In this issue of The Wealth Counselor, we will examine who can, who should, and who should not serve as trustee; non-tax and tax factors that should be considered when selecting a trustee; who can, and should, be given the right to remove and replace a trustee; and using a team approach to segregate duties among lay and professional trustees.

Background
Irrevocable trusts are created in two ways:

1. A revocable trust becomes irrevocable after the grantor has died.
2. An irrevocable trust is established while the grantor is living to save estate taxes (by removing assets from the grantor’s estate) and/or for asset protection or Medicaid (Medi-Cal in California) planning.

While a grantor may technically be allowed to serve as the trustee of an irrevocable trust he creates, it is not a good idea at best. That is because if the grantor has any discretion with trust asset distributions, it could lead to inclusion of the trust assets in his estate for tax, Medicaid and other purposes, which could frustrate the trust’s objectives.

Often there is someone the grantor knows who the grantor suggests to be the trustee. Typical choices are the grantor’s spouse, sibling, child, or friend. Any of these may be an acceptable choice from a legal perspective, but may be a poor choice for other reasons. For example, some families would be torn apart if one sibling had to ask another for a distribution.

Left to their own devices, clients trustee appointments will frequently be made (out of ignorance) with little consideration of the qualifications the trustee should have. Likewise, those who agree to be trustees typically have no idea what they are getting into. Non-professional trustees often are overworked, underpaid, unappreciated, find they are dealing with unhappy and unappreciative beneficiaries, and may even wind up being sued by the beneficiaries.

With this in mind, let’s look at some factors (non-tax and tax) that should be considered when selecting a trustee.

Non-Tax Considerations for Selecting a Trustee
Here are some of the characteristics that the client should consider in choosing an individual trustee:

Judgment: Clients typically want their trustee to make the same decisions they would. Someone who shares the grantor’s values, virtues, spending habits and faith is more likely to do this. Also, consider whether the trustee candidate will be aware of his own capabilities and weaknesses. If the trustee candidate does not have accounting or investment experience, would she have the judgment to admit this and engage an appropriate qualified professional?

Availability/Location: Does this trustee candidate have the time required to be a trustee? Will he be available when needed or will work and/or family demands leave too little time for trust responsibilities? Where does the candidate live? If the trustee lives in a place different than the trust situs, different laws may apply. Is living near the beneficiary important?

Longevity: How long will the trustee be needed? Many grantors are most comfortable with friends who share their values and have gained wisdom from life experiences, but someone near the grantor’s age may not live long enough to fulfill the job. A trust established for the grantor’s child will likely need a trustee for many years to come. Thus, for trusts that may last a long time, a corporate trustee is often the preferred choice.

Impartiality: The trustee must be capable of being impartial among the beneficiaries. This is especially difficult to do if the trustee is one of several beneficiaries. Corporate trustees, because they can be impartial, are often chosen to prevent a sibling or relative from being placed in an uncomfortable (and often unfair) position.

Interpersonal Skills: The trustee needs to be able to communicate well and effectively to the beneficiaries and to professionals who may be involved with the trust. Some people may be good record keepers or investors, but lousy at diplomacy or feel intimidated or even be offended if a beneficiary gets an attorney. A good trustee will need to be able to work calmly and well with all involved.

Attention to Detail: Does the trustee understand the serious duties that come with the job and is she willing to be accountable for her actions? Fiduciaries are often thought by the beneficiaries to be guilty until proven innocent. While it may not happen, the trustee should assume he will be sued at some point and keep meticulous records as a ready defense. A trustee who expects to be sued will be much better prepared than one who doesn’t think it will happen and, as a result, does not take the record keeping requirement seriously.

Investment Experience: While it is helpful to have investment experience, the trustee can certainly get by without it, as long as he/she recognizes this is an area for which to secure professional help. Also, if the trustee lives in a place different than the trust situs, different investment laws may apply, making it especially prudent or even essential to seek professional assistance.

Planning Tip: CPAs can make good trustees, but often are unwilling or unable (because of insurance considerations) to serve. Sometimes, the best choice would be a corporate trustee. Seldom will the unguided grantor even think of using a team, which can include both various professionals and friends and family members.

Fees: The non-professional trustee rarely discusses fees with the beneficiaries. Often, family members and friends will not charge a fee for their services out of a sense of family duty or respect for the grantor. But trustees should be paid and, more often than not, an unpaid trustee will eventually come to that conclusion or fail to diligently carry out his duties. From the outset, a trustee should keep close track of time and expenses so that a reasonable fee can be substantiated. Generally, a reasonable fee is what a corporate trustee would charge, so thinking that a non-corporate trustee will do the same necessary work for less is false economy.

Planning Tip: Become knowledgeable about the fees charged by corporate trustees in your area as a guideline. Talk about trustee fees when establishing the trust to avoid problems and misunderstandings later.

Insurance: Anyone serving as a trustee needs to have plenty of insurance (errors and omissions or liability). Some of the laws that govern trustees are absolute standards, so a trustee needs to have adequate insurance for protection in the event of a mistake or an innocent error. The amount of insurance needed can depend on the degree to which a trustee is indemnified. However, legal defense costs in trustee litigation can be very large and are typically borne by the insurer.

Indemnification: This often comes up when family members or friends are serving as trustee. Grantors want to indemnify family members and their friends; they do not want them to be sued. It is possible to reduce or eliminate the prudent investor rule for such trustees. However, indemnification is a two-edged sword because it may result in the non-professional trustee not taking the job seriously.

Planning Tip: A good alternative is to have a family member or friend serve with a corporate fiduciary that is assigned the administrative and investment responsibility. The family member or friend trustee could make or veto discretionary distributions, but having no oversight, administration, or investment obligations would be less likely to be sued if something goes wrong.

Planning Tip: Indemnification might be appropriate in a situation with obvious bad family dynamics, where the siblings are already fighting each other yet the grantor insists on naming one sibling as trustee. In such a situation, your recommendation to name a corporate fiduciary instead should be well documented.

Planning Tip: Waiving the prudent investor rule can also be helpful in other situations, depending on the use of the trust. For example, with the sale of an appreciated asset(s) to a grantor trust, the trustee is usually buying hard-to-value assets (real estate, wholesale business interest) from the client in order to shift future appreciation to the trust and away from the grantor. Rather than starting initially with a corporate fiduciary who is not familiar with the asset or situation, it may be more effective (saving both time and money) to have the initial trustee be someone close to the family who better understands the issues, and then change later to a corporate fiduciary. Waiving the prudent investor rule and providing indemnification for the initial trustee in this situation could make sense.

Planning Tip: Being able to waive all or part of the prudent investor rule when using an irrevocable life insurance trust (ILIT) gives greater latitude and peace of mind to make some of the transactions meet the unique needs of the client. Beware, however, of the risk that the trustee, shielded from liability, may fail to do the appropriate work to make sure that the insurance held in the ILIT is appropriate as markets change.

Note: Florida is considering a statute that would relieve trustees of the duty to review the propriety of investments in life insurance policies, which would, in effect, waive the prudent investor rule for life insurance policies owned by ILITs. This would help to solve the problem of corporate trustees not wanting to serve as the trustee of ILITs due to the obligation to review policies that have not performed very well.

Tax Considerations
Estate Tax
If a purpose of the trust is to remove assets from the grantor’s estate, the grantor cannot have any role in determining who gets distributions or when they occur. However, the grantor can have the power to remove and replace the trustee or to control the investments of the trust. Neither of those will cause estate tax inclusion providing the grantor cannot appoint a trustee who is related or subordinate to the grantor (as would be a brother, employee or someone else who will capitulate to the grantor’s wishes). Interestingly, there is no problem appointing, at the inception of the trust, an initial or successor trustee who is related or subordinate to the grantor.

