BIZ and ESTATE


BUSINESS

Choosing the Right Business Entity
Choosing the form of entity under which a business will operate is one of the first, and often the most important, decisions a business owner will make. Although the legal details underlying each entity type are inherently complex, exploring three major variables may help you determine which option is right for you: business control, owner liability, and tax implications.

The major business alternatives today include:
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Sole Proprietorship
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Partnership
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C-Corporation
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S-corporation
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Limited Liability Company

Sole Proprietorship. As its name implies, a sole proprietorship has a single owner, and is perhaps the most simplistic of all entity types. The main benefits of the sole proprietorship include its ease of implementation and lack of regulatory requirements. In addition, the sole proprietorship allows complete business control to a single business owner (proprietor). Under a sole proprietorship, the business owner is required to file a Schedule C (profit or loss from a business or profession) with their personal income tax filing. The proprietor personally assumes all liability and business risk, which can often be "transferred" through the purchase of liability insurance.

Partnership. The main difference between the sole proprietorship and the partnership is the number of business owners. Although quite easy to establish, it is a good idea to begin a partnership with a formal arrangement known as the partnership agreement. The partnership agreement sets forth the intent of the business owners in the event of a wide variety of business events such as the sale of the entire business, the sale of a single individual's holdings or the disposition of ownership in the event of the death of a partner.

Like the sole proprietorship, the partnership represents a "flow-through entity" where both cash flows and tax liabilities flow through to the business owners. The partnership provides its owners minimal protection from business risk.

C-corporation. Though often costly and time-consuming to establish and maintain, the C-corporation provides the greatest amount of liability and business risk protection to the business owner(s). Strict governmental regulations outline company structure, reporting, and disclosure requirements.

Corporations have unlimited lives with ownership rights passing to designated heirs upon the death of an owner. The corporate entity also has a great deal of income tax flexibility and can offer the broadest array of tax deductible benefits, but may also trigger "double taxation" of some corporate profits as they are taxed at the corporate level as profits and again, potentially, at the individual level as taxable dividends are paid to shareholders.

S-Corporation. The "S Corp" functions as something of a hybrid, assuming many of the best features of several other entity types. The S Corporation is a legal entity that offers owners the benefits of greatly limited liability, while allowing company profits or losses to flow directly through to the business owners for income tax purposes, thus avoiding potential double taxation. The legal requirements and costs associated with starting an S Corporation are modest, as are the regulatory requirements. There are limitations on the number of owners within an S Corporation, and a C Corporation may not be an owner.

Limited Liability Company. Like the S Corporation, the Limited Liability Company (LLC) combines many of the benefits of other entity types. In contrast to the proprietorship and partnership, the LLC provides its owners (or members) with limited liability for the debt and business risk associated with ownership. The LLC also avoids the "double taxation" of the corporation by functioning as a "flow-through entity" for income tax purposes.

Selecting a business entity can be a complex decision with long-term effects on the ownership, owner liability and taxation of a business. Once you have prepared a business plan and evaluated your business ownership goals, consider seeking the advice of trusted financial professionals and advisors in finalizing your final selection of business entity.

Protecting Against the Loss of Key Employee
The vast majority of small-business owners accept the wisdom of insuring the firm against the loss of its property values. We take care to insure the physical assets against fire, tornados and other disasters. Yet, protection from the loss a key executive may be far more important.

First, the probability of losing a key employee is far greater than a loss due to fire. It has been estimated that the chances of death of a key executive is 14 times greater at age 45, 17 times greater at age 50, and 23 times greater at age 55 than a loss caused by fire. Further, about one out of every three individuals dies in the working period of life with a consequent loss to his or her business.

Second, the loss due to a fire is temporary. Plants and factories can be rebuilt. Inventory can be replaced. The new building is likely to be more useful and valuable than the old one. On the other hand, a new hire may need several months or even years to become as productive as her or his predecessor. In fact, the deceased employee may prove impossible to replace.

Who Is Key?
Every corporation has at least one key executive or an employee who makes a substantial contribution to the operation, profitability and success of the business. Any individual who has critical intellectual information, sales relationships, bank relationships, product knowledge, and/or industry contacts that may adversely affect profits in the event of their absence, may be considered key.

The Role of Key Person Life Insurance
Although life insurance cannot ever fully replace the value of a key employee, it can indemnify the business for the financial setbacks that can occur. Life insurance can provide the business with needed funds to keep the business running, to assure creditors that their loans will be repaid, to assure customers that business will continue operations, to cover the special expenses of finding, hiring, and training a replacement.

How This Strategy Works
There is no particular form of agreement or special contract needed by the business to obtain key employee insurance on an executive or owner. However, the board of directors should authorize the maintenance and payment of the policy.

The applicant is the company. The application is signed by an officer of the business other than the insured party. Generally, the premiums will be paid by the business on an after-tax basis and are not deductible as a business expense. The business will be designated as the beneficiary and the insurance proceeds received upon the death of a key executive are not subject to federal income tax.

Replacing a key person may be difficult, but the proceeds from the life insurance policy can help ensure a smooth transition following their passing. With key person life insurance, that's one more risk that small-business owners can worry a little less about.

