2. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Principles of Taxation: Advanced Strategies Chapter 16 Wealth Transfer Planner Slide 16-1

3. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Gift Tax Planning Maximize use of the annual exclusion Give to reduce estate tax by reducing taxable estate Slide 16-2

4. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Impediments to Lifetime Giving Slide 16-3 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

5. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Giving Illiquid Assets Give undivided interests Transfer fractions of asset over time Sell assets on installment method  Installments may be forgiven Family partnership Slide 16-4

6. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Only general partner interests includable in gross estate of contributor Slide 16-5

7. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-6

8. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-7

9. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-8

10. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-9

11. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-10

12. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Gifts of Depreciated Property Should not be gifted or held since loss will never be recognized Optimal strategy: sell asset and deduct loss Slide 16-11

13. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-12

14. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Estate Planning Considerations Reduce value of estate Maximize any potential estate tax deductions and credits Defer payment of estate taxes Slide 16-13

15. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Life Insurance Slide 16-14 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

16. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Life Insurance Trusts Transferring policy irrevocably to a trust will keep proceeds out of gross estate  Grantor cannot trustee  In order to be effective transfer must be more than 3 years before death Transfer to trust is considered a taxable gift Slide 16-15

17. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-16

18. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-17

19. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Qualified Family Owned Business Exclusion Exclusion is lesser of  $1,300,000 over exemption equivalent in effect for year or  Adjusted value of decedent’s qualified family owned business interests Repealed for decedents dying after 2003 Slide 16-18

20. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Qualified Family Owned Business Exclusion Requirements:  Value of family owned business must be at least 50% of value of gross estate  Business must not have personal holding company income in excess of 35% of ordinary income in year of decedent’s death Slide 16-19

21. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Qualified Family Owned Business Exclusion Requirements (continued)  Decedent and family must own at least 50% of business at date of death  Business must have been owned and operated by decedent for 5 out last 8 years prior to death  Qualifying heirs must materially participate in business for 5 out of 8 years after death Slide 16-20

22. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Qualified Family Owned Business Exclusion Slide 16-21 If any requirement if failed to be met or the business is disposed within 10 years of death, all or part of tax benefit due to exclusion recaptured If violation occurs within 6 years after death, 100% of benefit recaptured Percentage declines 20% after year 6

23. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-22

24. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-23

25. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-24

26. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Marital Deduction Slide 16-25 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

27. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-26

28. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-27

29. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-28

30. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-29

31. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-30

32. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-31

33. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-32

34. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-33

35. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-34

36. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc 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 Slide 16-35

37. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Reducing Probate Costs Hold property in joint tenancy Use of a revocable living trust Slide 16-36