Planning Tip: It is unclear if a grantor can have the right only to remove a trustee and allow the next named successor trustee to take over. While also unclear, it seems that a grantor can reserve the right to remove and replace someone who is not a fiduciary (for example, a trust protector).

Income Tax
A non-adverse trustee having certain powers may trigger grantor trust rules and cause the grantor to be taxed on the trust’s income. In some instances the client may not want the tax to come back to the grantor and instead want a trust that is a separate tax-paying entity for which the income that is distributed to the beneficiaries is be taxed to the beneficiaries.

Planning Tip: Because the trustee’s identity may affect state income tax as well, you may be able to shift the trust situs to a state with a lower income tax rate. Depending on the trust assets, this could be important as some investments (such as oil and gas) may be taxed significantly higher in some states than in others.

Beneficiary Removal and Replacement of Trustee
This is an area that is customizable for each trust and can help maintain some downstream flexibility. Some grantors may not want the beneficiaries to be able to remove the trustee, especially if the grantor is aware of family quarreling. But if the corporate or individual trustee knows it cannot be replaced there is little need for responsiveness or careful attention to investments. Because there does need to be a way to have the trustee removed if things should deteriorate, the document can include that the trustee can only be removed for cause as determined by the court. On the other end, spendthrifts may want to “trustee shop” until they find one that will do whatever they want, so there will need to be some restraints on when a trustee can be replaced.

Team Approach
There are times when a team can do a better job than a single trustee. Having more than one trustee, even with different duties and responsibilities, can work well for many situations. The trust can benefit from assigning the trustees specific duties based on their strengths and experience. Of course, the fewer people who are involved, the less complicated the administration. Also, disagreements will have to be worked out. If there are two trustees or any even number, deadlocks are possible. With an odd number, a simple majority would be needed. If an agreement cannot be reached, the court can be allowed to intervene as a last resort.

Also, as mentioned earlier, family member trustees can work with professionals as paid advisors instead of as trustees. This would allow the advisors to provide valuable input and insight into both the grantor’s desires and the personalities of the beneficiaries, without being so exposed to possible lawsuits.

Planning Tip: Ethical issues can arise if the attorney represents more than one trustee, so she should be sure to have a waiver of conflict or other plan in place.

Planning Tip: Naming someone as trustee is a nomination. The person named is under no obligation to accept the responsibility when the time comes, and it is not unusual for someone to refuse to serve or to step aside once he understands the duties and responsibilities involved. For this reason, it is important for the trust maker to name several successor trustees and to clearly communicate with each before finalizing the choices. Most drafting attorneys will also recommend naming a corporate trustee as trustee of last resort, especially if no procedure for appointing successors is provided to the beneficiaries, short of going to court.

The Trustee’s Duties and Responsibilities

Conclusion
A competent trustee is as important to the success of a trust as its being well-drafted. Naming a favorite family member as trustee may not be the smartest (or kindest) thing the grantor can do. As experienced professionals who have seen the consequences of unwise choices for trustee, we are in a unique position to counsel our clients with their and their beneficiaries’ best interests in mind.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax adviser based on the taxpayer’s particular circumstances.

Your clients enjoy a lifestyle that is unique and complex. As an advisor, you play an important role in ensuring that their success is protected. The following questions can help you identify circumstances that may put your clients at risk.

1. Are your clients protected with enough personal excess liability insurance? Does their net worth exceed their liability coverage limits? If a lawsuit puts assets at risk, the last thing anyone wants to worry about is running out of insurance. Chartis can offer $100 million on a single policy to address claims of property damage and personal injury–including lawsuits filed by private staff, auto accidents with uninsured drivers and more.

2. Is their insurance program messy? Successful individuals acquire assets over time, so it’s not uncommon to insure them in different ways. A summer residence, for example, may be with a different agent and carrier than the home in the suburbs. Fine art may be insured independently from cars. Whatever the combination, the end result is fragmented, making insurance more difficult and expensive to manage. Don’t allow your clients to wait until claim time to find out what is–and is not–protected. A high net worth insurance provider is more likely to address the special circumstances that can come with success, or simply offer coverages that traditionally have been ignored in the mainstream marketplace.

3. Does the family travel frequently? Freedom to travel is one of the luxuries that come with success. Our worldwide travel protection plan provides year-long coverage, allowing your clients to plan vacations and other trips without worry. The  plan responds to circumstances beyond the policyholder’s control that cause a canceled trip, an early  return home or an emergency medical treatment while abroad.

4. Do they employ private staff? It’s not uncommon for nannies, housekeepers, private assistants, gardeners and others to take their employers to court. Our Employment Practices Liability Insurance (EPLI) option responds to allegations of sexual harassment, wrongful termination, discrimination and more. In addition, we offer complimentary background checks on private staff–helping ensure that only the most qualified and credible individuals are taking care of your clients’ loved ones and property.

5. Are your clients involved with charities or foundations? Not-for-profit organizations typically operate on tight budgets and carry a minimal amount of liability insurance. If your clients or their spouses sit on the board of a not-for-profit organization,1 they can add up to $1 million of protection on top of existing board coverage.

6. What sort of activities or hobbies do they enjoy? Whether it’s collecting cars, buying art or building a wine collection, we offer coverage to protect whatever passion your clients might have. As a complement to our Private Collections coverage, our art collection management experts are available to ensure that each collection is properly valued, adequately insured and protected in the event of a disaster–or even an everyday mishap.

7. What is the makeup of the family? Family members may increase exposure to unidentified risks. For example, having a youthful driver may increase the need for higher liability limits. Or, young children in the family may encourage your clients to consider kidnap and ransom coverage.  Your client may need an emergency preparedness plan for members of the family who are elderly or have special needs. Our specialists can assist in preparing a plan.

8. Are your clients’ insurance policies in sync with their estate plans? Many wealthy people structure their property ownership using LLC’s, LLP’s and trusts. Not all insurance providers enable policies to reflect these alternate structures, which can result in diminished protection or complications at claim time.

9. Is the home properly insured and protected? If your clients had to rebuild their homes in today’s market, would they have enough homeowners’ insurance to sufficiently cover the expense? Many properties are insured based on values that are vastly underestimated–especially those that have undergone extensive home improvements and renovations. For those living in wildfire- or hurricane-prone areas, we provide complimentary consultations to understand preventive measures that can help prepare your clients for a catastrophe.2

10. Are any of your clients public figures? Media exposure and public awareness increase the need for comprehensive protection.  We offer high limits of excess liability coverage to ensure that your clients’ assets are safeguarded against claims of personal injury or property damage, including libel and slander. Additionally, our emergency preparedness specialists can help assess whether proper security measures are in place.

Chartis is a leading property-casualty and general insurance organization serving more than 70 million clients around the world. With one of the industry’s most extensive ranges of products and services, deep claims expertise and excellent financial strength, Chartis enables its commercial and personal insurance clients alike to manage virtually any risk with confidence.

Our Private Client Group offers complete solutions for successful individuals and families. We provide the coverage necessary to preserve high-value assets and personal liability. Protection is augmented with services to minimize property damage and bolster safety–and all of this comes in one custom-tailored package. Look to us to safeguard homes, automobiles, excess liability, fine art, collectibles, yachts and more.

Guest article submitted by
SUZETTE MANN, CIC
Account Executive, Personal Risk Management
smann@sullicurt.com
Direct: (949) 852-4820

Suzette Mann manages the personal insurance needs for high net worth individuals, applying over 18 years of experience across a wide variety of insurance services.  During her career, Suzette has advised clients including large Fortune 500 companies, middle market businesses and non-profit organizations.  As a result, she provides a sophisticated approach to risk management solutions for high net worth clients. 

