Perspectives July 2012 - Credit Suisse Wpg

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Private Banking USA

PerspectivesWealth Planning Group Newsletter

July 2012



CSSU does not provide legal or tax advice. Please consult with your legal or tax advisors.

Dear Clients:

As we are now into the second half of 2012, an overview of our current estate and tax landscape as well as a discuregarding estate and tax planning considerations is in order.

The Tax Relief, Unemployment Insurance Authorization and Job Creation Act of 2010 (the “Act”) created signi cant chthe area of wealth transfer planning. Most notably, the Act increased the federal Estate, Gift and GST tax exemption amoyears 2011 and 2012 and reduced the transfer tax rate.

The Estate, Gift and GST exemption amount for 2012 is $5.12M per individual, $10.24M per married couple (as adfor in ation). The Estate, Gift and GST tax rate is 35% for 2012. As of the time of this publication, it is unclear whthese increased bene ts will ultimately be extended, reduced or eliminated. Because of the uncertainty, clients should seconsider taking advantage of this bene t as the year progresses. Without further Congressional action, beginning in 201Estate, Gift and GST exemption amount will decrease to $1M (with adjustments for in ation for the GST exemption) transfer tax rate will increase to a maximum rate of 55% with a surcharge for larger estates.

The combination of increased exemption amount, decreased tax rate, low interest rate, and relatively low asset values maan opportune time for wealth transfer planning.

In the following pages, we discuss numerous planning considerations that may assist you in transferring substantial wyour bene ciaries in an ef cient manner. Although not all of the planning vehicles discussed may be relevant to your pasituation, simply being aware of your options should better prepare you for planning discussions with your legal and tax

We hope that the information provided is helpful and informative.

With warmest regards,

Alpa PanchalWest Coast Head, Wealth Planning Group

Editor’s Note

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CSSU does not provide legal or tax advice. Please consult with your legal or tax advisors. 5

the estate and gift tax. In 2012, the GST exemption increaseto $5.12M per individual (or $10.24M per married coupTherefore, a grandparent may wish to consider making gito grandchildren, whether outright or in a GST trust, to taadvantage of the increased exemption. In a properly structurGST trust, assets held in the trust and any future income an

appreciation could effectively be shielded from future estor GST tax. In certain jurisdictions, this type of generatiskipping trust can continue in perpetuity (the so-called “DynTrust”), thereby potentially extending the tax bene ts for futgenerations.(4)

Sale to an Intentionally Defective Grantor Trust

One effective strategy to leverage the increased gift and GSexemption amount is the use of a sale to an intentionally defectgrantor trust (“IDGT”). Due to the nature of this structure, IDGT is typically the strategy of choice for GST planning.

In this strategy, the grantor creates an irrevocable trust antypically funds the trust with a gift of cash. The size of the gioften determined by the size of the transaction. The trust thepurchases an asset with high growth potential from the grantin exchange for an installment note. The note must include interest rate equal to at least the monthly Applicable FederRate (“AFR”) in effect at the time of funding. If the trust assgrow beyond the AFR, then the excess appreciation could pato the bene ciaries of the trust without further transfer tax.

For additional leverage, the grantor could sell assets, whi

qualify for a valuation discount (e.g., interests in a family limpartnership). If the grantor dies during the term of the nothen the fair market value of the note (to the extent the loahas not been repaid) is included in the grantor’s estate. Thvalue may sometimes be less than the outstanding principdepending on several factors.

(4) The Obama Administration Fiscal Year 2012 Revenue Proposals include a provithat would limit the use of the Dynasty Trust structure to a maximum of 90 years

Overview of Wealth TransferPlanning Opportunities

Lifetime Gifting

The lifetime gift tax exemption increased to $5.12M per individual (or $10.24M per married couple). This means thatan individual who has not yet utilized his or her lifetime gift taxexemption may now gift up to $5.12M (or $10.24M per marriedcouple) without incurring federal gift tax(1). An individual whohas previously used his or her $1M lifetime gift tax exemptionnow has the opportunity to make an additional gift of $4.12M(or $8.24M per married couple) without incurring federal gifttax. Additionally, the top gift tax rate has been reduced from45% to 35%.

There are several signi cant tax advantages to lifetime gifting.First, the asset gifted could be removed from the donor’sestate. Second, any future income and appreciation associatedwith the gifted asset could also be removed from the donor’sestate. Third, the gift tax is generally more ef cient from a taxperspective due to the nature of how the estate and gift tax arecalculated. For example, a client who wishes to make a lifetimegift of $1M to his or her children would need to have $1.35Mto do so ($1M gift and a federal gift tax of $350,000)(2). Incontrast, a client who bequeaths $1M at death to his or her children would need approximately $1,538,462 to do so ($1Mbequest and a federal estate tax of approximately $538,462)(3).The reason for this disparity is that the gift tax is tax-exclusive,meaning it is calculated exclusive of the gift tax owed. Theestate tax, on the other hand, is tax-inclusive, meaning that itis calculated inclusive of the estate tax owed. In other words,there is an estate tax imposed on the amount of estate tax tobe paid.

In addition, the use of lifetime gifts may also save state transfer taxes because many states, such as New York, impose aseparate estate tax but not a separate gift tax.

Lifetime Gifting to Grandchildren

The Generation-Skipping Transfer (“GST”) tax is a tax that isimposed on transfers to grandchildren or younger generations(or trusts for their bene t). This is a separate tax in addition to

(1) Note that a small number of states impose a separate gift tax and the exemptionamount may be lower than the federal exemption. Individuals should check withtheir counsel regarding their particular state gift, inheritance and estate tax rules.

(2) Assuming the current 35% federal gift tax rate and no use of the lifetime gift taxexemption amount.

(3) Assuming the current 35% federal estate tax rate and no use of the estatetax exemption.




