Outstanding presentation to clients and friends by two SDK CPAs on how to transfer wealth to the next generation.

1. September 25, 2009 [SDK’S LEARNING CURVE
Transferring Wealth to the Next Generation
Presenter, Jill Thompson, CPA
Schechter Dokken Kanter CPAs
I. Gift and Estate Tax – In General
a. Transfer Taxes
Estate and gift taxes are transfer taxes. An individual becomes liable for a transfer tax
when he or she transfers assets to another person (typically a transfer to the next
generation of family members, but could be anyone) in excess of a certain amount
(special rules apply for transfers to spouses). Transfer taxes differ from income taxes
which tax income earned by a taxpayer during the year.
An important difference between transfer and income taxes is that the grantor (the
person giving the gift) or the decedent’s estate (or revocable trust, etc.) must pay the
gift or estate transfer tax. The person receiving the gift or inheritance (the beneficiary)
is normally not responsible for transfer tax. However, if a grantor fails to pay an amount
of transfer tax due, the beneficiary could ultimately be held responsible for such tax.
b. Rates
With rates as high as 45% for both gift and estate [transfer] taxes (that’s just federal),
people who may have a “taxable estate” are naturally concerned about these taxes and
often engage estate planners to assist them in transferring wealth to the next
generation while minimizing transfer taxes to the extent possible.
II. Gift Tax Overview
a. The top gift tax rate is 45% under current law and anyone paying gift tax will pay at a
rate between 41% ‐ 45% after taking into account the applicable exclusion amount.
b. Applicable Exclusion Amount (or “Exemption” Amount) – The gift tax applicable
exclusion amount under current law is $1,000,000. Over a person’s lifetime he or she
may gift $1,000,000 of “taxable gifts” and not pay any gift tax. “Taxable gifts” are gifts
in excess of the annual exclusion amount.
c. Annual Exclusion – The annual exclusion is $13,000 for 2009. This is the amount that
you may gift to any one person during the year without creating a “taxable gift”. Gifts
must meet certain criteria to qualify for the annual exclusion. For example, they must
be of a present interest, and be completed gifts.
d. Exclusion for Educational and Medical Expenses – Payment of medical expenses or
tuition on behalf of another is excluded from gift taxes. The payments must be made
directly to the educational institution or medical provider in order to qualify.
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e. Generation Skipping Transfer Taxes are beyond the scope of this discussion but must
be considered when gifting to a person 2 or more generations younger than the donor.
Generation Skipping Transfer taxes also apply in conjunction with the estate tax.
f. Federal Tax only (does not apply to Minnesota).
III. Estate Tax Overview
a. Federal
i. Rates (same as gift tax rates)
ii. Applicable Exclusion (“Exemption”) Amount ‐ $3,500,000 for 2009.
iii. Coordination with Gift Taxes: The gift tax applicable exclusion amount under
current law is $1,000,000 as noted above. The federal estate tax applicable
exclusion amount is $3,500,000 for 2009 under current law. The two federal
transfer tax systems work together in that lifetime “taxable gifts” by a taxpayer
will reduce the taxpayer’s available estate tax applicable exclusion amount. In
other words, if a person uses up the $1,000,000 gift tax applicable exclusion
during life, he or she would essentially only be able to exclude $2.5 million of
assets from federal estate tax (assuming the 2009 estate tax exemption amount
of $3.5 million is in effect at the time of the decedent’s passing). This
computation is not always exact because there may be differences in the
gift/estate tax rate from the time when the gift was made to when the
individual’s estate tax return must be filed. This becomes a more complex issue
and is beyond the scope of our discussion today.
b. Minnesota
i. Rates (See attached table)
ii. Applicable Exclusion ‐ $1,000,000
IV. Tax Advantages of Lifetime Giving
a. Annual exclusion gifting provides an opportunity for individuals to transfer assets tax‐
free without cutting into their [$1,000,000] gift tax exemption amount. In planning for
annual exclusion gifts, taxpayers must be careful to not unintentionally over‐gift. Often
accountants and attorneys will advise clients to gift $13,000 to each of their children at
year‐end to utilize the annual exclusion amount (based on the 2009 amount). For
example if Bill writes checks for the annual exclusion amount at year‐end and forgets
that he already gave each of his children $1,000 in birthday gifts earlier that year, he will
create “taxable gifts” and start to eat away at his $1,000,000 gift tax exemption amount
(or, his if his gift tax exemption has already been exhausted, he will owe gift tax at a rate
of 41% or more).
b. Payment of tuition or medical expenses directly provides an additional means to remove
money from the donor’s assets (and ultimately his or her estate) completely tax‐free.
