the increased trust value. However the reverse is also true, and if the trust decreases in value, the income interest will also be affected. A CRUT is appealing for the investment-minded donor who wants to benefit from increased income payments resulting from the long-term appreciation of the trust assets. There are various types of CRUTs, which should be explored in greater detail before the client makes a final decision.

A disadvantage of using a CRT for art is that because art is personal property, the income tax deduction may be limited significantly. In addition, when a charitable contribution consists of a future interest in tangible personal property, no deduction may be taken until all interests and rights to possession or enjoyment of the property have expired or are held by a person other than the donor (Sec. 170(a)(3)).

The tax benefits of transferring art to a CRT and later selling it include avoiding the capital gains tax on the sale of the asset and removing the underlying value of the asset from the donor’s taxable estate. Of course, the reason that the art is removed from the taxable estate is that it is no longer owned by the donor. For that reason, some donors couple the use of a CRT with what is known as an irrevocable life insurance trust. When used together, these tools replace the art’s value and keep that value out of the donor’s taxable estate.

Trusts

The client may also choose to make a gift (lifetime or at death) of the art to family members in trust. If the client wishes the art or collection to stay with intended beneficiaries, he or she can establish an irrevocable trust and transfer the collection to it. That will protect the assets from the creditors of the beneficiaries and preclude its value from being taxed in the client’s estate. If doing so, it is advisable to add enough funds to that trust to insure and maintain the art. Choosing a trustee must be carefully considered as the trustee or trustees will have the continuing ability to manage the trust assets, including the art.

Fractional Interests

A gift of a fractional interest in art should also be considered. However, the Pension Protection Act of 2006 (PPA) greatly limited the value of this strategy. Until passage of the PPA, a collector could donate a fractional interest in a work of art to a museum that qualifies as a charitable institution. Collectors did so for many reasons, one of which was that they could take a tax deduction for the value of the fractional interest. For example, if a collector donated a 50% interest in a painting to a museum, he or she could write off half the value as a charitable deduction. The painting would spend half the year in the donor’s possession and half the year in the museum’s. Unfortunately, this led Congress to be concerned that collectors may have been abusing the write-off by enjoying more than their rightful share of the art. For example, if a collector donated 50% of the art but kept it for more than six months a year, the public would be losing out on the painting’s availability during the excess period.

To address this perceived abuse, Congress changed the law to make donations of partial interests in artwork much less attractive for donors. Generally, before the PPA, the collector would bequeath the remainder of the fractional interest to the museum so the collector’s estate would take a charitable contribution deduction for the remaining current fair market value at the time of the collector’s death. But the PPA changed the law to require that the write-off be based on the art’s value at the time the original fractional interest was donated if the art appreciated in value, rather than on its value at the time of the collector’s death. If the art’s value has appreciated in that period, as it typically does, the law will reward the collector by reducing the amount his or her estate could take as a deduction for the donation and thus increasing the estate tax liability.

Consider the example of a painting worth $1 million when the collector first donated 50% to the museum. The collector bequeaths the remaining 50% of the painting when she dies, at which time it is worth $10 million. Under the old rule, the painting would pass to the museum and the estate would take a $5 million charitable contribution deduction. Under the new law, her estate may only deduct $500,000 and the estate would have to pay taxes on $4.5 million more than it would have under the old law.

The PPA also introduced recapture rules (deductions turned back into taxable income) that further reduce the desirability of contributing a partial interest in art. If the collector fails to donate the balance of the art to the museum on or before the earlier of 10 years of the original gift or the collector’s death, the collector will be forced to recapture the deduction. In addition to paying income tax and interest on the recaptured amount, the collector must pay an additional 10% tax on it. This essentially requires the collector to donate or bequeath the remaining fractional interest or lose the tax benefit of the original gift.

Conclusion

If the client has valuable art, it is important that he or she assemble a team of advisers that understands how to deal with it. The team may include an attorney, financial adviser, tax specialist, and an art succession planner. It is wise to make sure that the team members know the extent and value of the art and how the client intends to dispose of it so that it can properly be taken into account when establishing a financial and estate plan.

The decisions and choices as to how to preserve the legacy of artwork should be thought through with care and involve a discussion with the client, the intended beneficiaries, the charitable organization, and the team of advisers.