Qualified Retirement Plans for Small Businesses
For the small-business owner, attracting and retaining valuable employees can be a daunting challenge. One way to make working for your business more attractive to current and potential employees alike is to implement a qualified retirement plan for you and your employees. Besides greater appeal to your workers, qualified plans can also provide you with numerous tax advantages, including:

- Contributions for all participants are 100% tax-deductible to the business up to certain limits.
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Annual contributions by the business are not considered taxable income to the plan participants.
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Capital gains and interest earned are deferred from taxation during the accumulation years.
- Income taxes are payable upon withdrawal.
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At retirement, favorable tax treatments may apply such as spreading payments over the participant's lifetime and special averaging formulas.

Non-Tax Advantages
In addition to the obvious tax and employee hiring/retention advantages, there are many other, equally important, reasons to implement a qualified plan. For example, plan assets are creditor-proof. The assets of the plan are not subject to malpractice lawsuits or bankruptcy rulings.

These and other advantages combine to help improve morale as the participants realize that their company provides the mechanism to help secure their retirement.

Types of Plans
The two most common types of qualified retirement plans are pension and profit-sharing plans. A business can also sponsor an IRA or SEP (simplified employee pension plan).

Pension Plans. There are three major types of pension plans -- defined benefit, money purchase, and target benefit.
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A defined benefit plan is one where the retirement benefit is determined by a plan formula - usually based on years of service.
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A money purchase pension plan is one where the plan formula specifies the percentage of each participant's compensation that will be contributed each year.
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A target benefit plan is a hybrid. It starts out as a defined benefit plan, which determines the benefit. Once the benefit is calculated, the plan converts to a defined contribution or money purchase plan.

Profit-Sharing Plans. The most popular type of profit-sharing plans is 401(k) plans. Elective deferrals to these plans are limited to $15,000 for the year 2006 ($20,000 for people 50 years of age and older, including catch-up provisions). Annual contributions to a profit-sharing plan are generally not required; instead, they can be discretionary each year. 

Implementing a Cafeteria Plan in Your Business
Internal Revenue Code 125 allows an employer to implement an employee benefit plan, which allows employees to select the benefit programs they prefer.

The plan offers two or more options and the employee chooses the option most appropriate for him or her from the "menu" of benefits available. It's sort of like ordering lunch from the local deli - which is why the plan is referred to as a "cafeteria plan"!

Cafeteria plans, along with 401(k)s, are among the most popular employee benefit plans of the past decade. The tax benefits to the employer and employees far exceed the minimal required government reporting.

Cafeteria Plan Benefit Options
In general, the IRS allows the following benefits to be present in a Section 125 plan:
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Group-term life insurance (up to $50,000; amounts above that level of death benefit may be subject to Social Security and Medicare taxation)
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Accident and health plans
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Long- and short-term disability benefits
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Flexible spending accounts to save for health, medical, and childcare expenses
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CODA [401(k) plans]
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Dependent group life, accident, and health insurance coverages
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Vacation

Employee Tax Aspects
The plan essentially allows expenses that normally would be paid by the employee on an after-tax basis to be paid via salary reductions on a pretax basis. This allocated income will not be subjected to FICA or income taxes. The result is that taxable dollars have been converted to nontaxable dollars - thereby increasing the employee's take-home pay.

Employer Tax Aspects
Generally, employer contributions to a plan are income tax deductible. In addition, contributions on behalf of the employees, if such contributions are not included in the employee's income, are not subject to FICA (Social Security) or FUTA (Federal Unemployment Tax Act). This can result in significant savings to the company's bottom line.

The employer must file an annual information return (IRS Form 5500) stating plan participation, cost and business type.

Use-It-or-Lose-It
An important point for the employee to remember is that there can be no claim of any unused benefits or contributions from one plan year to the next. This is known as the "use it or lose it" rule.

Many employees steer clear of these plans because of this rule. You have to decide up front how much to put in the plan and if you don't spend it all within a year, you forfeit the leftover amount.

Sounds risky - at least until you consider that the tax breaks are so powerful that even if you wind up forfeiting 20% of what you put into a plan, you'll still come out ahead.

For example, let's say you set aside $5,000 for medical expenses in 2007 and wind up spending just $4,000. At face value, you've lost $1,000. But consider: If you're in the 25% federal tax bracket and face a 5% state income tax as well as the 7.65% Social Security and Medicare tax, the $5,000 you put in the plan will save you more than $1,800 in taxes, leaving you $800 ahead. Put another way, you'd have to earn almost $6,300 to have $4,000 left over to pay those bills. Even if you forfeit $1,000, you still come out ahead. That's why it's wise to be aggressive in using flexible spending accounts.

Deferred Compensation
In addition to providing qualified plans to employees, many business owners implement nonqualified alternatives in order to supplement retirement benefits. These selective benefit plans are generally offered to key employees and owners. One popular nonqualified benefit is deferred compensation.

Basically, nonqualified deferred compensation refers to an arrangement between an employer and an employee in which compensation for current services is postponed until some future date or the occurrence of a future event. The effect is to postpone taxation for the employee until compensation is received - usually at retirement or disability.