Prior to joining SCM, Suzette wasan account executive for an independent agent also in Orange County, California.  Previously, she managed professional liability programs for non-profits in Washington D.C.  She began her insurance career at Marsh Inc. in Los Angeles in the casualty area, working with large energy accounts. 

Suzette is a licensed Property/Casualty broker in the state of California and holds the professional designation of Certified Insurance Counselor (CIC) and Associate in Personal Lines (API) designation.  Suzette is an active volunteer at Harbor Day School and Our Lady Queen of Angels Catholic Church, and is a member of the Junior League of Orange County.  She graduated from the University of Southern California (USC) with a B.A. in International Relations and a B.A. in Political Science. 

Information courtesy of the Private Client Group at Chartis. Reprinted with permission.

1. Qualifying organization is defined in the policy as any not-for-profit organization qualifying under Section 501(c) (3), (4) or (7) of the Internal Revenue Code, some exceptions apply.

2. Eligibility requirements apply; enrollment required.

Chartis is the marketing name for the worldwide property-casualty and general insurance operations of Chartis Inc. Private Client Group is a division of Chartis Inc. Insurance is underwritten by a member company of Chartis Inc. This is a summary only. It does not include all terms and conditions and exclusions of the policies described. All references to claim settlement information are based on the loss being covered by the policy and are subject to change without prior notice. Please refer to the actual policies for complete details of coverage and exclusions. Coverage and supplemental services may not be available in all jurisdictions and are subject to underwriting review and approval. Services provided by third parties are not part of the insurance policy, are not guaranteed by Private Client Group and may be discontinued at any time.

Most professionals who work with trusts have plenty of “nightmare stories” about trustees chosen by clients for their irrevocable trusts. No doubt this is because trustees are often chosen without careful consideration of the qualifications required.

Your clients enjoy a lifestyle that is unique and complex. As an advisor, you play an important role in ensuring that their success is protected. The following questions can help you identify circumstances that may put your clients at risk.

1. Are your clients protected with enough personal excess liability insurance? Does their net worth exceed their liability coverage limits? If a lawsuit puts assets at risk, the last thing anyone wants to worry about is running out of insurance. Chartis can offer $100 million on a single policy to address claims of property damage and personal injury–including lawsuits filed by private staff, auto accidents with uninsured drivers and more.

2. Is their insurance program messy? Successful individuals acquire assets over time, so it’s not uncommon to insure them in different ways. A summer residence, for example, may be with a different agent and carrier than the home in the suburbs. Fine art may be insured independently from cars. Whatever the combination, the end result is fragmented, making insurance more difficult and expensive to manage. Don’t allow your clients to wait until claim time to find out what is–and is not–protected. A high net worth insurance provider is more likely to address the special circumstances that can come with success, or simply offer coverages that traditionally have been ignored in the mainstream marketplace.

3. Does the family travel frequently? Freedom to travel is one of the luxuries that come with success. Our worldwide travel protection plan provides year-long coverage, allowing your clients to plan vacations and other trips without worry. The  plan responds to circumstances beyond the policyholder’s control that cause a canceled trip, an early  return home or an emergency medical treatment while abroad.

4. Do they employ private staff? It’s not uncommon for nannies, housekeepers, private assistants, gardeners and others to take their employers to court. Our Employment Practices Liability Insurance (EPLI) option responds to allegations of sexual harassment, wrongful termination, discrimination and more. In addition, we offer complimentary background checks on private staff–helping ensure that only the most qualified and credible individuals are taking care of your clients’ loved ones and property.

5. Are your clients involved with charities or foundations? Not-for-profit organizations typically operate on tight budgets and carry a minimal amount of liability insurance. If your clients or their spouses sit on the board of a not-for-profit organization,1 they can add up to $1 million of protection on top of existing board coverage.

6. What sort of activities or hobbies do they enjoy? Whether it’s collecting cars, buying art or building a wine collection, we offer coverage to protect whatever passion your clients might have. As a complement to our Private Collections coverage, our art collection management experts are available to ensure that each collection is properly valued, adequately insured and protected in the event of a disaster–or even an everyday mishap.

7. What is the makeup of the family? Family members may increase exposure to unidentified risks. For example, having a youthful driver may increase the need for higher liability limits. Or, young children in the family may encourage your clients to consider kidnap and ransom coverage.  Your client may need an emergency preparedness plan for members of the family who are elderly or have special needs. Our specialists can assist in preparing a plan.

8. Are your clients’ insurance policies in sync with their estate plans? Many wealthy people structure their property ownership using LLC’s, LLP’s and trusts. Not all insurance providers enable policies to reflect these alternate structures, which can result in diminished protection or complications at claim time.

9. Is the home properly insured and protected? If your clients had to rebuild their homes in today’s market, would they have enough homeowners’ insurance to sufficiently cover the expense? Many properties are insured based on values that are vastly underestimated–especially those that have undergone extensive home improvements and renovations. For those living in wildfire- or hurricane-prone areas, we provide complimentary consultations to understand preventive measures that can help prepare your clients for a catastrophe.2

10. Are any of your clients public figures? Media exposure and public awareness increase the need for comprehensive protection.  We offer high limits of excess liability coverage to ensure that your clients’ assets are safeguarded against claims of personal injury or property damage, including libel and slander. Additionally, our emergency preparedness specialists can help assess whether proper security measures are in place.

Chartis is a leading property-casualty and general insurance organization serving more than 70 million clients around the world. With one of the industry’s most extensive ranges of products and services, deep claims expertise and excellent financial strength, Chartis enables its commercial and personal insurance clients alike to manage virtually any risk with confidence.

Our Private Client Group offers complete solutions for successful individuals and families. We provide the coverage necessary to preserve high-value assets and personal liability. Protection is augmented with services to minimize property damage and bolster safety–and all of this comes in one custom-tailored package. Look to us to safeguard homes, automobiles, excess liability, fine art, collectibles, yachts and more.

Guest article submitted by
SUZETTE MANN, CIC
Sullivan Curtis
smann@sullicurt.com
Direct: (949) 852-4820

Suzette Mann manages the personal insurance needs for high net worth individuals, applying over 18 years of experience across a wide variety of insurance services.  During her career, Suzette has advised clients including large Fortune 500 companies, middle market businesses and non-profit organizations.  As a result, she provides a sophisticated approach to risk management solutions for high net worth clients. 

Prior to joining SCM, Suzette wasan account executive for an independent agent also in Orange County, California.  Previously, she managed professional liability programs for non-profits in Washington D.C.  She began her insurance career at Marsh Inc. in Los Angeles in the casualty area, working with large energy accounts. 

Suzette is a licensed Property/Casualty broker in the state of California and holds the professional designation of Certified Insurance Counselor (CIC) and Associate in Personal Lines (API) designation.  Suzette is an active volunteer at Harbor Day School and Our Lady Queen of Angels Catholic Church, and is a member of the Junior League of Orange County.  She graduated from the University of Southern California (USC) with a B.A. in International Relations and a B.A. in Political Science. 

Information courtesy of the Private Client Group at Chartis. Reprinted with permission.

1. Qualifying organization is defined in the policy as any not-for-profit organization qualifying under Section 501(c) (3), (4) or (7) of the Internal Revenue Code, some exceptions apply.

2. Eligibility requirements apply; enrollment required.

Chartis is the marketing name for the worldwide property-casualty and general insurance operations of Chartis Inc. Private Client Group is a division of Chartis Inc. Insurance is underwritten by a member company of Chartis Inc. This is a summary only. It does not include all terms and conditions and exclusions of the policies described. All references to claim settlement information are based on the loss being covered by the policy and are subject to change without prior notice. Please refer to the actual policies for complete details of coverage and exclusions. Coverage and supplemental services may not be available in all jurisdictions and are subject to underwriting review and approval. Services provided by third parties are not part of the insurance policy, are not guaranteed by Private Client Group and may be discontinued at any time.