Patricia Annino is a sought after speaker and nationally recognized authority on women and estate planning.  She educates and empowers women to value themselves and their contributions in order to ACCOMPLISH GREAT THINGS in the world – and in so doing PROTECT THEMSELVES, those they love, and the organizations they care about.  Annino recently released an updated version of her successful book, Women and Money: A Practical Guide to Estate Planning to include recent changes in the laws that govern how we protect our assets during and beyond our lifetime.  To download Annino’s FREE eBook, Estate Planning 101 visit, http://www.patriciaannino.com.

Patricia Annino Receives “Best in Wealth Management” Award

The Euromoney Legal Media Group chose Patricia Annino, Chair of Prince Lobel’s Estate Planning and Probate Practice Group, to receive the prestigious “Best in Wealth Management” award at the second annual Americas Women in Business Law Award ceremony held May 24, 2012, in New York City.

Selected from a short-list of eight well-known, highly-qualified nominees, Patricia’s award was based on extensive peer review research conducted by Euromoney’s research team, her professional accomplishments during the past 12 months, and her advocacy and influence in the field of wealth management.

Following the success of similar award ceremonies in Europe and Asia, the Americas Women in Business Law Awards was launched by Euromoney Legal Media Group to give law firms and professional services firms the recognition they deserve for their efforts in helping women advance in the legal profession.

Patricia Annino is a nationally recognized expert on estate planning and taxation, with more than 25 years of experience serving the estate planning needs of families, individuals, and owners of closely held and family businesses. She speaks regularly on many issues of concern to family owned businesses, including succession planning, risk management, managing a business with multiple stakeholders, the risk of divorce, and more. Annino is a graduate of Smith College and Suffolk University School of Law.

Patricia is the author of two widely utilized professional texts: Estate Planning in Massachusetts, and Taxwise Planning for Aging, Ill, or Incapacitated Clients. Patricia’s recent books for consumers include, Cracking the $$ Code: What Successful Men Know and You Don’t (Yet), Women in Family Business: What Keeps You up at Night, and Women & Money, A Practical Guide to Estate Planning.

About Prince Lobel

Prince Lobel Tye LLP is a full-service law firm providing a wide range of services for Fortune 1000 companies, closely held businesses, and individuals. Prince Lobel’s attorneys are guided by the highest standards of legal excellence, professionalism, and service – whether they are addressing complex business issues or providing advice on personal legal matters. Practice areas and industries served encompass corporate law, data privacy and security, domestic relations, employment law, estate planning and probate, insurance and reinsurance, intellectual property and Internet law, litigation, media law, nanotechnology, real estate, telecommunications law, construction law, environmental law, renewable energy, health care, and education. For more information, visit Prince Lobel at PrinceLobel.com.

Patricia Annino is a sought after speaker and nationally recognized authority on women and estate planning.  She educates and empowers women to value themselves and their contributions in order to ACCOMPLISH GREAT THINGS in the world – and in so doing PROTECT THEMSELVES, those they love, and the organizations they care about.  Annino recently released an updated version of her successful book, Women and Money: A Practical Guide to Estate Planning to include recent changes in the laws that govern how we protect our assets during and beyond our lifetime.  To download Annino’s FREE eBook, Estate Planning 101 visit, http://www.patriciaannino.com.

Estate planning for valuable art (Part One); Lessons Brooke Astor could have used.

According to many who knew her, noted heiress and philanthropist Brooke Astor had a favorite painting, a Frederick Childe Hassam work known as “Flags, Fifth Avenue.” This American impressionist painting hung in a prominent place in her apartment since the early 1970s. Her son, Anthony Marshall, sold the painting while she was alive (and not competent) for $10 million and paid himself a $2 million commission. A short time after the sale, the dealer resold the painting for $20 million.

For many individuals and families, what to do and whom to trust with art is a thorny issue. It is important to consider the legacy of the work itself. Understanding the choices of who should receive it, who can afford to pay any estate taxes on it, who can afford to maintain it, who will use it, and who will appreciate it is an important part of the planning process. For many families these are not simple decisions. The right solution lies at the intersection of many complex and sometimes competing considerations.