Types of Deferred Compensation
Deferred compensation plans can be categorized several different ways. Plans can be:
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Funded or unfunded
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Forfeitable or nonforfeitable
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Defined benefit or money purchase
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They can also provide one or a combination of death benefits, disability benefits and retirement benefits.

Funded plans generally involve a trust fund or escrow account where the employer transfers money at a later date for its "promise to pay" deferred compensation. These are not very popular as the participant may be deemed to have "constructive receipt" of such funds and therefore inherits a current tax liability when funded.

IRS Revenue Ruling 60-31, 1960-2 CB 174, states that an employee's right to receive deferred compensation, backed during the deferral period solely by an employer's "naked promise" to pay, produces no currently taxable income for the employee. A deferred compensation plan is not regarded as funded merely because the corporation purchased and owns a life insurance policy or annuity contract to make certain that funds will be available when needed.

Rabbi Trusts
One of the problems with a typical unfunded deferred compensation plan is that the employee has no guarantee that future payments will be made. If the employer defaults in making promised payments, becomes insolvent, or files bankruptcy, the employee simply becomes a general creditor waiting in line with all the other creditors hoping to recoup some of their receivables.

The rabbi trust protects an executive from an employer's future unwillingness or inability to pay promised benefits while retaining the benefits of deferred income taxation. The IRS has stated in a series of private letter rulings that an irrevocable trust or an escrow account can be established to fund a deferred compensation agreement as long as the assets placed into the rabbi trust remain subject to the claims of general creditors. If this condition is met, the employee will not be deemed to have "constructive receipt" of the assets, and, therefore, will not have received a current economic benefit. Hence, the employee will not be required to pay taxes until the payments are made at a future date.

The rabbi trust gives the employee security in knowing that the employer is, in fact, setting aside money to fulfill its obligation under a deferred compensation agreement.

Choosing the Right Continuation Plan for Your Business
The death of a major shareholder in a closely held corporation can seriously interrupt the continuity and profitability of the business. Surviving shareholders must struggle with how to continue the company as a profitable business with the loss of a key player. Heirs must concern themselves with how to replace the income that the shareholder had earned and how to extract their inherited portion of the company value.

To reduce potential areas of conflict and realize a smooth transition, company owners should enter into an agreement while the parties are still living. This is called a buy-sell agreement. Stock purchase plans are generally arrangements through which shareholders agree to sell their stock interests in the event of specific triggering events such as death, disability, or retirement.

Plan Types
Stock purchase plans are generally classified into three categories: stock redemption plans, cross purchase plans, and hybrid plans.

Under a stock redemption plan, the corporation agrees to purchase all or part of the stock interest of a shareholder. There are three approaches to stock redemptions - full redemptions, partial redemptions, and Section 303 redemptions.

In a cross purchase agreement, the remaining shareholders buy the stock interest of a single shareholder. They can either distribute the shares proportionally to what they had before the triggering event occurred or non-proportionally according to what is outlined in the buy-sell agreement.

A hybrid plan, or wait-and-see approach, gives the corporation the first chance to buy. If the corporation does not buy in within a specified time frame (for example, 90 days), the other stockholders have the option to buy. If that option is not exercised, then the corporation must buy the shares.

Many factors need to be considered when determining the best type of stock purchase plan to implement, cost factors, psychological factors, ease of administration, tax implications, and transfer for value rules to name a few. You should seek the advice of financial and legal counsel to help implement your plan.

ESTATE

Is It Time to Review Your Estate Plan?

Estate planning is an ongoing process. You must not only develop and implement a plan that reflects your current financial and family situation; you must also constantly review your current plan to ensure it fits any changes in your circumstances.

Of course, with the extensive changes under The Economic Growth and Tax Relief Reconciliation Act of 2001 and the probability that more changes will occur in this decade, reviewing your estate plan regularly is now more critical than ever. You'll especially want to update it after any of the events listed in the Planning Tip.

Where Do You Go From Here?
Remember, estate planning is about much more than reducing your estate taxes; it's about ensuring your family is provided for, your business can continue, and your charitable goals are achieved. So even if the estate tax is permanently repealed, you will want to have an up-to-date plan in place.

To this end, use the accompanying estate planning checklist to identify areas where you need more information or assistance. Or jot down a few notes about things you want to look at more closely and discuss with a professional advisor. It may be easy for you to put off developing a detailed estate plan - or updating it in light of changes in tax law or your situation. But if you delay, much of your estate could go to Uncle Sam - and this could be difficult for your family.

So please call me with any questions you may have about the strategies presented here or how they can help you minimize your estate tax liability. We welcome the opportunity to discuss your situation and show how we can help you create and help implement an estate plan that preserves for your heirs what it took you a lifetime to build.

 Fundamental Questions about Estate Planning

Many people assume estate planning is all about reducing taxes. But it's also about making sure your assets are distributed according to your wishes both now and after you're gone. Here are three questions to consider before you begin your estate planning.

