2. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved.

3. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Chapter Wealth Transfer Planning 17

4. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-3 Gift Tax Planning Maximize use of the annual exclusion Give to reduce estate tax by reducing taxable estate

5. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-4 Impediments to Lifetime Giving Taxpayers may feel they need the assets to fact an uncertain future Assets may be illiquid and not easily divisible Beneficiaries may be too young to effectively manage gifted property

6. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-5 Giving Illiquid Assets Give undivided interests Transfer fractions of asset over time Sell assets on installment method Installments may be forgiven Family partnership

7. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-6 Family Partnerships Parents or grandparents transfer assets to a partnership in exchange for a general partnership interest Limited partnership interests are gifted over time Gifts qualify for the annual exclusion Valued at a substantial discount due to lack or marketability and control Only general partner interests includable in gross estate of contributor

8. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-7 Trusts Can solve problem of gifting assets to beneficiaries unable to manage the property Gift to trust may not qualify for annual exclusion if not a present interest Annual exclusion available for qualified trusts to minors and trusts with Crummey power

9. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-8 Qualified Trust to Minor Trust must be irrevocable Both principal and interest may be expended by or for the benefit of minor Any trust principal must be distributed to beneficiary when he or she turns 21 If beneficiary dies before reaching age 21, trust assets must be payable to beneficiary’s estate or minor’s designated beneficiary

10. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-9 Crummey Trust Trust where beneficiary can demand distribution from trust equal to lesser of annual exclusion amount or annual contribution to the trust Gifts to trust qualify for annual exclusion even if beneficiary does not exercise power

11. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-10 Income Shifting Concept: Transfer income producing assets to taxpayer in lower income tax brackets Obstacle: Unearned income of children under 14 taxed at parent’s rates Possible solution: Appreciating assets with little current income

12. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-11 Gifts of Appreciated Property  Removes entire value from taxable estate  Any gain on sale will be recognized by donee  Potential step-up in basis at death lost

13. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-12 Gifts of Depreciated Property Should not be gifted or held since loss will never be recognized Optimal strategy: sell asset and deduct loss

14. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-13 Gift Planning for 2004-2010 During this period, gift tax exclusion will be $1,000,000 while estate tax exclusion substantially higher May want to limit taxable gifts during this period to $1,000,000

15. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-14 Estate Planning Considerations Reduce value of estate Maximize any potential estate tax deductions and credits Defer payment of estate taxes

16. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-15 Life Insurance Proceeds of a life insurance policy are includable in decedent’s gross estate unless decedent had no incidents of ownership Common incidents of ownership Power to change beneficiary Power to borrow against the policy Power to pledge the policy

17. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-16 Life Insurance Trusts Transferring policy irrevocably to a trust will keep proceeds out of gross estate Grantor cannot be trustee In order to be effective transfer must be more than 3 years before death Transfer to trust is considered a taxable gift

18. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-17 Closely Held Business Valuation Factors considered by IRS Nature and history of the business General economic outlook and economic condition of industry in which business located Book value of stock Company’s condition, earning capacity and dividend paying capacity Existence of goodwill Previous sales and size of ownership interest Market price of similar publicly traded corporations

19. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-18 Marketability Discounts Minority interest discounts Based on premise that stock worth less due to lack of control Blockage discount Theory: sale of large block of stock would depress price

20. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-19 Special Use Valuation Values assets used in a family owned farming or ranching business at current rather than best use Maximum reduction in value is $750,000 Elective provision

21. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-20 Special Use Valuation Requirements At least 50% of adjusted gross estate is property devoted to qualifying use At least 25% of adjusted gross estate is real property devoted to qualifying use Decedent or family must have materially participated in 5 out 8 years prior to death

22. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-21 Special Use Valuation Requirements (continued) Property must pass to qualifying heirs Heir must continue property for 10 years Estate tax benefits recaptured if requirements not met

23. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-22 Marital Deduction Common mistake: Overuse by leaving everything to surviving spouse Unified credit of decedent will essentially be lost Ultimate disposition of all assets left solely to second to die

24. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-23 Solutions to Overuse of Marital Deduction Leave exemption equivalent amount to someone other than surviving spouse May want to consider leaving even more than exemption equivalent amount to person other than spouse if assets appreciating quickly Estate tax rates progressive Keep appreciation out of second to die’s gross estate

25. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-24 Marital Trusts Terminal interests, (interests which will terminate on someone’s death) do not generally qualify for the marital deduction Bypass trust or credit shelter trust: trust where spouse gets income interest but others get remainder interest Transfers to trust will not qualify for marital deduction unless QTIP election made

26. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-25 QTIP Election Qualified Terminal Interest Property (QTIP) Property received from spouse which recipient has income interest Recipient must get income at least annually No portion of property can be appointed to any one other than recipient spouse during his or her life time

27. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-26 QTIP Election If election made Property transferred into QTIP trust qualifies for marital deduction Property is included in gross estate of recipient spouse on his or her death

28. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-27 QTIP Election Election is most advisable when surviving spouse has a long life expectancy Downside is assets may greatly appreciate and be subject to higher estate tax rate

29. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-28 General Power of Appointment Recipient can appoint property to anyone If surviving spouse has power, the assets transferred to him or her will qualify for the marital deduction Assets subject to a general power of appointment includable in gross estate of power holder

30. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-29 Estate Tax Deferral IRS may grant up to 10 year extension to pay tax for reasonable cause Interest payable at normal statutory rate If estate consists of closely held business, payment may be extended as long as 15 years

31. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-30 Deferral for Estates with Closely Held Businesses Requirement: Closely held business must represent at least 35% of adjusted gross estate Adjusted gross estate is gross estate less deductions for expenses, debts of decedent, taxes, casualty and theft losses

32. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-31 Closely Held Business Sole Proprietorship Partnership where decedent had at least a 20% capital or profits interest Partnership with 45 or fewer partners Corporate stock representing a 20% or greater voting interest Stock in a corporation with 45 or fewer shareholders

33. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-32 Deferral for Estates with Closely Held Businesses No payments on tax attributable to closely held business for five years Interest on unpaid tax due to closely held business imposed at 2% rate up to $1,000,000 of value Any disposal of business will result in acceleration of payments

34. McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 17-33 Reducing Probate Costs Hold property in joint tenancy Use of a revocable living trust