Valuing art is an inexact science. No one can ever be sure what the market will bear. A first step to understanding the value is to get a qualified appraisal and valuation. The appraiser should be a member of either the American Society of Appraisers, the Appraisers Association of America, or the International Society of Appraisers.

It is important that the client understands the impact of taxation on the art in his or her estate (editor’s note: for more on this topic also see this Journal of Accountancy article.) For estate tax purposes, the gross estate of a U.S. citizen or resident at the time of his or her death, includes “the value of all property, real or personal, tangible or intangible, wherever situated” owned by the decedent at the time of his or her death (Sec. 2031(a)).

The IRS has established an Art Advisory Panel whose task is to assist the Service in reviewing and evaluating appraisals of artwork in conjunction with federal income, gift, and estate tax returns. (IRS Internal Revenue Manual, §42(16)4). The panel consists of 25 art experts. If a tax return containing art with a claimed value of at least $20,000 is selected for audit, the case must be referred to the panel. If the artwork exceeds $50,000, Rev. Proc. 96-15 (modified by Announcement 2001-22) provides that a request can be made for an IRS-expedited review of the art valuation.

The client should understand that with valuable art, more may be included in his or her gross estate than the art itself. Art may have to be sold and substantial commissions paid on the sales. If that is the case, it may be desirable to mandate in estate planning documents that a sale be made by the executor so that the commissions are deductible as administrative expenses. The only other way that commissions paid on the sale of the art after death are deductible from the estate is if the sale is necessary to pay the estate taxes. In other words, if the art is sold by the estate (for any reason other than it was essential to pay estate taxes) and the estate planning documents do not mandate that the art be sold, then the expenses of the sale, which can be significant, will not be deductible. Therefore, in essence, the heirs will be paying an estate tax on the lost deduction.

That is one reason it is important to have a frank discussion with family, beneficiaries, and any intended charity before bequeathing art. If a piece of art has always been in the client’s family and the client believes that his or her children wish to receive it, it is wise to have a conversation with the children or heirs to see if they want the art or if they are more interested in converting it to cash. In reality, the children or heirs may be unable to pay the taxes and the cost of maintaining the art.

The possible lack of deduction from the taxable estate for expenses attributable to the sale of art underscores how critical it is to discuss the art’s legacy with heirs and with any charitable organization in the planning process. If the client wants to leave the art to a charitable organization and the organization is willing to accept it, then the art’s value is included in the taxable estate and the estate receives a charitable deduction for the gift. If the charitable organization does not accept it and there is no alternative provision and the art is sold and added to the residue or passes to individual heirs, the expenses attributable to the sale are not deductible.

If, in the discussion about art, one family member does wish to receive it, then in the planning process you must carefully address how the estate taxes on that art are to be paid —who is to bear the burden of that tax? Is it the recipient or is it the estate’s remaining assets? Another option may be to consider what is known as a disclaimer—that is, the client leaves the art to the charitable organization or to a family member, and if they disclaim it (or choose not to take it) then the will mandates the sale of that asset to ensure that the estate will receive the requisite deduction.

If the client is considering gifting art to a charitable organization, find out now whether it is realistic for that organization to accept the gift and discuss any terms of the gift. Will there be any restrictions? Are those restrictions realistic? Are there endowment funds that will accompany the donation? It can be a burden to maintain and store art for a significant period of time. In my experience, donating funds to assist with maintenance and storage is prudent.

Charitable Remainder Trusts

Lifetime gifting options should be explored. There can be income tax benefits to making the gift of art—whether outright, in trust, or by fractional interest now. To assess the benefit, you must determine the income tax basis in the asset and quantify any capital gains tax that will be due on the sale. To avoid that gain, some clients consider transferring the art to a charitable remainder trust (CRT). A CRT (known as a split interest gift) is an irrevocable trust. The donor can gift the assets to the trust and retain the right to receive income for a predetermined period. When the income period ends, the CRT ends, and the remaining assets are distributed to the charitable organizations the donor has selected.

When the donor contributes an asset to the CRT, the donor will (in most cases) receive a current income tax deduction equal to the present value of the gift the charity will eventually receive when the CRT ends. Because CRTs are generally tax-exempt, appreciated assets can be gifted to a CRT and later sold without the donor or the trust owing capital gains tax. However, a CRT with unrelated business taxable income may be subject to a 100% excise tax on the unrelated business taxable income.