The IDGT is considered a grantor trust for income tax purposes.Therefore, the grantor does not recognize gain or loss on thesale of assets to the IDGT. The grantor is also not taxed on theannual interest payments received from the note. In addition,the grantor is obligated to pay the income tax on the incomeattributed to the trust, thereby allowing the assets in the trust to

more effectively grow for the bene t of the bene ciaries.

Because current AFRs are low (e.g., mid-term AFR for July 2012 is 0.92%), it may be possible to shift substantialappreciation to bene ciaries at a relatively low transfer tax cost.The increased lifetime gift and GST tax exemptions also allowfor more assets to be sold without incurring an immediate gifttax. In addition, if assets sold can be discounted (i.e., due tolack of marketability, fractional interest, control, etc.), additionalwealth may be transferred to bene ciaries.

Quali ed Personal Residence Trust

Transferring a personal residence to a Quali ed PersonalResidence Trust (“QPRT”) is a popular estate planning strategythat may help reduce the size of your estate. The increasedlifetime gift tax exemption and relatively low value of homesmake QPRTs a popular strategy.

This strategy consists of a gift of a personal residence to anirrevocable trust. The grantor would retain the exclusive rightto use and occupy the personal residence for a period ofyears. This retained right creates a discount on the value ofthe home for gift tax purposes. At the expiration of the trustterm, the property in the trust would pass to the bene ciaries.The grantor could continue to live in the residence at that timewith the consent from the bene ciaries and the payment of fair market rent.

An essential element to consider is the length of the term ofthe QPRT. This is because the grantor must survive the termof the QPRT in order for this strategy to work. If the grantor dies during the QPRT term, the value of the home is includablein the grantor’s estate and the estate planning bene ts of theQPRT have not been achieved.

The transfer of fractional interests in a residence could beused to hedge against the possibility of premature death. For example, a grantor may create three QPRTs with terms of 5,10 and 15 years. For example, if the grantor transfers a 1/3interest in the residence to each of the trusts and if the grantor dies in year 12, only the remaining 1/3 interest is included inthe grantor’s estate. Another possibility is for a married coupleto create two QPRTs, each with his or her 50% interest in the

property. If one spouse dies during the term of the QPRT, thethe other 50% interest in the home belonging to the survivispouse’s QPRT could still be successful. A valuation discoumay be possible due to the fractional interests involved.

During the term of the trust, the grantor is still considered towner for income tax purposes and could receive the beneof any income tax deductions related to the property, as weas the tax bene ts associated with the sale of a principalresidence.

A QPRT could be an effective strategy for individuals to tranvaluable residences to the next generation. Depressed reaestate values and increased lifetime gift tax exemption coupermit the transfer of potentially large amounts of wealth afuture growth related to a residence to the bene ciaries at areduced gift tax cost.

Grantor Retained Annuity Trust Another attractive planning strategy in the current low interrate environment is a Grantor Retained Annuity Trust (“GRAOver the last couple of years, several bills were introducedCongress to restrict the use of GRATs.

A GRAT is an irrevocable trust to which a portion of grantor’s property is transferred with the grantor retaining tright to receive a xed payout, or annuity, each year for the termof the trust. The GRAT must pay the required annuity eacyear regardless of the amount of income actually generated b

the trust assets. If the trust assets do not generate suf cientincome to fund the annuity amount, the trust principal must utilized to make up any de ciency. When the trust terminatethe assets remaining in the trust pass to the bene ciaries (or atrust for their bene t) without the imposition of any additiotransfer tax. However, if the grantor dies before the end of thtrust term, a portion or all of the trust assets will be includedthe grantor’s estate for estate tax purposes.

Upon the creation of the GRAT, the grantor is deemed to havmade a gift equal to the present value of the assets that wipass to the bene ciaries at the end of the trust term. A GRATis usually structured to set the annuity suf ciently high so ththe value of the remainder interest (the value of the gift) as close to zero as possible. The value of the annuity streatypically equals the value of the assets in the GRAT plus imputed interest rate (the “§7520 rate”) — a rate that variemonthly, and remains in effect for the term of the GRAT onestablished.

The GRAT allows the transfer of appreciation in excess

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the §7520 rate to pass to the bene ciaries without additionaltransfer tax. If the assets do not appreciate, all of the assetswould have been returned to the grantor by the end of the GRATterm without adverse tax consequences. From an income taxperspective, all income tax liability incurred by the GRAT duringits term is attributed to the grantor.

Assets that have signi cant potential for appreciation are idealfor GRATs. Because the current §7520 rate is low (e.g., 1.2%in July 2012), a GRAT may shift signi cant amount of wealth tobene ciaries at little or no transfer tax cost.

Charitable Lead Trust

For individuals who are charitably inclined, this is an idealtime to consider establishing a charitable lead trust (“CLT”). ACLT is an attractive option during the current low interest rateenvironment that could help optimize the increased lifetime gifttax exemption by gifting to family members and charity at thesame time.

A CLT permits an individual to donate the income stream froman asset to one or more charities for a set number of years or for one or more person’s lifetime. The remaining assets of thetrust, at the end of the trust term, pass to the bene ciaries (or a trust for their bene t). There are different ways to set up aCLT, either grantor or nongrantor, depending on one’s goalsand objectives. A grantor CLT permits the grantor an immediateincome tax deduction at the time the CLT is established.

However, during the term of the CLT, the grantor would beresponsible for the income tax liability of the trust. A nongrantor CLT, on the other hand, does not allow the grantor to receive animmediate income tax deduction. The trust would be liable for all income tax consequences. However, during the term of thetrust, the trust would receive an income tax deduction for theincome stream paid to charity.