We need to be prepared to help our clients as they begin to draw down retirement savings and look for more tax-efficient investments for their stocks, bonds, real estate and savings.

In this issue of The Wealth Counselor, we will examine some of the top income tax planning ideas to implement in 2011 and 2012.

Income Tax Overview
Anything can happen between now and January 1, 2013, but, based on current law, that will be the date the top income tax rate increases from 36% to 39.6%, qualified dividends become subject to ordinary income tax rates, the tax on long-term capital gains jumps from 15% to 20%, and the 3.8% Medicare surtax kicks in (unless the Florida Federal District Court decision striking down the health care reform act is upheld). Let’s look more closely at how these taxes can impact your clients, and what you can do to help them.

Qualified Dividends
Under current law, in tax years beginning on or after January 1, 2013, qualified dividends will be subject to ordinary income tax rates. Therefore, C Corporations with accumulated earnings and profits and the cash to do so should consider making larger dividends in 2011 and 2012.

Example, Distribution of C Corp Dividends: Should the sole shareholder of a C Corp make a $1 million dividend to himself in one lump payment in 2012 or in $200,000 increments over five years (2012-2016)? Assuming he is in the highest marginal income tax bracket, 15% capital gains tax rate on dividends in 2012, and 39.6% + 3.8% = 43.4% ordinary income tax rate on dividends for 2013 and beyond, he would pay $150,000 in taxes on the lump sum distribution in 2012 and $377,200 on the incremental distributions paid over five years. He would save $ 227,200 by taking the lump sum in 2012.

Long-Term Capital Gains
Under current law, in tax years beginning on or after January 1, 2013, long-term capital gains will be taxed at a top rate of 20%. Taxpayers should consider selling (or otherwise disposing of) appreciated property and recognizing the taxable gain in 2011 and/or 2012. Taxpayers who have realized capital gains deferred on an installment note may want to consider accelerating the unrecognized gain in 2011 and/or 2012.

Example, Acceleration of Gains: In 2012, Judy sold her business for $1 million in exchange for a nine-year installment note. At the time of the sale, she realized a $900,000 gain. By electing out of the installment treatment, she would pay $135,000 in capital gains tax on the lump sum in 2012 vs. $175,500 on the installments in 2012-2021, and would save $40,500 in taxes (900,000 x .15 = 135,000 versus 900,000 x .1 x .15 = 13,500 plus 900,000 x .9 x .2 = 162,000).

Ordinary Income
Under current law, in tax years beginning on or after January 1, 2013, ordinary income tax rates will increase to their pre-2001 levels. Taxpayers should consider accelerating certain types of ordinary income (bond interest, annuity income, traditional IRA income, compensation income) into 2011 and 2012 if they expect to be in the same tax bracket or higher in future tax years. This is especially true for top bracket taxpayers who may pay the 3.8% Medicare surtax on their “net investment income.”

Example, Accelerating Bond Interest: Mike has $100,000 of accrued bond interest that will be paid on January 3, 2013. Mike is in the 35% tax bracket for 2012 and 39.6% + 3.8% for 2013. If he sells his bonds (at par) before the end of 2012 and recognizes the accrued interest income, he will pay $35,000 in taxes vs. $43,400 if he waits and collects the interest in 2013, and will save $8,400 in taxes.

Example, Sale/Repurchase of Bond: James purchased $1 million of corporate bonds in 1993 at par value; they mature December 31, 2011. On December 31, 2012, he sold them for $1,050,000. On January 3, 2013, he repurchased the same bonds for $1,050,000. Under tax law, this $50,000 premium can be used to offset his interest income over the remaining life of the bond (one year). By selling the bonds in 2012 and repurchasing them in 2013, he realizes a net income tax savings of $14,200 ($21,700 in income tax savings on the bond premium, less $7,500 in capital gains tax on the sale of the bonds = $14,200).

Additional Income Tax Planning Ideas
Oil and Gas Investments
Intangible drilling costs (IDCs) provide a large immediate income tax deduction (up to 85% of the initial investment). Losses, if any, created as a result of IDCs will be ordinary and will lower the taxpayer’s Adjusted Gross Income. Depletion and other depreciation provide for additional deductions during the term of the investment. Additional tax credits may be available for certain oil and gas ventures.

Planning Tip: Be careful with oil and gas investment where the client may be subject to the alternative minimum tax (AMT). The AMT may limit the amount of deductions allowed.

Gold Investments
Generally, gold held as coins or bullion is treated as “collectibles,” for which the long-term capital gain rate is 28%. All short-term capital gains are treated as ordinary income. Therefore, a taxpayer in a lower tax bracket would be better off triggering short-term rather than long-term capital gain on gold coins or bullion. On the plus side, the “wash sale rule” (explained below) does not apply to “collectible” losses.

Planning Tip: The “collectibles” tax rate does not generally apply to gold held in mutual funds or to non-exchange-traded options on gold. Gold futures must be “marked to market” and the unrealized gain/loss must be recognized each tax year. Moreover, gold futures gains are subject to special tax treatment (60% long-term capital gain or 40% short-term capital gain).

Foreign Currency Transactions
Gains and losses in foreign exchange transactions are ordinary income/loss rather than capital gain/loss. Generally, taxpayers will want to recognize ordinary income in 2011 and 2012 and push ordinary losses to 2013 and later years.

Index Options
These have special gains treatment on certain broad-based listed options (60% long-term and 40% short-term). For taxpayers in the highest marginal income tax bracket in 2013, this would result in a blended capital gains tax rate of 29.36% ((.6 x .2) + (.4 x .434)).

Loss Harvesting
Loss harvesting can apply to individuals, trusts/estates, and charitable lead and remainder trusts. Considerations include:

Wash Sale Rule: Capital losses are denied to the extent that a taxpayer has acquired (or has entered into a contract or option to acquire) a “substantially identical” stock or security within a period beginning 30 days before the sale and ending 30 days after the sale of a stock that was sold at a loss (“loss stock”). The disallowed loss on the loss stock is added to the cost basis of the new stock, and the holding period of the loss stock is carried over to the new stock. This rule also applies to ETFs, index funds, IRAs and taxable investment accounts. It does not apply to “collectibles.”

Diminishing Real Value of Capital Losses: Because of the cost of capital, the sooner a capital loss is used the better.

Efficiency of Capital Loss Offsetting: In general, capital losses are more tax effective if they can be used to offset income taxed at higher tax rates (short-term capital gains and ordinary income). Long-term losses used against short-term gains are tax-efficient. Short-term losses used against long-term capital gains are tax inefficient.

Income Shifting to Junior Generations
Income taxes can be saved by shifting income-producing assets from parents or grandparents who are in a high income tax bracket to their children and grandchildren who are in lower tax brackets. Planning considerations include asset protection (accomplished through the use of trusts) and the “kiddie tax” for beneficiaries under age 24.

What makes this most attractive in 2011 and 2012 is the $5 million per person gift tax exemption: a married couple can gift up to $10 million and no gift tax will be incurred on the gift. The gift can be made in trust and then used to invest and/or purchase life insurance on the donors.

Example: Husband and wife, who are taxed at the current top (35%) rate, own $16,000,000 in S Corporation stock. They gift $10 million of it to their four adult children (15 5/8% of the S Corporation stock to each child). The S Corporation income is $2 million per year. After the gift, 37.5% is attributed to the parents and taxed at their rate and 62.5% is attributed to the children and taxed at their lower rates (assume 25%). Annual income tax savings: $10,000,000 x 10% = $100,000.

Planning Tip: Income can also be shifted upwards. For example, a high-earning professional can make the gift to his/her elderly parents who are in a lower tax bracket. The additional income can be used to help pay for medical and/or assisted living expenses. After the parents die, the assets can go to the original donor’s children (if the “kiddie tax” does not apply) for additional income shifting.