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c. Payment of gift transfer tax in and of itself removes a portion of the assets that will
ultimately become the donor’s estate, unless the related gifts are made during the last
three years of a person’s life. This is often referred to as the “exclusive” feature of gift
taxes.
d. Gifting freezes the value of an asset at the time a gift is made, which means further
appreciation and earnings will accumulate transfers tax‐free. For example, if Bill gifts
1,000 shares of XYZ stock to his daughter on January 1, 2008, when it is valued at
$30/share, he has made a $30,000 gift which is reportable on his gift tax return. Let’s
assume Bill is single, so he uses up $17,000 of his lifetime applicable exclusion ($30,000 ‐
$13,000 annual exclusion allowed). On January 1st of 2009, the stock is worth
$100/share. Bill has effectively transferred an additional $70,000 to the next generation
without any gift or estate tax consequences – and without using any more of his
applicable exclusion because this increase in value happened after he had already
transferred the asset.
e. Minnesota does not impose a gift tax. However, Minnesota does impose an estate tax.
(Under certain limited circumstances, gifts made within the three years prior to a
decedent’s date of death will be pulled back into the grantor’s estate. This could
potentially subject those gifts to the Minnesota estate tax.) When a Minnesota resident
makes lifetime gifts, he or she will generally completely avoid any Minnesota transfer
tax on the gifted assets.
i. Example :
1. Single Taxpayer Bill is a Minnesota resident.
2. $2,000,000 Net Taxable Estate (assets less liabilities & expenses)
3. Passes away in 2009
4. Federal Estate tax is not a concern (remember the $3.5 million dollar
applicable exclusion)
5. Estate must pay $99,600 in Minnesota Estate Tax
6. What if Bill had gifted $1,000,000 (in cash) during his lifetime?
a. No Federal Estate Tax
b. No Minnesota Estate tax (remember Minnesota is not subject to
the gift tax)
V. Disadvantages (Tax‐Related) of Lifetime Gifting
a. Loss of opportunity for step‐up in basis on gifted assets
b. Higher exemption amount for estate taxes than for gift taxes could mean unnecessary
payment of transfer taxes for some individuals.
c. Potential Repeal of the Estate Tax
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VI. Use of Trusts
a. Family (Credit Shelter) Trust
i. The purpose of a Family (Credit Shelter) Trust is to make sure that the children
and surviving spouse are provided for and also to take full advantage of the
applicable exclusion (exemption) amount for both spouses to the extent
possible.
ii. The 1st Spouse to pass away leaves his or her remaining applicable exclusion (his
or her remaining amount of the $3.5 million) amount to a Family Trust which
will not end up in the surviving spouse’s estate. The Family Trust is designed
primarily to take care of the children and will not end up in the surviving
spouses estate provided certain requirements are met.
iii. Assets in excess of the remaining exemption amount are put into a marital share
trust which is designed to take care of the surviving spouse and will end up in
the surviving spouse’s estate.
iv. It is important to make sure the surviving spouse is provided for. As noted
above, agreements are often drafted to fund the Family Trust with the
applicable exclusion amount (currently $3.5 million) and provide the excess to a
marital trust. The amount going to the family trust can change drastically as the
applicable exclusion amounts change from year to year. Right now we do not
know what 2010 or years beyond will look like due to various pending house
and senate bills; none of which have been passed into final law at this time.
Ideally most people don’t want to leave their surviving spouse with next to
nothing.
v. The surviving spouse can be a beneficiary of the Family Credit Shelter Trust –
but there must be specific restrictions in place to ensure this trust doesn’t end
up in the spouse’s estate.
vi. Depending on the total net worth of a married couple in Minnesota, it may
make sense to have estate planning documents that allocate the Minnesota
applicable exclusion amount ($1 million under current law) to a family credit
shelter trust and leave the excess to the surviving spouse.
vii. Disclaimers may also be used in conjunction with Family Trust and Marital Trust
planning to provide the surviving spouse with added flexibility.
VII. Other Types of Trusts
a. There are a number of trust variations that estate planners use to accomplish an
individual’s estate planning objectives and help minimize taxes. For example, an
individual may set up a lifetime revocable trust and transfer essentially of their assets
into this trust. A primary objective of the revocable trust is to avoid probate.
b. Other trusts are used to facilitate lifetime gifting – to the next generation and/or to
charity. These trusts provide a mechanism to transfer the wealth in a tax efficient
manner.