Who Should Inherit Your Assets?
If you are married, you must consider marital rights before deciding who should inherit your assets. States have different laws designed to protect surviving spouses. If you die without a will or living trust, state law dictates how much passes to your spouse. Even with a will or living trust, if you provide less for your spouse than state law deems appropriate, the law will allow the survivor to receive the greater amount.

Once you've considered your spouse's rights, ask yourself these questions:

  • Should your children share equally in your estate?
  • Do you wish to include grandchildren or others as beneficiaries?
  • Would you like to leave any assets to charity?

Which Assets Should Your Survivors Inherit?
You may want to consider special questions when transferring certain types of assets. For example:

  • If you own a business, should the stock pass only to your children who are active in the business?
  • Should you compensate the others with assets of comparable value?
  • If you own rental properties, should all beneficiaries inherit them?
  • Do they all have the ability to manage property?
  • What are each beneficiary's cash needs?

When and How Should They Inherit the Assets?
To determine when and how your beneficiaries should inherit your assets, you need to focus on three factors:

  • The potential age and maturity of the beneficiaries,
  • The size of your estate versus your and your spouse's need for income during your lifetimes, and
  • The tax implications of your estate plan.

Outright bequests offer simplicity, flexibility and some tax advantages, but you have no control over what the recipient does with the assets once they are transferred. Trusts can be useful when the beneficiaries are young or immature, when your estate is large, and for tax planning reasons. They also can provide the professional asset management capabilities an individual beneficiary lacks. 

Strategies for Special Situations

Standard estate planning strategies don't fit every situation. Single people, unmarried couples, noncitizen spouses, individuals planning a second marriage, and grandparents are among those who might benefit from less common techniques. In this section, we look at several special situations and estate planning ideas that may apply to them.

Singles - the potential repeal of the estate tax is especially helpful to this group because it eliminates the disadvantage of not having the unlimited marital deduction, which allows a spouse to leave assets to a surviving spouse's estate tax free. But a will or a living trust can ensure that your loved ones receive your legacy in the manner you desire. In addition, with the use of trusts, you can provide financial management assistance to your heirs who are not prepared for this responsibility.

Second Marriages - estate planning for the second marriage can be complicated, especially when children from a prior marriage are involved. Finding the right planning technique for your situation can not only ease family tensions but also help you pass more assets to the children at a lower tax cost.

A Qualified Terminal Interest Property (QTIP) marital trust can maximize estate tax deferral while benefiting the surviving spouse for his or her lifetime and the children after the spouse's death. Combining a QTIP with life insurance benefiting the children or creatively using joint gifts or GST tax exemptions can further leverage your gifting ability.

A prenuptial agreement can also help you achieve your estate planning goals. But any of these strategies must be tailored to your particular situation, and the help of qualified financial, tax and legal advisors is essential.

Unmarried Couples - because unmarried couples are not automatically granted rights by law, they need to create a legal relationship with a domestic partnership agreement. Such a contract can solidify the couple's handling of estate planning issues. In addition, without the benefit of the marital deduction, unmarried couples face a potentially overwhelming estate tax burden as long as the estate tax is in effect.

There are solutions, however. One partner can reduce his or her estate and ultimate tax burden through a traditional annual gifting program or by creating an irrevocable life insurance trust or a charitable remainder trust benefiting the other partner. Again, these strategies are complex and require the advice of financial, tax and legal professionals.

Noncitizen Spouses - the marital deduction differs for a surviving spouse who is a non-U.S. citizen. The government is concerned that on your death, your spouse could take the marital bequest tax-free and then leave U.S. jurisdiction without the property ever being taxed.

Thus, the marital deduction is allowed only if the assets are transferred to a qualified domestic trust (QDOT) that meets special requirements. The impact of the marital deduction is dramatically different because any principal distributions from a QDOT to the noncitizen spouse and assets remaining in the QDOT at his or her death will be taxed as if they were in the citizen spouse's estate. Also note that the gift tax marital deduction is limited to a set amount annually.

Estate Settlement Issues

You also should be aware of the other procedures involved in estate settlement. Here is a quick review of some of them. Your attorney, as well as the organizations mentioned, can provide more details.

Transferring Property
When thinking about transferring your property, what probably first comes to mind are large assets, such as stock, real estate and business interests. But you also need to consider more basic assets, including:

  • Safe deposit box contents. In most states, the bank seals the box as soon as it learns of the death and opens it only in the presence of the estate's personal representative.
  • Savings bonds. The surviving spouse can immediately cash in jointly owned E bonds. To cash in H and E bonds registered in the deceased's name but payable on death to the surviving spouse, they must be sent to the Federal Reserve.

Receiving Benefits
The surviving spouse or other beneficiaries may be eligible for any of the following:

  • Social Security benefits. For the surviving spouse to qualify, the deceased must have been age 60 or older or their children must be under age 16. Disabled spouses can usually collect at an earlier age. Surviving children can also get benefits.
  • Employee benefits. The deceased may have insurance, back pay, unused vacation pay, and pension funds to which the surviving spouse or beneficiaries are entitled. The employer will have the specifics.
  • Insurance they may not know about. Many organizations provide life insurance as part of the membership fee. They should be able to provide information.