Zeroed-out CLATs (Charitable Lead Annuity Trusts) allow thetransfer of appreciation in excess of the §7520 rate to pass tothe bene ciaries. Because current §7520 rates are low, CLATsare an attractive strategy for those who want to bene t familymembers and charities. If structured as a grantor CLT, theindividual could also receive an immediate income tax bene t,which could be bene cial in a high income earning year.

Intrafamily Loan

The current low interest rate environment is an ideal time toconsider loans between family members. For example, a parentmay wish to lend money to a child (or a trust for the child’s

bene t). The parent must charge a minimum interest rate basedon the appropriate AFR. The child can then use the borrowemoney to invest for a higher return (or pay off other debt withigher interest rate). This strategy will generally be successfif the investment returns more than the interest being chargeon the note.

For individuals with existing intrafamily loans, this may be a gtime to consider “re nancing” using the current lower intererates. Others may wish to take advantage of the increasedlifetime gift tax exemption and forgive any existing intrafaloans (a forgiveness of loan is deemed a gift to the debtor).

Note Regarding Gifts in 2012

Commentators have suggested that there may be a possibilitthat there will be a “clawback” of the prior tax bene t. Threason for this uncertainty is based on how the estate tax icomputed. In essence, the estate tax takes into account theamount of any post-1976 taxable gifts and adds it back to thtaxable estate. The gift tax previously paid is then backed oof the computation. Individuals who make lifetime gifts in 20should be aware that because of the potential disparity in thestate, gift and GST exemption and rates in 2013 and beyon(i.e., if the exemption decreases to $1M or another amount)there is some uncertainty as to how prior gifts may be treated

However, even assuming a clawback applies, donors who eleto use their $5.12M gift (and GST) tax exemptions in 201

should be no worse off than those who pass away withohaving made those gifts. In fact, there may be bene ts to usingthe $5.12M exemption in 2012. The appreciation on the gifteassets will unlikely be subject to the “clawback”, even if gifts themselves are. Also, leveraging the gifts through some the vehicles discussed above could enable donors to transfeappreciation on assets in excess of the $5.12M exemption.

Conclusion

Even if additional gifting is not in your current plans, it is crito review your current estate plan to ensure that it is consisten

with existing law and your current wishes, in light of recchanges to legislation. In addition, the increased estate, giand GST exemption amounts along with decreased tax rate 2012 may create an opportunity for signi cant wealth transfe

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8 CSSU does not provide legal or tax advice. Please consult with your legal or tax advisors.

Planning with Family LimitedPartnerships in 2012

A family limited partnership (“FLP”) is a legal structure potentiallyoffering a number of bene ts for wealthy clients who are interestedin transferring a portion of their wealth to future generations offamily members. Estate planners have also utilized limited liabilitycompanies (“LLCs”) for wealth transfer purposes. While the FLPstructure has been used successfully by clients for many years,FLPs have been challenged by the IRS as an estate planningtool. Thus, the ability of clients to transfer their wealth throughthe use of FLPs largely depends upon the client’s understandingof the rules and limitations of FLP planning, as described below.

What is a Family Limited Partnership?

An FLP is a type of partnership formed by family members for a varietyof tax and nontax reasons. With a typical FLP, senior members of afamily (e.g. parents) transfer a portion of their investment assets toan FLP in exchange for either general partnership interests, limitedpartnership interests, or both.

When Should One Consider Forming an FLP?

One may consider forming an FLP in the following situations:

1. One is interested in transferring some of his or her wealth toyounger generations of their family in a tax-ef cient manner.

2. One wants to educate younger members of the family regardingmanagement of the assets owned by the FLP.

3. One wants to protect the assets contributed to the FLP from thepotential creditors of the FLP’s partners, including anticipatedfuture partners such as the client’s children.

4. One has suf cient assets outside of the FLP to maintainhis or her standard of living and does not need to rely upondistributions from the FLP.

5. One has nontax reasons for forming the FLP outside of estateand gift tax planning reasons (this is discussed in more detailbelow).

What are the Bene ts of an FLP?

1. Transfers of FLP interests generate discounts against the valueof the assets owned by the FLP, which may result in gift andestate tax savings. The inherent lack of marketability of theFLP interests and lack of control by the limited partners over the operation of the FLP give rise to these discounts.

2. Transferring FLP interests to family members rather thanfractional interests in the actual assets owned by the FLP

allows the client to transfer the economic bene t of the FLassets without having to divide the ownership of the asseamong different individuals.

3. The FLP is a ow-through entity and, therefore, does not havto pay a separate layer of income tax. All items of partnersincome, deduction, gain and loss ow through to the partnerin the same proportions as their ownership in the FLP.

4. Creditors of a limited partner are generally restricted accessing the partner’s share of distributions from the FLP, b

cannot obtain voting or management rights over the FLP.

What are Some Possible Disadvantages of an FLP?

1. Although FLPs are widely used to lower estate and gtaxes through the application of valuation discounts, the Icontinues to challenge the use of FLPs to generate thesediscounts. Careful planning is required to avoid any potenIRS issues.



9CSSU does not provide legal or tax advice. Please consult with your legal or tax advisors.

2. If a client transfers an FLP interest during his or her lifetime, thetransferee interest will not receive a step-up in the income taxbasis of either the FLP interest or the transferee’s share of theFLP assets on the client’s death.

3. The client may have increased annual expenses (e.g.,accountants’ and attorneys’ fees) related to the administrationand tax reporting of the FLP.

Other Issues One Should Consider Before Formingan FLP

Before forming an FLP, one should also be aware of the followingissues:

1. If the creation and funding of the FLP occurs too close in timeto subsequent transfers of interests in the FLP, the IRS mayargue that there was a “gift on formation” — essentially that theclient made a gift of underlying FLP assets, rather than gifts

of the discounted FLP interests to his or her family members.This may cause unintended gift tax consequences to the client.Gifts of FLP units should be made as far into the future aspossible following the formation of the FLP.