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5. September 25, 2009 [SDK’S LEARNING CURVE
i. Examples of trusts designed to help minimize transfer taxes and provide a
benefit to charity are as follows:
1. Charitable Remainder Unitrust (CRUT)
2. Charitable Remainder Annuity Trust (CRAT)
3. Charitable Lead Trust (CLT)
ii. Examples of non‐charitable trusts designed to help minimize transfer taxes and
transfer wealth to the next generation include the following:
1. Grantor Retained Annuity Trust (GRAT)
2. Qualified Personal Residence Trust (QPRT)
The above mentioned trusts are just some examples of trusts that estate
planners use to transfer wealth.
VIII. Charitable Options
a. As mentioned above, an individual may make a transfer in trust that will provide a
benefit to charity. The details of these trusts are beyond the scope of today’s discussion
but can provide significant tax and charitable benefits under the right circumstances.
b. Outright Lifetime Gifts
Outright lifetime gifts to charity provide an income tax deduction and remove the
property from assets which will ultimately make up a person’s estate. Generally, under
current law, taxpayers may gift up to 50% of their adjusted gross income and receive a
charitable income tax deduction.
Gifting appreciated property to charity potentially provides an additional tax advantage.
When gifting appreciated property, a taxpayer receives a deduction in the amount of
the fair market value of the asset without having to recognize and pay tax on the capital
gain. The only potential disadvantage to a gift of appreciated property is that you can
only gift up to 30% of your AGI in gifts of appreciated property and receive an income
tax deduction for the fair market value of the gifts.
c. Gifting IRAs (or Qualified Plans) to Charity
i. During Lifetime
Special rules extended through 2009 allow taxpayers over 70 ½ years old to
distribute up to $100,000 of IRA or qualified plan to charity and exclude the
amount from income.
ii. As an Asset of Taxpayer’s Estate
If you are thinking about leaving a portion of your estate to charity and you
believe you will have an IRA or qualified plan in your estate ‐ this is a great asset
to leave to the charity from a tax perspective, particularly if you expect to have
a federally taxable estate ($3.5 million in 2009). Bear in mind that the
mechanics of this transaction are very important! If the proper mechanics are
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not implemented, you can lose out on some of the tax benefits unnecessarily.
The surest method of transferring your IRA to charity and ensuring that your
estate will reap the tax benefits is to name the charity as the designated
beneficiary of the IRA or qualified plan.
If a taxpayer who is wealthy enough to have a federally taxable estate passes
away with an IRA in his or her estate and does not properly designate that it
must go to charity, the following taxes may apply under current law:
1. Federal Estate tax ‐ 45%
2. Minnesota Estate tax ‐ 6.4% ‐ 16%
3. Federal Income Tax (top rate of 35%)
4. Minnesota Income tax (approximately 8%)
When a taxpayer designates a charity as the beneficiary of his or her IRA, both
federal and Minnesota estate taxes are avoided via a charitable deduction on
the federal estate tax return (which also carries into the MN estate tax
computation, and the charity should not have to pay income tax as distributions
are made out of the IRA.
IX. Potential Changes to Current Legislation (list the bills and highlight a few items of each)
a. Current Law Review
Under Current law, the gift tax applicable exclusion (the amount excludable from tax) is
$1,000,000. The estate tax applicable exclusion is $3.5 million for 2009; estate taxes are
completely repealed for 2010, and the estate tax applicable exclusion will return to
$1,000,000 in 2011 and beyond if new legislation is not passed.
b. Proposed Bills (Refer to the following website for updates:
http://www.thomas.loc.gov)
i. H.R. 436 “Certain Estate Tax Relief Act of 2009”
1. $3.5 Million Federal Exemption
2. 45% Top Tax Rate
3. 5% Surcharge on estates larger than $10 Million
4. Limitations on Valuation Discounts
ii. H.R. 96 “Save Family‐Owned Farms and Small Businesses Act of 2009”
1. Provides for lower property valuations for purposes of the estate tax
filing if certain requirements are met for qualified use property
2. Return of the Qualified Family Owned Business Deduction
iii. H.R. 498 “Capital Gains and Estate Tax Relief Act of 2009”
1. Provides for annual increases in the estate tax exclusion amount
between 2010 and 2015 and establishes a permanent exclusion amount
of $5 million for 2015 and thereafter (indexed for inflation after 2015)
2. Reduces Estate Tax brackets
3. Portability (One spouse is able to use the other spouse’s unused
applicable exclusion amount)
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4. Re‐unification of gift and estate tax applicable exclusion amounts
5. Repeals state death tax deduction
iv. S. 722 Title III Permanent Extension of Estate Tax as in Effect in 2009
1. Re‐unification of the Gift and Estate tax credit (applicable exclusion
amount)
2. Continuation of $3.5 Million Estate tax applicable exclusion (adjusted
for inflation)
3. Maximum Estate tax rate of 45%
4. Portability
v. Potential for $3.5 million Exemption “Patch” as a temporary fix for 2010.
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