Keep It All in the Family with FLPs

The Family Limited Partnership, or FLP - pronounced "flip" - is designed to reduce the value of your estate for estate tax purposes while allowing you to maintain full control of the investments and assets inside the partnership.

FLPs are established much like traditional limited partnerships. There are two parties involved: the general partners, who control the trust, and limited partners who have a share in the profits (but no control). The general partners (often, you and/or a spouse) design the partnership to give limited partnership shares to family members. General partners control the operations of the FLP and make day-to-day investment decisions. They can also receive a percentage of the FLP's income in the form of a management fee.

Limited partners (your heirs) have an ownership interest in the FLP, but they have very limited control. They share in the income generated by the FLP, depending on how many shares they own. When the FLP is dissolved, a proportionate amount of FLP property will pass to each limited partner.

Setting Up a FLP
FLPs have come under increased IRS scrutiny in recent years, so you should work with a reputable estate planning attorney. With the attorney's assistance, you can place your assets within the FLP using your estate tax credit. For instance, a husband and wife can each transfer up to $2,000,000 ($4 million total) into the FLP and allocate those assets to the limited partnership side. They can then place a smaller amount (e.g. $12,000) in the FLP for the general partnership side. There are usually no taxes incurred when funding a FLP with your assets.

In the beginning, you and your spouse own both General Partner and Limited Partner shares. Over time, you gift to your heirs Limited Partner shares using your annual $12,000 gift exclusion. Don't worry about giving away too much of the shares. Based on current tax law, the General Partners may own as little as 1% of the FLP's assets and still retain control. That means you can still buy and sell assets, dispose of property, and declare any distributions of FLP shares.

Leverage Your Estate Tax Credit
FLPs allow you to pass on more than the maximum $2 million (in 2006; $4 million per couple) Unified Estate Tax Credit. A gift of $2 million in limited partnership assets often may appraised at a substantially lower dollar amount. That's because there is no "market" for LP shares - they lack control and cannot be sold to others. This lower appraisal is called "discounting" the value of LP shares. Avoid discounting the shares too aggressively, however - the IRS could take exception and invalidate your FLP.

Protection Against Creditors
Because of their lack of control, LP shares are most undesirable to creditors. Creditors will find it difficult to seize limited partner shares, since they are not publicly traded.

Creditors also don't want to pay tax on income they don't receive. If the partnership has earned income, but the general partner does not declare a distribution, each general and limited partner is required to report a proportionate share of the earned income on his or her personal tax return, without actually receiving any dollars with which to pay the tax.

Two More Advantages of FLPs
FLPs are considered an "intangible asset" - most likely, only the state of your domicile will be able to impose any inheritance tax on Partnership units. This is ideal for real estate investors owners who own property in several states.

FLPs can provide additional retirement income - as mentioned previously, FLPs can provide general partners with management fees. This fee reflects the work you do as the general partner to maintain the FLP as a working business, and is considered earned income.

Family Limited Partnerships involve significant costs and risks involved, and are not ideal for highly appreciated assets. FLPs must also be drafted by an experienced estate planning attorney, and have a tangible business intent. For this reason, we strongly urge you to consult with a professional with specific expertise in this area.

Without a Will, There's No Way

A will is a legal document that transfers what you own to your beneficiaries upon your death. It also names an executor to carry out the terms of your will and a guardian for your minor children, if you have any.

Your signature and those of two witnesses make your will authentic. Witnesses don't have to know what the will says, but they must watch you sign it and you must watch them witness it.

Hand-written wills -- called holographs -- are legal in about half the states, but most wills are typed and follow a standard format.

Who Needs a Will?
The short answer is everyone! However, it's imperative to make a will as soon as you have any real assets, or get married, and certainly by the time you have children.

What If You Don't Have a Will?
Without a will, you die intestate. The law of your state then determines what happens to your estate and your minor children. This process, called administration, is governed by the probate court and is notoriously slow, often expensive, and subject to some surprising state laws. It's estimated than more than two-thirds of Americans die intestate. Do you really want a court deciding vital family matters such as how to divide your estate and custody of your children?

What Should Your Will Include?
Your will should contain several key points in order to be valid. The following list is a start; check with a local estate attorney for a more comprehensive list:

  • Your name and address.
  • A statement that you intend the document to serve as your will.
  • The names of the people and organizations -- your beneficiaries -- who will share in your estate.
  • The amounts of your estate to go to each beneficiary (usually in percentages rather than dollar amounts.)
  • An executor to oversee the disposition of your estate and trustee(s) to manage any trust(s) you establish.
  • Alternates to provide both executor responsibilities and trustee(s).
  • A guardian to take responsibility for your minor children and possibly a trustee to manage the children's assets in cooperation with the guardian.
  • Which assets should be used to pay estate taxes, probate fees and final expenses.

What Is A Living Will?
A living will expresses your wishes about being kept alive if you're terminally ill or seriously injured.

What Is A Living Will?

In the aftermath of the tragic case involving Terri Schiavo, interest in living wills has increased markedly. A living will expresses your wishes about being kept alive if you're terminally ill or seriously injured.