2. The size of the valuation discount on the transfer of the FLPunits will largely depend upon the character of the assets heldby the FLP. For example, the valuation discount applicable tounits of an FLP that owns liquid assets such as cash, CDs,stocks and bonds will generally be smaller than the valuationdiscount applicable to units of an FLP that owns non-liquidassets such as real estate. In any event, the valuation discountmust be determined by a quali ed appraiser. The terms of theFLP agreement, drafted by an experienced attorney, are crucialin determining the appropriate valuation discounts.

3. Care should be taken to address all other issues other thanestate and gift tax planning with respect to the formation andoperation of the FLP. For example, if real estate subject to aloan will be transferred to the FLP, lender consent may needto be obtained prior to the transfer so as not to trigger a “due-on-sale” clause in the loan document. If the property has beenleased to tenants, lease assignments will need to be executedto re ect the new owner of the property. Property tax issuesmust be analyzed to ensure that the property is not reassessedupon the transfer of the property to the FLP by the partnersor, thereafter, upon the transfer of partnership interests by theclient to his or her family members.

Using FLPs in Estate Planning

Once the FLP has been formed and funded, the client can engagein a number of different strategies to transfer FLP interests to family

members to reduce the size of his or her taxable estate. This woube particularly relevant during the remainder of 2012 while thetax exemption amount is $5.12M per person ($10.24M for a marrcouple). The following techniques are among the most widely uespecially this year, to take advantage of the historically high gifexemption amounts before they expire:

1. Direct Gift of FLP Interest

FLP interests can be gifted directly to family members trusts created for their bene t (see below). This is simple tdo – most FLP agreements allow for these types of transferwithout triggering a standard right of rst refusal in favor the other partners. Gifts of FLP interests should qualify for tvaluation discounts discussed earlier, thus providing for greagift and estate tax savings. If the limited partnership interesare gifted outright to individual family members, each indiviwill become a limited partner in the FLP and must agree to bbound by all of the terms of the FLP agreement. The clienwould be required to le a gift tax return to report the gift of tFLP interest. If the client does not have suf cient lifetime gtax exemption available when the gift is made, the client mayrequired to pay gift tax on the gift.

2. Gift of FLP Interest to IDGT

Rather than gifting an FLP interest directly to a family membthe FLP interest could be gifted to a special type of trust knowas an Intentionally Defective Grantor Trust (“IDGT”). An Iis an irrevocable trust generally created by the client for tbene t of a family member such as a child or grandchild. Foincome tax purposes, the client is taxed on all of the incomgenerated by the IDGT, whether or not distributed to thbene ciary of the IDGT. A gift to an IDGT is an attractive optif a client does not want a bene ciary to own the FLP interesoutright (for example, if the bene ciary is a minor), and/or thclient desires to pay the income taxes on the income earneby the IDGT’s assets, which is tantamount to a tax-free gift the IDGT bene ciaries of the income taxes so paid. As with thgift of an FLP interest to an individual bene ciary, a gift of FLP interest to an IDGT would require the donor to le a gtax return, and possibly pay gift tax on the transfer. The cliemay also allocate a portion of his generation-skipping trans(“GST”) tax exemption to the transfer so that distributions frthe IDGT to individuals two or more generations below client are exempt from GST tax.




3. Sale of FLP Interest to an IDGT

The transfer could be structured as a sale of the FLP interest toan IDGT, rather than as an outright gift. In the sale transaction,the client would sell an FLP interest to an existing IDGT inexchange for a promissory note with a relatively low rate ofinterest (but not less than the “Applicable Federal Rate”released each month by the IRS). The term of the promissorynote should generally be long enough to allow the IDGT to payoff the promissory note. The IDGT would use the income fromthe FLP interest it would then own to make interest and principalpayments on the promissory note. This would allow the client tocontinue to receive an income stream from the FLP interest inthe form of interest and principal payments on the promissorynote. In addition, all of the appreciation of the FLP interestafter the sale would be removed from the client’s estate, withthe client only retaining in the client’s taxable estate the value

of the note that has not been paid at death. Often the trust isfunded with a seed money gift of at least 10% of the total saleto assure that the note is respected as bona de debt; clientsshould consult with counsel on this step and the correspondinggift tax consequences.

4. Transfer of FLP Interest to a GRAT

One may also transfer all or a portion of his or her FLP interestto a special trust called a Grantor Retained Annuity Trust

(“GRAT”). The GRAT is designed to pay an annuity backthe client for a set number of years. The annuity payment cabe in the form of cash (generated from the income of the FLinterest), FLP units, or a combination of the two. The goof using a GRAT in this context is to pay back to the cliethe entire value of the FLP interest initially contributed by

client to the GRAT, plus a rate of interest established by thIRS (currently 1.2% for June 2012). At the end of the term othe GRAT, any appreciation on the FLP interest in excess othe speci ed interest rate would be distributed free of gift anestate tax to the grantor’s designated family members or trustfor their bene t.

Avoiding IRS Challenges on FLP Discounts

Over the years the IRS has repeatedly — and often successfully challenged the use of FLPs in estate planning. Speci cally, the IRhas attempted to reduce or eliminate the valuation discounts tak

by taxpayers on the transfer of FLP interests reported on estaand gift tax returns. If the valuation discounts are ignored, the clwould be treated as if he or she had transferred the full fair markvalue of the underlying FLP assets (in the case of a gift or sale of tFLP units) or as if he or she had died owning the underlying assof the FLP, rather than the FLP interest itself.