When the CRT is being established, the donor must decide the length of the income interest. In many cases, it is a lifetime payment stream (and/or for the lifetimes of one or more other persons the donor designates). As an alternative, the donor may direct that the income interest be paid for a specified period not to exceed 20 years. Once the specified income interest has concluded, the CRT terminates and the remaining assets are distributed to the charities that the donor has chosen.

Next week we’ll continue this discussion by looking at several types of trusts you may want to consider when making these types of gifts, as well as, the Fractional Gift option, and changes in the way these are managed.

Patricia Annino is a sought after speaker and nationally recognized authority on women and estate planning.  She educates and empowers women to value themselves and their contributions in order to ACCOMPLISH GREAT THINGS in the world – and in so doing PROTECT THEMSELVES, those they love, and the organizations they care about.  Annino recently released an updated version of her successful book, Women and Money: A Practical Guide to Estate Planning to include recent changes in the laws that govern how we protect our assets during and beyond our lifetime.  To download Annino’s FREE eBook, Estate Planning 101 visit, http://www.patriciaannino.com.

A Special Gift for Moms on Mother’s Day

As Mother’s Day approaches, I am reminded of those times when I was just not sure of what to give my Mom on her special day.  I recall a time when I helped get her estate planning and affairs in order, and how much she appreciated the peace of mind that it allowed her once the process had been completed.  Now that she has Alzheimer’s disease I am very glad we had that conversation and she had the ability to put her affairs in order. I am also glad we had the opportunity to discuss what type of care she wanted and how that should be managed.

Whether you’re looking to support your Mom, or get your own house in order, take this time to make sure that, much like you normally focus your time as a Mom making sure that everyone else is protected and safe throughout the year, that you and yours are, too, as it relates to your estate planning needs.

It reminds me of what the flight attendants say every time the plane takes off, if the barometric pressure changes and the oxygen mask drops from the sky, put the mask over your own face first…it is only when you do that, and protect yourself, that you can know that you are strong enough to protect the others you by instinct protect.

What a wonderful gift to you and your family at a time when we pause to honor you on Mother’s Day.

Patricia Annino is a sought after speaker and nationally recognized authority on women and estate planning.  She educates and empowers women to value themselves and their contributions in order to ACCOMPLISH GREAT THINGS in the world – and in so doing PROTECT THEMSELVES, those they love, and the organizations they care about.  Annino recently released an updated version of her successful book, Women and Money: A Practical Guide to Estate Planning to include recent changes in the laws that govern how we protect our assets during and beyond our lifetime.  To download Annino’s FREE eBook, Estate Planning 101 visit, http://www.patriciaannino.com.

Gifting Ownership of the Vacation House: A Gift or a Curse?

Ben Franklin once said that fish and houseguests smell after three days. But what if the houseguest co-owns the house? The perils of the vacation home, what to do with it, who should own it and what the rules are can be a source of family satisfaction and family conflict.

Under current law, the 2012 federal gift exemption is $5,120,000. Since many parents and grandparents are uncertain of their economic future, they may not want to gift assets that still earn income. Nor do they want to give away assets that have a low income tax basis that may be sold in the future. For these families, the vacation home is an attractive asset to consider gifting.

Gifting the vacation house to the next generation, or to a dynasty trust for the benefit of subsequent descendants, can remove that home (and any appreciation in its value) from the taxable estate. But before heading down that path, homeowners must carefully consider how that home will be owned post transfer.  We will explore three options: (i) outright ownership, (ii) an irrevocable trust (which could be a dynasty trust), and (iii) a family limited partnership or a limited liability company.

Outright Ownership

Often, the choice of making an outright gift of the vacation home is not appealing, whether the next generation owns the property as tenants in common, or as joint tenants with a right of survivorship. Many states have the right to compel a sale of that asset through a court proceeding, so the ownership of the home may be divisible in a divorce and subject to that family member’s creditors.