Other famous Americans have used living wills to retain control over their final medical care through use of a living will and a health care power of attorney. During the final weeks of his life, former President Richard Nixon refused "heroic measures" and received only palliative (comfort-easing) care at his home. Similarly, former First Lady Jacqueline Kennedy Onassis refused life-prolonging medical intervention before her passing.

Perhaps you've reflected on your own wishes if you were to face a similar situation. Although no one likes to imagine the possibility of being in such a helpless state, the statistical possibility of such an event remains significant. This is why it's wise to ensure that your wishes will be respected if you become incapacitated.

Just as a will becomes the governing entity for your estate after you die, a living will can make your wishes clear and legally binding in the event of a devastating illness or injury. A living will is often referred to as a health care power of attorney. In it you state how you should be treated in the event of a terminal disease, severe illness, or tragic accident. By giving such directions when you are healthy, your relatives won't have to make difficult decisions on your behalf, and you'll receive the type of care you desire.

Issues you might want to consider addressing include:

  • Organ donation
  • Religious and faith issues
  • Hospital, nursing home, and hospice arrangements
  • Funeral arrangements

To carry out your living will, you'll need a health care directive, a written statement that expresses how you wish to be treated in advance of any incapacity. Make sure you give precise, comprehensive directions.

You'll also need a health care proxy, designating a representative to make your health care decisions based on the guidelines you provide in the directive if you are incapacitated or unable to communicate your desires.

Wills: The Cornerstone of Your Estate Plan

If you care about what happens to your money, home, and other property after you die, you need to do some estate planning. There are many tools you can use to achieve your estate planning goals, but a will is probably the most vital. Even if you're young or your estate is modest, you should always have a legally valid and up-to-date will. This is especially important if you have minor children because, in many states, your will is the only legal way you can name a guardian for them. Although a will doesn't have to be drafted by an attorney to be valid, seeking an attorney's help can ensure that your will accomplishes what you intend.

Wills avoid intestacy
Probably the greatest advantage of a will is that it allows you to avoid intestacy. That is, with a will you get to choose who will get your property, rather than leave it up to state law. State intestate succession laws, in effect, provide a will for you if you die without one. This "intestate's will" distributes your property, in general terms, to your closest blood relatives in proportions dictated by law. However, the state's distribution may not be what you would have wanted. Intestacy also has other disadvantages, which include the possibility that your estate will owe more taxes than it would if you had created a valid will.

Wills distribute property according to your wishes
Wills allow you to leave bequests (gifts) to anyone you want. You can leave your property to a surviving spouse, a child, other relatives, friends, a trust, a charity, or anyone you choose. There are some limits, however, on how you can distribute property using a will. For instance, your spouse may have certain rights with respect to your property, regardless of the provisions of your will.

Gifts through your will take the form of specific bequests (e.g., an heirloom, jewelry, furniture, or cash), general bequests (e.g., a percentage of your property), or a residuary bequest of what's left after your other gifts.

Wills allow you to nominate a guardian for your minor children
In many states, a will is your only means of stating who you want to act as legal guardian for your minor children if you die. You can name a personal guardian, who takes personal custody of the children, and a property guardian, who manages the children's assets. This can be the same person or different people. The probate court has final approval, but courts will usually approve your choice of guardian unless there are compelling reasons not to.

Wills allow you to nominate an executor
A will allows you to designate a person as your executor to act as your legal representative after your death. An executor carries out many estate settlement tasks, including locating your will, collecting your assets, paying legitimate creditor claims, paying any taxes owed by your estate, and distributing any remaining assets to your beneficiaries. Like naming a guardian, the probate court has final approval but will usually approve whomever you nominate.

Wills specify how to pay estate taxes and other expenses
The way in which estate taxes and other expenses are divided among your heirs is generally determined by state law unless you direct otherwise in your will. To ensure that the specific bequests you make to your beneficiaries are not reduced by taxes and other expenses, you can provide in your will that these costs be paid from your residuary estate. Or, you can specify which assets should be used or sold to pay these costs.

Wills can create a testamentary trust
You can create a trust in your will, known as a testamentary trust, that comes into being when your will is probated. Your will sets out the terms of the trust, such as who the trustee is, who the beneficiaries are, how the trust is funded, how the distributions should be made, and when the trust terminates. This can be especially important if you have a spouse or minor children who are unable to manage assets or property themselves.

Wills can fund a living trust
A living trust is a trust that you create during your lifetime. If you have a living trust, your will can transfer any assets that were not transferred to the trust while you were alive. This is known as a pourover will because the will "pours over" your estate to your living trust.

Wills can help minimize taxes
Your will gives you the chance to minimize taxes and other costs. For instance, if you draft a will that leaves your entire estate to your U.S. citizen spouse, none of your property will be taxable when you die (if your spouse survives you) because it is fully deductible under the unlimited marital deduction. However, if your estate is distributed according to intestacy rules, a portion of the property may be subject to estate taxes if it is distributed to heirs other than your U.S. citizen spouse.