Fortunately for those who wish to use FLPs in their own estplanning, there are a number of cases and IRS rulings that provid




roadmap for establishing and operating an FLP to best protect thestructure from an IRS challenge. One should be prepared to do thefollowing:

1. Establish a Legitimate and Signi cant Nontax Reason for Forming the FLP

One should have “legitimate and signi cant” nontax reasons for forming the FLP other than reducing taxes by discounting assetvalues. For example, obtaining the creditor protection of thelimited partnership entity can be a valid and signi cant nontaxreason for transferring an asset into an FLP. Other possiblenontax reasons include: 1) allowing for the joint managementof family investment assets, 2) allowing for gifts of partnershipinterests to family members rather than fractionalized interestsin the underlying FLP assets, 3) providing for a single pool ofassets that would allow the partners access to other investmentopportunities that would not otherwise be available to them,4) providing a mechanism to resolve disputes among the variousfamily members relating to the FLP property, and 5) continuingto keep ownership of the FLP assets within the family byrestricting the rights of non-family members to the assets.

2. Observe Partnership Formalities

One should treat the partnership as an actual business. Ifbasic partnership formalities are not followed, the IRS may notrespect the partnership as a legitimate business entity. Separatebooks and records for the FLP should be kept. Required stateling should be made on time. A separate bank account for the FLP should be established, and partnership assets shouldnot be commingled with assets of any partner. The partnersshould attend regular meetings and minutes of those meetingsshould be recorded. Decisions regarding the management ofthe FLP assets should be made by the general partner only.Distributions to partners should be made in accordance withthe terms of the FLP agreement and in the same proportionateinterest as the par tners’ ownership in the FLP.

3. Forego Unrestricted Control and Access of Assets Transferred to FLP

One should not transfer substantially all of his or her assets tothe FLP, nor should the client have the need for the income ofthe FLP to pay his or her current or future liabilities (includinganticipated estate and gift taxes). The client should retainenough assets outside of the FLP to support his or her standardof living independent of any potential income from the FLP.The client should only transfer investment or business assetsto the FLP. Personal use assets, such as personal residences

or automobiles, should not be transferred. The IRS has beesuccessful in invalidating FLPs in numerous cases whethe donor/decedent operated the FLP as his or her personacheckbook, as if the assets were still owned by the donordecedent in his or her own name. Neither should the clieremain in control of the FLP as its general partner without f

knowledge and understanding that the IRS could seek to puback into the client’s taxable estate the full value of the FLinterests gifted or sold, notwithstanding such gift or sale, virtue of such retained control.

Conclusion

If one closely follows the rules of forming, funding and operatinFLP, the FLP can be a viable and effective estate planning strateg

Anyone considering the FLP strategy should consult with his orprofessional advisors, including estate planning counsel experienin the use of FLPs.

Article contributed by Robert Strauss and Jeffrey Geida the rm of Weinstock, Manion, Reisman, Shore, & Neumann. For o50 years, the law rm of Weinstock, Manion, Reisman, Shore Neumann, a Law Corporation, has provided assistance and counin the areas of estate planning, probate and trust administratiogeneral business and corporate law, taxation, real estate, trust anestate, and litigation..




Determining Basis for Giftedand Inherited PropertyMore and more individuals are considering gifting this year given theincreased lifetime gifting exemption ($5.12M per person). A commonquestion that arises when gifting transactions are considered is –what happens to the basis of the property being gifted?

Generally, lifetime gifts receive carryover basis. This means thatthe basis of the property in the hands of the donee (the personreceiving the gift) is the same as that in the hands of the donor (the person giving the gift). In addition, the donee gets to tack onthe donor’s holding period. For example, Mom purchased a shareof stock more than one year ago for a price of $100. Mom nowgifts the stock to Daughter. Daughter’s basis in the stock would be

$100 and if she were to sell the stock the next day for $110, shewould recognize long term capital gain of $10 because she wouldreceive the bene t of Mom’s holding period. In contrast, bequestsat death generally receive a step-up in basis to the fair marketvalue at the date of death (unless alternate valuation is elected) andsubsequent sale will always be long term capital gain (regardlessof how long the decedent has held the property). For example,Mom purchased a share of stock for $100 and Mom passes awaythe next month when the stock is worth $150. In Mom’s will, shebequeaths the stock to Daughter. Daughter’s basis in the stockwould be $150 and if she were to sell the stock the next day for

$170, she would recognize long term capital gain of $20.

There are several exceptions to the above rules. First, if a donor made a gift in excess of his/her lifetime gift tax exemption and paysa gift tax, then the donee’s basis in the gift would be increased bya proportionate amount of the gift tax paid that is attributable tothe net appreciation on the property.

Second, if a donor made a gift to a donee that subsequently dieswithin one year of the gift, and that donee bequeaths the propertyback to the donor, then there would be no step-up in basis at death.Instead, the donor receives the property back at its original basis.This is done to avoid the so-called “death bed gift.” For example,Dad gifted Son property with basis of $100 and Son passes awaywithin a year of that gift. At the time of Son’s death, the propertywas worth $150. Son’s will bequeathed the property back to Dad.In this case, Dad’s basis in the property would be $100.

The third exception is perhaps the most applicable in theseeconomic times – special rules apply to gifts of property that havedecreased in value (e.g., property with a fair market value lower than basis). In this case, the donee’s basis depends on whether there will be a gain or loss. For purposes of determining loss, the

donee’s basis is the fair market value of the property at the timof gift. For purposes of determining gain, the donee’s basis the adjusted basis in the hands of the donor. For example, Mompurchased a share of stock for $100. The stock has since droppedin value to $80. Mom now gifts the stock to Daughter. If Daughtwere to sell the stock for $70, she would have a loss of $10because she must use the fair market value at the time of the gifas her basis to calculate the loss. On the other hand, if Daughtewere to sell the stock for $130, then she would have a gain o

$30 because she must use Mom’s adjusted basis as her basisto calculate the gain. If the sale price falls between the donorbasis and fair market value at the time of gift, then there is no gaior loss realized. Therefore, it is generally recommended that tdonor in this case sell the property to recognize the loss and themake a gift of the sale proceeds to the donee.