Roth IRA Conversions
Benefits of converting include a lowering overall of taxable income long-term; tax-free compounding; no required minimum distributions (RMDs) during the owner’s life; tax-free withdrawals for beneficiaries; and more effective funding of the bypass trust. For most people, converting to a Roth IRA is highly beneficial over the long term.

Planning Tip: When exploring a Roth IRA conversion, consider the tax rate in the year of conversion vs. the tax rate in years of withdrawals; the owner’s ability to use outside assets to pay the income tax on the conversion; and the need for the IRA to meet annual living expenses.

Net Unrealized Appreciation (NUA) Planning
If an employee has employer securities in his/her qualified retirement plan, he/she may be able to convert a portion of the total distribution from the plan from ordinary income into capital gain income. The distribution must be made as a lump-sum distribution due to the employee’s death, attaining age 59 1/2, separation from service, or becoming disabled within the meaning of Code section 72(m)(7).

Taxation of Lump-Sum Distribution
Ordinary income is recognized on the cost basis of the employer securities distributed (a 10% early withdrawal penalty is due if the employee is under age 55 at the time of distribution). The difference between the fair market value at distribution and the cost basis is Net Unrealized Appreciation (NUA). NUA is not taxed at the time of distribution, but at a later time when the stock is sold, and is taxed then at long-term capital gain tax rates. (Ten-year averaging is available to those born before 1/2/1936; 20% capital gain applies to pre-1974 contributions only.)

Planning Tip: NUA does not receive a step-up in basis at death, although subsequent gain above the value at distribution should. Also, if an estate or trust contains NUA stock, a fractional funding clause must be used; otherwise, the NUA will be subject to immediate taxation.

Charitable Planning
If the capital gains tax rate increases to 20% and the 3.8% Medicare surtax applies, charitable remainder trusts (CRTs) could become very attractive again. That’s because appreciated assets that are transferred to a CRT are not taxed, so the full value of these assets is available to provide income to the donor, generating much more income than if the donor had sold the asset, paid the capital gains tax, and re-invested the proceeds.

Planning Tip: With the current historically low 7520 rates, charitable lead trusts can be used now by charitably inclined clients to shift significant wealth while using only an insignificant amount of their estate/gift tax exemption.

Inherited IRAs
An IRA is treated as inherited if the individual for whose benefit the IRA is maintained acquired the IRA upon the death of the original owner. Under the tax law, the IRA assets can be distributed based upon the life expectancy of the beneficiary if the beneficiary is a living person or a trust that meets certain requirements, such as that it is irrevocable, all beneficiaries are natural persons, and the oldest possible beneficiary can be determined.

Spouse as Beneficiary
A surviving spouse named as beneficiary of the deceased spouse’s IRA may roll it over into a new or existing IRA in the spouse’s own name. The spouse is then treated as the owner and may delay taking required minimum distributions (RMDs) until he/she turns age 70 1/2 and then take distributions based on his/her life, often allowing for a greater stretch-out period.

Planning Tip: If the surviving spouse is under 59 1/2, rolling over can expose him/her to the early withdrawal penalty if the IRA funds are needed before the surviving spouse reaches 59 1/2. Safer strategy is to wait until then to roll over and use the inherited IRA withdrawal rules before then.

Non-Spouse as Beneficiary
Naming a non-spouse beneficiary avoids having the IRA assets being subject to estate tax in the surviving spouse’s estate. Required minimum distributions (RMDs) occur over the life expectancy of the designated beneficiary.

Common Inherited IRA Mistakes to Avoid
For non-spouse beneficiaries, it is critical to keep the inherited IRA in the name of the deceased IRA owner. Correct wording for an individual: “John Smith, deceased, IRA for the benefit of James Smith.” Correct wording for a trust: “John Smith, deceased, IRA for the benefit of James Smith as Trustee of the Smith Family Trust dated 1/1/2010.”

Other mistakes include not taking required minimum distributions, not using disclaimers when appropriate, not analyzing contingent beneficiaries, and taking a lump-sum distribution at the death of the IRA owner.

Life Insurance Planning for Inherited IRA
If the IRA owner’s taxable estate does not have sufficient other assets, it could be necessary to use a portion of the IRA to pay estate taxes. Because this use triggers additional income taxes, between 60-80% of the IRA could be lost to taxes.

A solution is to establish an Irrevocable Trust that holds a life insurance policy on the IRA owner’s life. Upon his/her death, the death benefit proceeds can be used to provide liquidity to the IRA owner’s estate and preserve the inherited IRA. To the extent that the grantor does not hold any “incidents of ownership,” none of the trust assets will be included in his/her taxable estate. Another alternative is to annuitize the IRA and contribute the annuity payments to the Irrevocable Trust where they are used to pay premiums for life insurance on the IRA owner.

Conclusion
The current income tax laws and the tax increases that will happen in just 16 months (unless the Congress and President agree otherwise) provide some unique opportunities for estate planning professionals to work together as a team to help our mutual clients. Take advantage of this limited time to meet with your clients, ask the right questions, and make a positive difference for them and their families.

A living will is a document that outlines your wishes for the kind of care and medical intervention that you want (or specifically do not want) if you become terminally ill or find yourself in need of life-support but are unable to speak or otherwise communicate, as could be the case if you fall into a coma.

Careful Drafting Required

A majority of states have statutory laws that specifically define when a living will must be “activated.”  Some states limit the type of medical procedures and interventions that can be controlled with a living will, and interpretation of your wishes is always an issue.  Incorporating complex wishes and desires into a legal document is far from a perfect science, but it’s incredibly important and deserves your attention and the attention of a detail-oriented professional attorney.

Removing Uncertainty and Guilt

Take a moment to consider your loved ones deliberating over whether you would choose to live or die.  Imagine them thinking and talking about life support decisions.  Imagine the feelings that would overcome them during those discussions and the guilt they might feel.  Now, realize that such conversations need never occur.  By implementing a living will, you can express your wishes in advance and keep your loved ones from ever having to feel responsible or guilty for making what is essentially a very personal choice—a choice that only you can authentically make.

A Healthcare Surrogate

Decisions expressed in living wills are generally taken very seriously and respected by medical professionals and the legal system.  When ambiguities do exist, the chances of your wishes being followed are greatly increased if you have appointed a healthcare surrogate.  A healthcare surrogate is a person with whom you have discussed your wishes.  It is a person who understands you and, in some cases, a person who is authorized to act on your behalf if you are legally incapacitated.

Healthcare surrogates are appointed via healthcare proxies (a.k.a. medical power of attorney).  As is the case with living wills, the importance of properly forming your medial power of appointment cannot be overstated.  Equally important is figuring out who is willing to serve as your surrogate and who you trust enough to make decisions on your behalf when you’ll literally be more vulnerable than ever before.  Deciding who you trust with your life and death choices could be the most important decision you ever make.  And once the choice is made, it’s critical that you and your surrogate have as many conversations as necessary to make your wishes absolutely clear.  There is no room for uncertainty here.  Your life literally hangs in the balance, and it’s imperative that you realize the last decision you ever make could be the next decision you make.

When choosing a surrogate, remember that your designated decision-maker needs to be capable of three things: Understanding critical medical information about your condition and treatment, handling stress associated with difficult decisions, and respecting and honoring your wishes.

Let’s Talk it Over

If you’d like to learn more about medical directives and estate planning, call our office today to schedule a time for us to sit down and talk.  We normally charge $750 for a Family Wealth Planning Session, but because of the importance of medical directives and proxies, I’ve made space for the next two people who mention this article to have a complete planning session at no charge.  Call today and mention this article.