Assets disposed of through a will are subject to probate
Probate is the court-supervised process of administering and proving a will. Probate can be expensive and time consuming, and probate records are available to the public. Several factors can affect the length of probate, including the size and complexity of the estate, challenges to the will or its provisions, creditor claims against the estate, state probate laws, the state court system, and tax issues. Owning property in more than one state can result in multiple probate proceedings. This is known as ancillary probate. Generally, real estate is probated in the state in which it is located, and personal property is probated in the state in which you are domiciled (i.e., reside) at the time of your death.

Will provisions can be challenged in court
Although it doesn't happen often, the validity of your will can be challenged, usually by an unhappy beneficiary or a disinherited heir. Some common claims include:

· You lacked testamentary capacity when you signed the will
· You were unduly influenced by another individual when you drew up the will
· The will was forged or was otherwise improperly executed
· The will was revoked

Updated 12/7/2011

Living Trusts: A Tool for the Living

One of the most popular estate planning instruments today is the revocable living trust.

Trusts are used to maintain control and disposition of assets after death, and some can be used to minimize the estate tax impact of property transfers.

The difference between a revocable and irrevocable trust is whether the trust creator can change or terminate the trust. In the revocable trust, the creator can change the terms and conditions of the trust, or even eliminate the trust altogether. An irrevocable trust, on the other hand, cannot be altered once established.

When used and implemented correctly, an irrevocable living trust offers many benefits.

Using a Living Trust for Financial Protection
A revocable living trust provides financial protection in the event you are no longer able to manage your financial affairs yourself. You can be trustee while you are healthy, but if you have a stroke or become otherwise incapacitated, your successor trustee would manage your assets in the trust.

Using a Living Trust for Privacy
Another benefit of revocable living trusts is continued privacy because the instrument will bypass probate. The trust can function like a will, dictating at what age children are to receive trust assets and the percentage shares of the distribution. The trust can be linked to a pour-over will, a short document that names the executor and that determines how taxes, creditors, and final expenses will be paid. The pour-over will directs the executor to gather all assets not included in the trust and pour them over into the trust. Once that happens, the trustee will follow the directions included in the trust. The pour-over will must be filed with the probate court, but because it doesn't say much, it doesn't reveal much.

Using a Living Trust to Reduce Probate
Regarding probate, living trusts offer another useful feature -- if you own property in a state other than your state of residence, when you die, that property must go through what's known as an ancillary probate. Many people think it's worth setting up the trust just to avoid the out-of-state probate hassle, which necessitates hiring a lawyer in that other state.

Using a Living Trust as a Management Tool
The living trust can be used as a tool to manage your property, and can be especially helpful if you become incapacitated because the successor trustee can manage your property, rather than a court-appointed trustee, which takes time. The benefit of having an immediate successor can be especially important if you own a business or other assets that need to be managed seamlessly.

Other Benefits of a Living Trust
Finally, you can include provisions in the trust that preserve the use of your estate and use the gift tax exclusion to set up other trusts that will help reduce estate taxes.

Disadvantages of a Living Trust
There are disadvantages to using a revocable living trust as well. You must re-title assets into the trust name, which entails a lot of paperwork. And although creditors only have a limited time after your death to make claims against your estate while it's being probated, there is no time limit within which creditors may go after assets in a living trust.

Conclusions
If your goal in using a revocable living trust is only to avoid probate, there are easier ways to accomplish this task. However, the revocable living trust can provide a wide variety of estate planning benefits that are difficult to achieve with any other estate-planning tool.

Trusts can be extremely complex and generally require the aid of an experienced estate-planning attorney. Please contact us for more information on charitable trusts.

Selecting an Executor or Trustee

Whether you choose a will or a living trust, you also need to select someone to administer the disposition of your estate - an executor or personal representative and, if you have a living trust, a trustee. An individual (such as a family member, a friend or a professional advisor) or an institution (such as a bank or trust company) can serve in these capacities. Many people name an individual and an institution to leverage their collective expertise.

What does the executor or personal representative do? He or she serves after your death and has several major responsibilities, including:

  • Administering your estate and distributing the assets to your beneficiaries.
  • Making certain tax decisions.
  • Paying any estate debts or expenses.
  • Ensuring all life insurance and retirement plan benefits are received.
  • Filing the necessary tax returns and paying the appropriate federal and state taxes.

Whatever your choice, make sure the executor, personal representative or trustee is willing to serve, and consider paying a reasonable fee for the services. The job isn't easy, and not everyone will want or accept the responsibility. Designate an alternate in case your first choice is unable or unwilling to perform. Naming a spouse, child, or other relative to act as executor is common, and he or she certainly can hire any professional assistance that might be needed.

Finally, make sure the executor, personal representative, or trustee doesn't have a conflict of interest. For example, think twice about choosing an individual who owns part of your business, a second spouse or children from a prior marriage. A co-owner's personal goals regarding the business may differ from those of your family, and the desires of a stepparent and stepchildren may conflict.

Selecting a Guardian for Your Children
If you have minor children, perhaps the most important element of your estate plan doesn't involve your assets. Rather, it involves your children's guardianship. Of course, the well being of your children is your priority, but there are some financial issues to consider:

  • Will the guardian be capable of managing your children's assets?
  • Will the guardian be financially strong? If not, consider compensation.
  • Will the guardian's home accommodate your children?
  • How will the guardian determine your children's living costs?