In regard to large gifts, clients often choose to utilize a trustructure (as opposed to outright gifts) for exibility, tax ef cienand asset protection. A trust is a separate legal entity andoften a separate taxpayer. Therefore, the same rules discussedabove apply when determining the basis of the gifted propertythe hands of the trust. In the case of a grantor trust, the trustis disregarded and the trust and the grantor are considered thesame entity for income taxes purposes. Therefore, the basis othe property remains unchanged. Similarly, if the grantor were

sell property to the grantor trust, there would be no realizationgain or loss and the basis of the property sold remains unchange

This is a great year for clients to make gifts due to the favorabtax environment. Clients with depreciated assets might takadvantage of this opportunity to gift such assets to their childrto maximize the use of their increased lifetime gift tax exempti

An understanding of the basis rules is important to the futugeneration as they contemplate investment options.




The Landscape for Taxes:2012 and 2013The past few years have involved landmark changes in estate,gift, and income tax treatments. Many of these changes wereimplemented on a temporary basis set to expire December 31,2012. In this time of uncertainty, many clients look for directionin tax planning due to the possibility that tax laws may changesigni cantly in 2013. Exploring the tax reform proposals of thecampaign promises of Mitt Romney, President Obama’s 2013budget proposals, and current legislation help provide insightinto possible outcomes.

1. Current Tax Laws

We are well into 2012, and it is unlikely we will see signi cantchanges in tax laws affecting clients this year. Much of this

year’s rates are a result of extensions passed in 2010, andit is unlikely to see a two-year extension cut short during anelection year. It is also unlikely that there would be enoughtime after the elections to implement signi cant changes, andfrom a practical sense, it would be easier to focus on all of thechanges in 2013 or beyond. The maximum ordinary incometax rates are at 35%, long term capital gains and quali eddividends remain at 15%, and an increased estate, gift, andGST exemption at $5.12M at a 35% rate. All of the precedingrates and limits are set to expire December 31, 2012.

2. As Legislated for 2013

The 2012 tax rates are indirectly a result of President Bush’stax packages passed in 2001 and 2003. The laws enactedlowered tax rates, but on an initial limited time period. As2010 approached, rather than reform the tax code, Congresspassed a mix of 2-year income tax extensions and temporarilymodi ed the estate/gift tax laws. As we near the end ofthe 2-year extension period, without further Congressionalaction, we will effectively revert to 2001 tax laws with a fewmodi cations. Namely, top ordinary income tax rates will revertto 39.6%, long term capital gain rates will revert to 20%, and

all dividends (including quali ed dividends) will be taxed asordinary income. A new tax, the Medicare surtax, is 3.8% onnet investment income, which effectively makes capital gainson larger transactions 23.8%. In addition, the estate and gifttax exemption will revert from the current $5.12M to $1M, witha 55% rate.

3. President Obama’s 2013 Budget/Proposals

Overall, the budget contains many of the reversions that are

slated to take place, but made applicable only to the higheincome earners (households with greater than $250,000adjusted gross income). The budget favors a top rate of 39.6%long term capital gains at 20%, and quali ed dividends taxed aordinary income rates. The President’s proposal limits itemizdeductions to 28%, which for a taxpayer in the 39.6% brackerepresents a potential 11.6% rate differential on the value ofitemized deductions (such as mortgage interest or charitablcontributions). The estate tax and gift tax rates however, wourevert to 2009 levels, which allow for a $3.5M estate and GSTtax exemption, $1M gift tax exemption and 45% rate.

4. Mitt Romney

GOP Candidate Mitt Romney favors lower income taxerepealing the AMT (Alternative Minimum Tax) and repealestate tax. No mention is made with regard to what would

happen to the gift tax. His campaign proposals include lowerinall income tax brackets by 20% from current levels so that thtop ordinary tax rate would be 28%. Long term capital gainand dividends for higher income earners would remain thsame as today at 15%. Investment income would be exemptfrom tax for married households earning less than $200,000.

5. 2013 Outlook

Given the polls, many experts predict we will continue to haa divided government; the Republicans may keep control othe House and may take control of the Senate, and President

Obama may be re-elected. Many experts also predict taxrates for upper income earners will rise, at least until a morcomprehensive tax overhaul can be addressed in 2013 or2014. Again, there is also a possibility that the current lawwill be extended for one additional year, in order for a mothorough legislative package to be executed.




2012 Federal Gift/Estate/Retirement Contribution Amounts

Candidates Ordinary Income Brackets Long-term CapitalGains/Quali ed Divi-dend Rate

AMT Estate Tax Other

As Currently Legislated Brackets return to 2001

levels (39.6% top rate)

20% capital gains

(18% if purchasedafter 12/31/00 andheld for more than 5years), ordinary incomeon dividends

Assumed AMT

patch

Revert to 2001 rates

($1M exemption, 55%rate)

Additional 3.8%

Medicare surtax oninvestment income

Pres. Obama(2013 Budget)

Allow 39.6% and 36%brackets to return for incomes over $250,000(married lers)

20% capital gains,ordinary income ondividends for higher income earners

3 year AMT patch Maintain 2009 rates($3.5M exemption,45% rate)