Most of the discussion about estates is focused directly on physical assets and how they should be passed to family members and other loved ones.  Physical assets include things like houses, cars, cash, stocks, bonds, and real estate.  However, in a world of increasing technological advancements, assets without physical form are becoming more and more abundant and more and more valuable.

Some Examples of Assets without Physical Form

Do you own a domain name . . . you know, a web address?  How about a Facebook account?  What about an easily recognizable email address or a Twitter handle?  Are any of those things valuable and worth passing on to your loved ones?  If so, have you made arrangements to have ownership of those assets transferred upon your death?

Those sorts of assets without form are just a few examples of intangible assets.  Other examples include copyrights, patents, trademarks, and licensing agreements, to name a few.  You must include these assets in your estate plan or else you risk having a court decide who gets the revenue streams derived from those assets.  In an increasingly complex world, value becomes locked into all sorts of unexpected places.  Think about a cellular telephone packed with customer contact information as an example.  The information locked in the phone is much more valuable than the phone itself.

The value of your legacy is no different.  The value of your life is not locked into or limited to your physical form.  It goes well beyond the physical.  Your greatest legacy is your story and what you share with your loved ones while you’re alive, so that you can see and enjoy the impact you have on your family and friends.  We all shape the world in our own unique ways.  What’s important is that you pass on your story so it can inspire and shape your family for generations beyond your life.

Maximize Each Moment of Your Life

It’s important to implement a comprehensive estate plan, but it’s also important to share information on how to access your estate plan and your intangible assets with someone you really trust.  That way your physical and intangible assets get passed to the people you want to have them, and you never have to waste any of your valuable life worrying about what will happen after you’re gone.  To the contrary, you can revel in knowing that you’ll be a positive force in your family for many, many years after your death.  That’s true peace of mind, and it will allow you to live in and fully maximize each moment without fear of forgetting to pass on your important heirlooms, stories, and secrets—the things that might serve as a foundation for your family going forward.

The process of planning your estate can be daunting.  The good news is that you’re not alone, because we are a law firm dedicated to helping you develop and monitor a complete plan that achieves your desired results and minimizes the obligations of your loved ones.

If you’d like to learn more about what that means, call our office today to schedule a Family Wealth Planning Session.  We normally charge $750 for a Family Wealth Planning Session, but to give you an opportunity to consult with us and understand the estate planning process, I’ve made space for the next two people who mention this article to have a complete planning session at no charge.  Call today and mention this article.

No one likes to think of their children being left parentless – especially if you have kids who are minors. But sadly, accidents do happen, and there is no guarantee in life that you will be around until they are grown and self-sufficient.

Which is why the Newport Beach guardianship lawyers at Morgan Law Group urge all parents to come up with a concrete plan, in writing, which outlines what needs to be done in the event that you unexpectedly pass away.

One of the key components of this outline should be deciding who will oversee the money your child inherits along with his or her expenses. Many parents automatically assume that assigned legal guardian will be the one to handle the funds. This is not always the case, nor does it have to be.

Perhaps the person you want your child to live with and be raised by isn’t the best choice when it comes to handling their finances. It is completely acceptable to assign the task of managing money to someone else in the family, or even a lawyer or financial advisor.

You want to ensure that the legal guardian is not financially burdened by taking care of your child, so it is important to take into consideration all of the expenses that the guardian may incur, and make sure that there are funds to cover them. Here are some important aspects of money management that you should consider:

- Basic living expenses like food and clothing

- Education, including private school tuition (if necessary), books and supplies

- Sports and their related costs

- Medical care, including doctors’ visits and prescription medication

- Hobbies or other extra-curricular activities

Chances are that the person or couple you entrust your children to will be more than happy and willing to provide for your child. But taking the financial burden off of their shoulders is the least you can do to help with the huge responsibility you are asking of them.

Need help deciding your child’s future after you are gone? Contact me, your Newport Beach guardianship attorney at (949) 260-1400 discuss these important options.

In this issue of The Wealth Counselor, we will examine some of the basics of income tax planning and some of the techniques used in estate tax planning that have income tax impacts.

The Goals of Income Tax Planning

The taxpayer’s goal is generally to pay the least amount of income taxes they are legally obligated to pay at the latest possible date. Income tax planning is done to help the client get as close to those goals as the law allows.

Typically, the amount of tax due is reduced by having the income be in a class that has favorable treatment. Favorable rate treatment is granted to long-term capital gains and qualified corporate dividends. Some income is excluded from taxation altogether, such as interest paid by state and local governments, certain gain realized on the sale of the taxpayer’s residence, and certain income earned while not living in the United States. The last two are subject to limiting rules and so not always available.

Income tax liability usually arises when an asset changes hands other than by gift or inheritance. However, the tax liability can sometimes be postponed. Examples are certain like-kind exchange transactions and certain installment sales. Sometimes, the fact of an asset changing hands is ignored for income tax purposes because the tax laws treat the transferring party and the transferee as the same taxpayer.

Basic Estate Planning Has No Income Tax Impact

Neither a Will nor a revocable living trust changes a client’s income taxes. A Will only takes effect when the client dies and a revocable living trust is classified by the IRS as a grantor trust. Grantor trusts are disregarded for income tax purposes.

Advanced Estate Planning Can and Often Does Have Income Tax Implications

Advanced estate planning, on the other hand, often involves income tax considerations. Advanced planning involves creation of trusts and/or entities.

Sometimes, advanced estate planning is used to reduce income taxes by shifting income from a taxpayer in a high bracket to a taxpayer in a lower bracket. Irrevocable trusts are often used for this purpose when the “kiddie tax” does not apply. The “kiddie tax,” when applicable, imposes the parent’s tax rate to the income of the taxpayer’s child who is under age 24.

For this donor to donee income tax liability shift to occur, the trust cannot be a grantor trust with respect to the donor. On the other hand, if the trust is a grantor trust, the donor’s paying the income tax on the trust’s income is not an additional gift. Thus not shifting the tax responsibility can be used to transfer additional wealth to children and grandchildren without using the donor’s gift tax exemption.

When an asset is sold, the tax is determined by the amount of gain realized. Gain is generally the difference between the net proceeds of the sale and the taxpayer’s basis in the asset. If the taxpayer receives the asset as a gift, the taxpayer’s basis is the previous owner’s basis plus any subsequent investment by the taxpayer. If the taxpayer received the gift as an inheritance, the basis is the asset’s value at the death of the prior owner plus any subsequent investment by the taxpayer. Advanced estate planning, therefore, weighs the estate and gift tax avoided against the increased capital gain that would be due on the recipient’s sale of a gifted asset as opposed to an inherited asset.

Some advanced estate planning involves charities. Trusts with charity and non-charity beneficiaries all have income tax effects. Such trusts are characterized as charitable lead trusts (CLTs) if the charity beneficiaries take before the non-charity beneficiaries and charitable remainder trusts (CRTs) if the charity beneficiaries get what is left over after payment to the non-charity beneficiaries. Both CLTs and CRTs can be grantor trusts or non-grantor trusts, depending on what the client is trying to achieve.

Advanced planning with income tax aspects also includes:

• Investing in assets that produce tax-free income;

• Converting ordinary income into capital gain income;

• Defering income for the maximum period of time;

• Accelerating deductions to the earliest possible year;

• Taking maximum advantage of depreciation rules;

• Taking maximum advantage of income exclusion rules;

• Avoiding tax-inefficient business structures;

• Structuring transactions to include some or all of the above.

Deciding which of these techniques should be used in a particular case requires advanced estate planning experience and probably accounting analysis. It is, however, important for every advisor to be at least aware that they exist so that the appropriate team member can be called on when needed.

Planning Tip: Remember, there is nothing illegal or improper about rearranging our clients’ business affairs to take maximum advantage of all lawful strategies to reduce taxes.