Also, family issues and resentments may develop with co-ownership. The child who lives out of state and never uses the home may resent sharing the expenses. Plus, with each generational transfer, the ownership becomes more fractionalized and the ownership of the asset is included in the taxable estate of each subsequent generation. There could also be conflict, such as who uses it the week of July 4th? Who pays for maintenance? Should rent be charged to cover expenses?

Irrevocable Trust (could be a dynasty trust)

A more appealing option for many families is transferring ownership of the home to an irrevocable trust. To complete the gift, the trust must be irrevocable, meaning that the donor cannot retain the ability to change, amend, or revoke its terms. The art of drafting an irrevocable trust is to remember that life is a movie not a snapshot, and that the document, while irrevocable, must also be flexible enough to contemplate the future.

The trust should address what happens to the child’s share at his or her death, whether or not the child’s spouse or stepchildren can continue to use the property in a divorce, or if the child predeceases his or her spouse. It should also address who is responsible for paying expenses, the line of succession of trustees, how the home should be furnished or updated, whether nonpaying guests may use the property, and who sets the rules for using the property.

Reasonable rules include who can use the property and when, the process for how that determination is made, whether use can be exclusive or must be open to all families all the time, payment of operating expenses, noise, cleanliness, pets, number of people, who pays for landscaping, parking, whether the property can be rented to nonfamily members, and other issues affecting the use and enjoyment of the property. The trust document can also address who has the right to determine the operating reserve and when income and/or principal may be distributed to the beneficiaries.

It may be also helpful for the donor to state intent – perhaps the use of the property is not intended to be equal, but based on relative degrees of interest in and ability to enjoy the property, and to take into account relative contributions (financial or otherwise) to its maintenance and improvement.

The document may also include a buyout provision by which one beneficiary (or beneficiary’s family) can sell his or her interest to other family members. Many families do not allow family members to cash out of their share in the home. An advantage to restricting what a family member can do to convert his or her share to liquid funds provides additional creditor protection and also helps keep that interest out of the taxable estate of subsequent descendants.

The trust should also address the mechanism by which a decision can be made to sell the home – should a decision that important be left only in the hands of the trustee? Should it include the trustees and all adults in the next generation? Should the vote be by majority or unanimous? The tension in that choice is that one family member who wants to use it more than others may block the sale for personal gain.

It is important to fund the trust with enough liquid assets to cover ongoing expenses and trustees. Future family discord might be avoided if family members who do not use the property are not expected to help cover its expenses. The funding can occur during the donor’s lifetime or at his or her death, through the donor’s estate plan. Once the property is transferred to the trust, the trustees should ensure that the property has sufficient property and casualty insurance coverage.

The trust document should also address the duration of the trust. It could end at a certain date, when the underlying asset is sold, when the trustees decide to end it, when the trustees and all adult beneficiaries agree to end it, when the Rule Against Perpetuities Period ends it, or if it is governed by a state that does not have any Rule Against Perpetuities, then it may never end.

Family Limited Partnership or Limited Liability Company.

A third choice is transferring the home to a family limited partnership or limited liability company, where the terms of the operating agreement control how the property is used. These entities are more businesslike than a trust, as they are members or partners. They offer the same benefits of the irrevocable trust, but may be more flexible. The operating agreement can provide a mechanism that allows it to be amended. If the entity is underfunded, the manager or general partner can make a capital call on the owners to contribute additional funds to the entity. As with the trust, the agreement will appoint a manager or management committee. The ownership structure can have two classes- voting and nonvoting. The transfer of ownership through sale or gift can be restricted.

Another benefit to gifting in this manner is that the valuation of the gift may have additional leverage and qualify for minority discounts or lack of marketability discounts. If the gift is not made all at once – but rather over several years – then all gifts are made off the record of the respective Registries of Deeds. In other words, the transfer to the entity is recorded initially, but ensuing gifts are transfers of the units or shares in the entity and are done within the entity itself, not in the Registry. This can save annual recording fees.  Additional benefits include income tax consequences in that each owner may have the benefit of the income and deductions flow through to his or her individual income tax returns.

Summary. Gifting the vacation house this year while the federal exemption is so high may be a very wise move. It is important for clients to think through their choice of entity and the considerations mentioned above before making this irrevocable decision.