Limit itemized deduc-tions to 28%

Mitt Romney Reduce all current ratesby 20%; top bracket tobe 28%

0% capital gains,dividends, and interestfor married lersearning less than

$200,000; 15% capitalgains and dividends for higher income earners

Repeal AMT Repeal estate tax

Sources: Bloomberg BNA, Tax Policy Center, Department of Treasury

Annual exclusion gift per donee $13,000

Estate tax exemption / GST per individual $5,120,000

Lifetime gift exemption $5,120,000

GST exemption per individual $5,120,000

Traditional & Roth IRA deductible contribution max $5,000

Age 50+ $6,000

401K / 403b deferral max $17,000

Catch-up contribution (age 50+) $5,500

Annual gift tax exemption for gifts to non-US citizen spouses $139,000

Summary of Key Stated Positions on Taxes Affecting Clients




2012 Federal Individual Income Tax BracketsSingle Married ling joint

Taxableincome is

over

But notover

The tax is Plus Of theamount

over

Taxableincome is

over

But notover

The tax is Plus Of theamount

over

$0 $8,700 $0 10% $0 $0 $17,400 $0 10% $0

$8,700 $35,350 $870 15% $8,700 $17,400 $70,700 $1,740 15% $17,400

$35,350 $85,650 $4,867.50 25% $35,350 $70,700 $142,700 $9,735 25% $70,700

$85,650 $178,650 $17,442.50 28% $85,650 $142,700 $217,450 $27,735 28% $142,700

$178,650 $388,350 $43,482.50 33% $178,650 $217,450 $388,350 $48,665 33% $217,450

$388,350 $112,683.50 35% $388,350 $388,350 $105,062 35% $388,350

Tax Law Summary 2010–2013Recent tax law changes have made long-term tax and estate planning more challenging. Clients are inquiring as to what the curreexpiring laws will mean for them. The following two charts highlight the changes over the next few years.

Income Tax Summary 2010–20132010 2011 2012 2013

Top Federal Tax Bracket 35% 35% 35% 39.6%

Quali ed Dividends 15% 15% 15% Ordinary Income

Long-Term Capital Gain Rate 15% 15% 15% 20%

Medicare Tax on InvestmentIncome

N/A N/A N/A 3.8%

Add’l Medicare Tax on Wages N/A N/A N/A 0.9%

New QSBS (Quali ed SmallBusiness Stock) Acquired

75% gain exclusion taxedat 28% rate for QSBSacquired after 2/17/09 andbefore 9/26/10. 100% gainexclusion up to $10MM after 9/26/10

100% gain exclusion up to $10MM for stock acquiredafter 9/26/10 and before1/1/12

50% gain exclusion, taxedat 28% rate

50% gain exclusion,taxed at 28% rate

Estate Tax Summary 2010–20132010 2011 2012 2013

Top Estate Tax Rate 35% with full step-up in basis,or election for 0% estate tax

but apply limited basis step-upamounts below

35% 35% 55%

GST Tax Rate 0% 35% 35% 55%Estate and GST Tax Exemp-tion

$5MM $5MM $5.12MM* $1MM (GST exemptionsubject to in ation adjust-

ment)

Lifetime Gift Exemption $1MM $5MM $5.12MM* $1MM

Annual Gift Exclusion $13,000 $13,000 $13,000 $13,000 (subject to in a-tion adjustment)

Basis Step-up of $1.3MM (additional $3MM step-up to survivingspouse). Carryover basis for remainder of assets

Full step-up in basis Full step-up in basis Full step-up in basis

*In ation adjustment applied




Opportunities for Life Insurance in 2012The tax legislation passed in late 2010 has provided one of the most important estate planning opportunities for high netindividuals that has ever existed – the opportunity for each individual to shift up to $5.12M out of his or her estates tax-free. Athere are many ways to take advantage of the increased gift tax exemption in 2012, the possibility of upgrading, pre-payinguaranteeing life insurance coverage for estate planning purposes is proving to be more popular. Below are some case studie

provide ideas on how individuals are taking advantage of the increased gift tax exemption with life insurance.

For those who have existing individually-owned life insurance policies, the increased gift tax exemption in 2012 can propportunity to easily shift the insurance (and underlying cash value) out of the estate tax-free.

Before the $5.12M gift tax exemption was available, the only way to purchase life insurance within an irrevocable trust withoutadditional gift tax for those who had already utilized their previous exemption amount was to utilize complicated techniquesthe effect of minimizing the amount of premiums that could be paid into a policy each year, minimizing the amount of death becould be purchased and stretching the funding over a long period of time.

With the increased exemption amount, high net-worth individuals have an opportunity in 2012 to “pre-pay” or fully fund policies with face amounts large enough to satisfy expected estate tax liabilities.

Case Study #1Reduce Taxable Estate by Transferring Existing Policies

An individually-owned policy that was originally issued in 1995 and required annual premiums of $71,000 was reviewed by our team. At the time, the insured(s) ages were 73 and 67, the policy had a cash surrender value of $1.05M and a death bene t

of $20M. The audit revealed that at the then current interest crediting rate, the policy would lapse at ages 86 and 80 – aterrible result.Utilizing a portion of their increased gift tax exemption (the policyholders had already used their previous gift tax exemptions of

$1M each), the policyholders were able to transfer the policy and cash suf cient to fund the policy to age 120 to a newly formedirrevocable trust for the bene t of their children gift tax-free. Importantly, the policy proceeds will not be subject to estate tax –assuming that both insureds survive for 3 years after the transfer.

Case Study #2Fully Fund Policies to Provide Estate Tax Liquidity

A 50 year old couple had a $100M estate, most of which was generated through the sale of a closely-held business. Even withnominal growth of the estate, the couple anticipated a future estate tax liability of at least $50M.Using the current exemption amount, the couple was able to transfer approximately $3M (or approximately 3% of their net worth)into trust tax-free, which was then used to pay a single premium on a $50M survivorship contract. As a result, the couple wasable to ensure a replacement for the wealth they expected to lose to estate taxes in exchange for a relatively small portion oftheir current net worth. Without the increased exemption amount, this strategy would have required an additional outlay in gifttaxes of over $1M.




A common challenge of families with signi cant assets is balancing philanthropy and the appropriate level of inheritance fogenerations. Life insurance has been used for years to address this challenge in the form of the “zero estate tax plan”, the objwhich is to avoid all taxes at death. This is accomplished by the purchase of a speci c amount of life insurance for the bene t of chand other family and a speci c bequest of the entire taxable estate to charity – often a family foundation.