Taxation of Corporations, Limited Liability Companies, Partnerships, and Non-Grantor Trusts

Most corporations, limited liability companies (LLCs), and all partnerships, and non-grantor trusts are taxed differently than individuals. An exception is the LLC owned by an individual or the partnership or LLC owned 100% by a married couple. They will be disregarded for income tax purposes unless the taxpayer owner(s) elect otherwise.

Partnerships, for example, are not taxed at all. They report income and deductions, but the taxes are paid by the partners individually.

Some corporations and LLCs are eligible to elect to be taxed under Subchapter S of the Internal Revenue Code’s Chapter 1. They are called S-corporations, and they are treated for income tax purposes very much like partnerships – as pass-through entities. Corporations that do not elect or are not eligible for Subchapter S treatment are taxed as separate taxpayers under Subchapter C. They are called C-corporations.

LLCs can elect to be taxed as corporations, otherwise they are taxed as partnerships or are disregarded. Some are eligible to be taxed as Subchapter S corporations.

Partnerships and LLCs that are taxed as partnerships, have special allocation rules. S-corporation taxation is available only if a number of qualification conditions are met. Some trusts, for example, are not qualified to be Subchapter S owners. Entities in which they own interests, therefore, are ineligible for Subchapter S tax treatment. And with corporations that are not Subchapter S corporations, there are adverse taxation, liquidation and distribution of property issues.

Some Specific Income Tax Planning Techniques
Home Sale Exclusion

Many clients will be able to take advantage of the limited exclusion of gain on the sale of a personal residence. It allows a taxpayer to exclude from income up to $250,000 ($500,000 if filing jointly) of gain, providing the property sold has been the owner’s primary residence for two out of the five years preceding the date of sale. This exclusion is also available for residences owned in revocable living trusts and certain irrevocable trusts, including defective grantor trusts.

Planning Tip: Many clients have more than one residence. With planning and a responsive market, a client can use this exclusion every two years to sell multiple properties. For example, sell the principal residence first. Then move into the vacation home, make it the principal residence for two years, then sell it.

Converting Income Taxable Assets into Non-Taxable Assets
IRAs have built-in income taxes. Plus, they are includible in the owner’s estate as income in respect of a decedent (IRD). Distributions from an inherited IRA are also taxed when received by the beneficiary (although the beneficiary receives an itemized deduction for estate taxes paid on that income). In taxable estates, the net result is that a $1 million IRA is often only worth about $250,000 net to the beneficiary. There are several solutions to this dilemma. Some are:

Solution #1: Stretch out the inherited IRA as long as possible to offset the double tax. The longer tax-deferred growth will allow it to earn back some of the amount paid in estate taxes. Naming a young beneficiary will provide the maximum stretch out, allowing for more growth over a longer period of time. To make sure this happens, consider a special-purpose trust designed to receive and stretch inherited retirement plan benefits.

Solution #2: Convert the IRA to a Roth IRA. It may make sense to convert and pay the tax now if the IRA assets are expected to increase substantially over the next few years. As with a regular IRA, naming a young beneficiary will provide the maximum stretch out, allowing for more tax-free growth over a longer period of time.

Solution #3: Liquidate the IRA now and pay income tax at the current rates. Then gift the net proceeds to an irrevocable life insurance trust (ILIT) where the trustee can use the money to purchase life insurance. This will work well in 2011 and 2012 when the gift tax exemption is $5 million. Using this approach, a $1 million taxable IRA could be converted to over $1 million in tax-free assets for multiple generations.

C-Corporations

A C-corporation is taxed at a maximum rate of 35%, but, unlike individuals, it has no preferential capital gains rate. Thus, while capital gain income to an individual is taxed at a maximum of 15%, capital gains realized by a C-corporation are taxed at up to 35%. Then, when a C-corporation distributes a dividend to its shareholders, the dividend is taxed at up to 15% on the shareholder’s return – thus creating double taxation on the same income. Even worse, if a C-corporation distributes appreciated assets to its shareholders, a deemed sale will have occurred at the corporate level, regardless of whether the corporation has any cash to pay the tax.

S-Corporations

An S-corporation is a pass-through entity so there is only one level of tax. Grantor trusts, including revocable living trusts, can be S-corporation shareholders. An irrevocable trust can also be designed so that it is eligible to be an S-corporation shareholder.

Getting Out of the C-Corporation Trap

Many clients form corporations and elect C-corporation taxation unaware of the problems it can cause in the future because a C-corporation is tax-inefficient. Often the issue only surfaces when there is a real need to get out of the election. Liquidating the C-corporation and re-forming as an LLC (taxed as a partnership) will trigger capital gain on appreciated assets owned by the C-corporation, and shareholders will recognize gain on the receipt of corporate assets. This is not a viable solution unless assets are not appreciated and shareholders have unused capital losses.

A better solution is to liquidate the C-corporation, re-form as an LLC, and make the election to be taxed as an S-corporation. This will eventually eliminate the double taxation. However, a 10-year rule applies, so it is best to get the process started as soon as the problem is detected because any disposition of corporate assets within this 10-year period will result in some double taxation.

Deferring Income Recognition

Any time a client can defer taxes, it is wise to do so unless the tax rate increases. The longer a client can defer the payment of tax the better, because he or she can use and invest that money. Here are some of the opportunities the IRS gives us to defer the tax on income:

Exchange of Insurance Policies (Code Section 1035)

Allows the exchange of a current policy for one with better underwriting or a better product. Often the gain in the current policy is used to partially fund the new policy.

Like-Kind Exchange of Tangible Property (Code Section 1031)

Relinquished tangible property must be of a “like kind” to the replacement property (for example, a herd of cattle cannot be exchanged for a commercial building), and the exchange must occur within certain timing requirements (45 days for identifying and 180 days for acquiring the replacement property). No constructive receipt of cash is allowed in a non-simultaneous exchange, so a qualified intermediary is often used. To completely defer gain recognition, the value of the replacement property must be greater than or equal to the value of the relinquished property, and the taxpayer’s equity in the replacement property must be greater than or equal to the taxpayer’s equity in the relinquished property. If either is not true, there will be a taxable “boot” that is recognized in the year of the exchange. Tangible property not eligible for a 1031 exchange includes stock in trade or other property held primarily for sale. Intangible property, such as stocks, bonds, notes, other securities or evidences of indebtedness or interest, partnership interests, and certificates of trust or beneficial interests are not eligible for section 1031 exchange deferral.

Certain Corporate Reorganizations (Code Section 368)

Certain corporate reorganizations permit corporations to merge and acquire each other on a tax-free basis, which allows the client to rearrange corporate structure without an immediate income tax.

Installment Sale (Code Section 453)

Generally, if property is sold at a gain and at least one payment is received after the close of the tax year of sale, installment reporting is required unless the taxpayer elects out. There are many specific rules that apply to installment sales.

Charitable Trusts

In the right circumstances, charitable trusts can also provide tax deferral.

Charitable Remainder Trust (CRT)
The grantor retains an annual income stream and the remainder, if any, at the end goes to charity. The annual income stream can be an annuity or a “unitrust”: i.e., an amount that is a fixed percentage of the balance of the trust at the beginning of the year. The net present value of the remainder interest when the trust is created must be at least 10% of the value of the initial contribution. The annual distributions can be payable for a term of years, a single life, joint lives or multiple lives.

Tax Deferral with a CRT
A CRT is exempt from income tax because the ultimate beneficiary of the trust is a charity. There will be no capital gain tax when appreciated property is placed in the trust or when it is sold by the trust. Capital gain is eventually taxed as annual payments are made to the grantor, but only after ordinary income has been taxed. Distributions that exceed ordinary income and accumulated capital gains are tax-free. The client also gets a charitable deduction in year one for the present value of the remainder interest.