Patricia Annino is a sought after speaker and nationally recognized authority on women and estate planning.  She educates and empowers women to value themselves and their contributions in order to ACCOMPLISH GREAT THINGS in the world – and in so doing PROTECT THEMSELVES, those they love, and the organizations they care about.  Annino recently released an updated version of her successful book, Women and Money: A Practical Guide to Estate Planning to include recent changes in the laws that govern how we protect our assets during and beyond our lifetime.  To download Annino’s FREE eBook, Estate Planning 101 visit, http://www.patriciaannino.com

Donor Education & Financial Literacy

Educating the Donor about Tax Savings and Efficiency Matters

A significant advantage of financial literacy is that it can save the donor in estate tax depending on the type of gift made to institutions. It is important for donors to realize that inaction is involuntary philanthropy.  That is, what donors pay in taxes to the federal and state governments is spent by the government as it wishes on programs of its choosing.

So when donors pay taxes or give money without exercising any specific influence, they have engaged in de facto involuntary philanthropy.  That involuntary philanthropy can be at least partially converted to voluntary philanthropy by donating part of what the government would otherwise receive to charities of the donor’s choosing for purposes of the donor’s choosing.

Once donors realize that they have engaged in involuntary philanthropy, they are often motivated to consider philanthropic gifting. In other words, when the donor makes a private charitable gift and receives an income tax deduction for that gift, then the government loses part of its share of revenue and those funds are instead redirected to the specific philanthropic causes of the donor’s choosing.

Careful planning is needed to minimize transfer taxes, and charitable giving can play an important role in an estate plan. (http://www.360financialliteracy.org/Topics/Budgeting-Spending/Budgeting-and-Saving/Charitable-giving?print=1). By leaving money to charity, a donor may deduct the full amount of a charitable gift from the value of a gift or taxable estate. Understanding that there may be tax benefits and exploring what those benefits may be can be an effective way to start the giving conversation.

In particular the effective use of specific bequests to institutions, charitable lead trusts and charitable remainder trusts result in the donor and his/her family paying less in estate taxes. In 2011, generally, the federal gift and estate tax is imposed on transfers in excess of $5 million and at a top rate of 35 percent. (http://www.360financialliteracy.org/Topics/Budgeting-Spending/Budgeting-and-Saving/Charitable-giving?print=1).

Making an institution the beneficiary of a tax deferred retirement plan is the most tax efficient way to leave money if assets are greater than the federal estate tax exemption, as the charitable institution will receive the funds free of both estate and income tax. (Ann Kaplan. 2010.”Philanthropic Planning” Smith College, October 20, presentation).

Patricia Annino is a sought after speaker and nationally recognized authority on women and estate planning.  She educates and empowers women to value themselves and their contributions in order to ACCOMPLISH GREAT THINGS in the world – and in so doing PROTECT THEMSELVES, those they love, and the organizations they care about.  Annino recently released an updated version of her successful book, Women and Money: A Practical Guide to Estate Planning to include recent changes in the laws that govern how we protect our assets during and beyond our lifetime.  To download Annino’s FREE eBook, Estate Planning 101 visit, http://www.patriciaannino.com.

Woman to Wed Slain French Soldier Posthumously

Yes, you read that correctly.  It got my attention, too!  Here’s a link to the entire article:  http://www.guardian.co.uk/world/feedarticle/10161149

In a nutshell, under certain circumstances, the French President is able to approve such a marriage for several reasons, this one being because his widow is pregnant and the marriage will serve to give his unborn child a father.

What came to mind for me is how shocking this is and how something like this here would dramatically affect the way we look at estate planning. When you consider the ramifications of this type of unusual ceremony, it’s impossible to contemplate what else the future may hold!

Patricia Annino is a sought after speaker and nationally recognized authority on women and estate planning.  She educates and empowers women to value themselves and their contributions in order to ACCOMPLISH GREAT THINGS in the world – and in so doing PROTECT THEMSELVES, those they love, and the organizations they care about.  Annino recently released an updated version of her successful book, Women and Money: A Practical Guide to Estate Planning to include recent changes in the laws that govern how we protect our assets during and beyond our lifetime.  To download Annino’s FREE eBook, Estate Planning 101 visit, http://www.patriciaannino.com.

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