As the case studies above illustrate, the use of life insurance to utilize an individual’s $5.12M exemption amount in 2012 capowerful and effective way to accomplish both tax and non-tax planning goals.

Considering all of the above, it is important to perform a “life insurance audit” before the end of the year to determine if youcoverage is structured to take advantage of this year’s unique gifting opportunity and to assess whether additional life insplanning is necessary.

Article contributed by John Meisenbach, founder and CEO of MCM.Since 1961, MCM has partnered with organizations and high net-worthindividuals to develop and implement long-term strategic solutions to meetpersonal and business goals. MCM provides objective consulting acrossmultiple business lines, delivering expertise in insurance advisory, employeebene ts, executive bene ts, retirement plans, and property and casualty.

Case Study #4Zero Estate Tax Plan

A couple with three children was strongly motivated to provide for charity and also wanted to ensure their children were taken careof upon the surviving spouse’s death. Though they had a net worth of approximately $100M and were capable of accomplishingboth objectives, they realized that by avoiding estate taxes, they would be able to provide signi cantly more to charity. As a result,they were able to utilize $5M of their exemption to provide a tax-free gift into a trust and purchase a $10M policy for the bene tof their children. At the same time, their estate planning documents were revised to ensure that the entirety of their taxable estatewas to pass to a private foundation managed by their children.

Case Study #3Fully Fund Policies to Guarantee Inheritance

A couple, ages 65 and 60, were concerned that although they had a signi cant estate of $50M, a long life, poor investmentperformance or unexpected medical expenses could leave them unable to provide an inheritance to their children. As a result,they were unwilling to engage in a lifestyle that they otherwise could afford.The increased exemption amount available to this couple in 2012 was successfully used to fully fund a guaranteed inheritancefor their children by purchasing a $10M “no lapse guarantee” survivorship life insurance contract through a one-time tax-free giftof $1.6M into a trust. Purchasing insurance with guarantees allowed for greater peace of mind for the couple knowing that aninheritance would be available to their families without the risks of extenuating factors.




Cyber Security Concernsand the High Net-WorthFamily OfficeThe digitally interconnected nature of our society extends

throughout the range of human activities, spanning socialcommunication, family member interaction, business networking,education, nancial transactions, medical care and travel.Moreover, these information exchanges are now proliferatingacross mobile networks, and highly private information ismanaged and moved across the internet by a diverse castof characters (banks, telecommunications companies, mediaconglomerates, technology rms, etc.). The intersection of theselayers of “connectedness” each represents a potential point ofvulnerability. Many of these vulnerabilities can be mitigated bychanges in user behavior. These changes have to be based onan understanding of how your behavior makes a difference.

Protecting and Educating Minors

Educating your family members and your staff on how their digital decisions affect the family’s virtual and physical securityis critical. High net-worth families may have a higher publicpro le to begin with, and represent an interesting news subjectfor a content hungry public. This means that your informationwill be more likely to be sought after than the average internetuser. Education must include younger family members as well.Children are less aware of the potential dangers of over sharinginformation and more in uenced by peers who encourage suchdecisions for social reasons. Even mature teens can fail tounderstand the very real risks of sharing personal informationvia social media (see sidebar).

One fth of all registered Facebook accounts belong topeople under the age of 17. Children are passionate aboutnetworking and rarely consider the dangers of over sharingfamily information. Additionally, poor understanding of privacysettings, and the desire to compete socially can lead to bad

decisions about online personal conduct. This avenue of familydata is speci cally targeted by cyber stalkers who rely on thedigital garrulity of children to obtain personal information for a variety of potentially criminal purposes, ranging from sexualpredation, bullying, extortion, kidnap or nancial data. Changingthe way minors think about their online behavior has to happendeliberately, and education is one component. Monitoringonline behavior is also bene cial, and can be negotiated withyour family.

Location Based Services Can Be A Special Hazard

The proliferation of Global Positioning Services (GPtechnology in our personal and business devices offertremendous advantages. It also is a source of great vulnerabilitThis can manifest in a variety of ways. Two of the most seriofor potential cyber stalking are social media games and digipictures. Social media games which encourage “check in’strack the physical behavior of family members who “like” ca

movie theaters, schools, malls etc. Pictures taken with moderdevices include special, hidden information (called EXIF dawhich records the date, time, location, device type etc. allowinthe possessor of the image to easily track the subject. Staff andfamily members need to be aware that they are participatinin games and that images which they post should be rstscrubbed of EXIF data.

In April 2011, Ivan Kaspersky, son of the multi-millionairefounder of Russian internet security rm Kaspersky Softwarwas kidnapped and held for ve days before being rescued

by Special Forces and police. A college student, he waabducted while commuting to his internship at a technolocompany. Ivan was very active in social media, and subsequedebrie ng of his captors revealed that he was targeted due tothe combination of his father’s wealth and the readily availabdetailed information about his routine and his family postedIvan in social medial site Vkontakte.Source: Evgeny Kaspersky, May 2 011




Wealth Planning Group/Wealth Strategist Contact Information

Bill WoodsonManaging Director, Wealth Planning Group(312) [email protected]

West

Mark Peterson(415) [email protected]

Alpa PanchalHead, Western Region(415) [email protected]

Emily Yetter(312) [email protected]

Lisa Drabicki(312) [email protected]

Jason CainHead, Central Region(312) 345-6822

[email protected]

Central

Julia Chu(212) 538-5734

[email protected]

Alvina Lo(212) [email protected]

Sam PetrucciHead, Eastern Region(212) [email protected]

East

Nicolas Tavormina(305) 347-7594 [email protected]

Latin America

Perspectives July 2012 - Credit Suisse Wpg

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