Charitable Lead Trust (CLT)
With a CLT, a charity is the beneficiary that gets a stream of annual payments and the remainder, if any, goes to the grantor or whoever the grantor chooses. A CLT is funded with income-producing assets that are ultimately earmarked for heirs. At termination of the CLT, the trust assets pass on to the heirs free of any transfer tax on appreciation realized after the date the trust was created, as long as the rate of return on the assets exceeds the AFR in effect when the CLT is established. The taxable gift to the heirs is calculated in the year the CLT is created if the stream of payments is an annuity, or at termination if the CLT is a unitrust. When the grantor gets a charitable deduction depends on whether the CLT is a grantor trust.

Tax Deferral with a CLT
A CLT is not exempt from income tax because the ultimate beneficiary of the trust is not a charity. If it is a non-grantor CLT, there is an income tax deduction for the amount paid to the charity each year. If it is a grantor CLT, the charitable income tax deduction can be accelerated and taken on the grantor’s income tax return in the year the trust is created. This can be very beneficial for a client who has a substantial amount of income in one year. All taxable income earned by the trust in future years will then be taxed to the grantor.

Conclusion
Income tax planning should be an integral part of the estate planning process. We hope that this review will be useful for issue spotting and serve as a reminder that we need to work together as a team in order to provide the best possible service for our mutual clients.

This is an eye opening comparison that demonstrates the reasons that involving experienced professionals saves families and businesses time, money and headaches in the long term.

House 1 – Do it yourself.  Quicken Family Lawyer / Will Maker

• Didn’t interview the realtor, lender, insurance agent, builder – got names out of phone book – Never discussed options with anyone – he took what was given to him
• No toilets
• No lights
• No carpet
• No insulation in the walls
• Single pane windows
• Property boundary issues with neighbor – no title work – didn’t want to pay for it
• Environmental issues as land used to be a landfill
• Never used a lawyer – why would I need one of those?
• Mechanic’s lien issues, litigation, huge costs and expenses to make it livable

House 2 – Budget – driven homeowner – Standard Attorney Form

• Cheapest of everything – windows, roofing, framing, insulation, fixtures
• Unfinished basement
• No lawn or landscaping in back
• Chose color of carpet & window coverings – Only involved in one meeting with builder – Corresponded via email and fax with everyone else
• Property boundary issues and Environmental issues – Will handle himself – “not that big of a deal”

House 3 – Fully custom home – Morgan Law Group

• Fully involved in the process – Several meetings with realtor, builder, architect, attorney, land planner, designers, movers and used each professional to do what each was experienced in doing and to design & build exactly what they wanted
• Had dozens of choices on everything involved – they took the time to learn what their options were on everything that was important to them
• Got exactly what they wanted, with no outstanding title issues and no lingering environmental issues
• Also save ~ $200 per month on their utility bill over the other homeowners because they had upgraded windows and insulation installed – that $200 per month allowed them to have a large deck with a hot tub installed on the back of the home off of the master bedroom for the same price that they had budgeted
• In addition, got a maintenance plan – every year the builder comes back to the house and fine tunes all of the systems, the electrical, plumbing, HVAC, roof, foundation, the appliances, fixes any squeaks and leaks and just generally makes sure the home continues to meet their goals
• More time, More money – Peace of Mind

Legal advice for estate and business plans is not a commodity.

Do lawyers have computers – Yes.

Is it easier to edit someone else’s document than it is to create one from scratch – Absolutely.

Will the documents you end up with accomplish your goals, I don’t know.   It depends on a number of factors,  that’s where we spend our time,  trying to figure out what you want and what will best suit your needs.

There is no mystical legal database in the universe somewhere that you can hook up to in the privacy of your own home, after the hours of 8am to 5pm, download your hopes, dreams goals and fears, punch the button and have it spit out the perfect set of documents that will be custom matched for you, your family, your business, now and forever, and do all of that for $100 or less.

All of our estate planning documents cost about the same – about $100. That’s about the cost of the binder, the paper, the ink, the printer materials, the electricity to run the printer and computer, and so forth.

IT’S THE WISDOM OF KNOWING WHAT QUESTIONS TO ASK AND WHAT TO PUT IN THE DOCUMENTS THAT WE CHARGE FOR.

WISDOM IS ALWAYS SOLD SEPARATELY.

A woman, let’s call her Elizabeth, has passed away.  Elizabeth is survived by four adult sons.

Our fictional character was a very caring woman, and she lived simply.  She had a nice home with a garden and grandchildren who loved her.  Nobody would ever have expected that Elizabeth had several hundred thousand dollars in the bank and owned her home outright.  Elizabeth was also very thoughtful.  She left a last will and testament.  She did the best job she could to express her wishes clearly, but she made one critical mistake.

Rather than having a bank account in her name alone, Elizabeth listed her eldest son on the account as a joint tenant with a right of survivorship.  What that means now, in simple terms, is that her eldest son is the sole owner of all the cash in that bank account.

An Honest Boy

Elizabeth knew her sons were very close with one another.  She knew that the son who was listed on her bank account would share the money with her other sons.  She had no doubts in that respect.  In this case, let’s assume Elizabeth’s intuition was right.

Assume that Elizabeth’s son is an honest boy and wants to share the money with his brothers.  He is between a rock and a hard place.  To understand why, we first need to ask why many people choose to arrange their finances in the ways they do.

The simple answer is that many people want to avoid probate court.  They want the administration of their estates to be simple for their daughters, sons, grandchildren, and other heirs.  Most people don’t want the courts involved at all.

In California, wills don’t have to be probated (i.e. a court doesn’t have to be involved) if the entire estate is worth less than a certain dollar amount, $100,000.  By essentially giving cash to relatives—by naming a relative as joint owner with the right of survivorship—estates can effectively be reduced to a level that avoids probate.

Here’s the rub in this situation: Elizabeth’s eldest son is now the sole owner of several hundred thousand dollars.  If he distributes that money to his brothers, there will be gift tax consequences.  Worse, if he dies before he’s able to make those distributions, then his estate will retain the money.  In other words, if he dies before figuring out a way to get the money to his brothers, it’s likely that his mother’s last wishes won’t be fulfilled.

Remember, the characters are hypothetical, but this situation happens all the time.

The Cost of Traditional Law Practices

It is true that Elizabeth’s son could use part of his lifetime gift tax exemption to pass the money directly to his brothers, but once that exemption is used, it’s gone forever.  Elizabeth should have used her lifetime gift tax exemption, but she didn’t know how.  So what could she have done differently and why didn’t she do it?

Forming a simple living trust is the easiest way to avoid probate court.  In the legal field we call it a revocable inter vivos trust.  The use of a simple living trust can easily accomplish the goal of reducing an estate to a level that avoids probate.  Even better, it allows you to retain control of your assets.  Shared or joint ownership is not required.  More importantly, use of a living trust absolutely ensures that your wishes will be carried out.  In other words, it eliminates risk.

Why don’t more people create living trusts?  My intuition is that most people simply lack the information they need to make good decisions with respect to estate planning.  Most people have heard of a will but don’t know that a will often isn’t enough.  Many people even hire attorneys to draft wills, and their attorneys neglect to inform them of the benefits of a living trust.

That, Ladies and Gentlemen, is a disgrace to my profession.  Attorneys have done a great job marketing themselves as personal injury advocates, but they’ve dropped the ball when it comes to informing families about the things that really matter.

That’s the primary reason that we run a different kind of Orange County estate planning law firm.  We are here to fully educate and serve, not just draft a will and move on.

If you’d like to learn more about what we mean, call our office today to schedule a Family Wealth Planning Session.  We normally charge $750 for a Family Wealth Planning Session, but to give you an opportunity to consult with us and understand what issues your current estate plan may have, I’ve made space for the next two people who mention this article to have a complete planning session with me at no charge.  Call today and mention this article.