If you prefer, you can name separate guardians for your child and his or her assets. Taking the time to name a guardian or guardians now ensures your children will be cared for as you wish if you die while they are still minors.

The Role of Life Insurance in an Estate Plan

Life insurance can play an important role in your estate plan. It is often necessary to support your family after your death or to provide liquidity. Not only do you need to determine the type and amount of coverage you need, but also who should own insurance on your life to best meet your estate planning goals.

Avoid Liquidity Problems
Estates are often cash poor, and your estate may be composed primarily of illiquid assets such as closely held business interests, real estate or collectibles. If your heirs need cash to pay estate taxes or to support themselves, these assets can be hard to sell. For that matter, you may not want these assets sold. Insurance can be the best solution for liquidity problems.

Even if your estate is of substantial value, you may want to purchase insurance simply to avoid the unnecessary sale of assets to pay expenses or taxes. Sometimes second-to-die insurance makes the most sense. Of course, your situation is unique, so please get professional advice before purchasing life insurance.

Choose the Best Owner
If you own life insurance policies at your death and you die while the estate tax is in effect, the proceeds will be included in your taxable estate. Ownership is usually determined by several factors, including who has the right to name the beneficiaries of the proceeds. The way around this problem? Don't own the policies when you die. But don't automatically rule out your ownership either.

Determining who should own insurance on your life is a complex task because there are many possible owners: you or your spouse, your children, your business, an irrevocable life insurance trust (ILIT), a family limited partnership (FLP) or limited liability company (LLC). Generally, to reap maximum tax benefits, you must sacrifice some control and flexibility as well as some ease and cost of administration.

To choose the best owner, you must consider why you want the insurance: to replace income, to provide liquidity, or to transfer wealth to your heirs. You must also determine the importance to you of tax implications, control, flexibility, and ease and cost of administration. Let's take a closer look at each type of owner:

You or your spouse. Ownership by you or your spouse generally works best when your combined assets, including insurance, do not place either of your estates into a taxable situation. There are several non-tax benefits to your ownership, primarily relating to flexibility and control. The biggest drawback to ownership by you or your spouse is that on the death of the surviving spouse (assuming the proceeds were initially paid to the spouse), the insurance proceeds could be subject to federal estate taxes, depending on when the surviving spouse dies.

Your children. Ownership by your children works best when your primary goal is to pass wealth to them. On the plus side, proceeds are not subject to estate tax on your or your spouse's death, and your children receive all of the proceeds tax free. There also are disadvantages. The policy proceeds are paid to your children outright. This may not be in accordance with your general estate plan objectives and may be especially problematic if a child is not financially responsible or has creditor problems.

Your business. Company ownership or sponsorship of insurance on your life can work well when you have cash flow concerns related to paying premiums. Company sponsorship can allow premiums to be paid in part or in whole by the company under a split-dollar arrangement. But if you are the controlling shareholder of the company and the proceeds are payable to a beneficiary other than the company, the proceeds could be included in your estate for estate tax purposes.

An ILIT. A properly structured ILIT could save you estate taxes on any insurance proceeds. Thus, a $2 million life insurance policy owned by an ILIT could reduce your estate taxes by hundreds of thousands of dollars in 2006. How does this work? The trust owns the policies and pays the premiums. When you die, the proceeds pass into the trust and are not included in your estate. The trust can be structured to provide benefits to your surviving spouse and/or other beneficiaries. ILITs have some inherent disadvantages as well, foremost among them that you lose control over the insurance policy after the ILIT has been set up.

Planning Tip: CONSIDER SECOND-TO-DIE LIFE INSURANCE
Second-to-die life insurance can be a useful tool for providing liquidity to pay estate taxes. This type of policy pays off when the surviving spouse dies. Because a properly structured estate plan can defer all estate taxes on the first spouse's death, some families find they don't need any life insurance then. But significant estate taxes may be due on the second spouse's death, and a second-to-die policy can be the perfect vehicle for offsetting the taxes. It also has other advantages over insurance on a single life. First, premiums and estate administrative costs are lower. Second, uninsurable parties can be covered. But a second-to-die policy might not fit in your current irrevocable life insurance trust (ILIT), which is probably designed for a single life policy. Make sure the proceeds are not taxed in either your estate or your spouse's by setting up a new ILIT as policy owner and beneficiary. 

Asset Protection in Estate Planning

You're beginning to accumulate substantial wealth, but you worry about protecting it from future potential creditors. Whether your concern is for your personal assets or your business, various tools exist to keep your property safe from tax collectors, accident victims, health-care providers, credit card issuers, business creditors, and creditors of others.

To insulate your property from such claims, you'll have to evaluate each tool in terms of your own situation. You may decide that insurance and a Declaration of Homestead may be sufficient protection for your home because your exposure to a claim is low. For high exposure, you may want to create a business entity or an offshore trust to shield your assets. Remember, no asset protection tool is guaranteed to work, and you may have to adjust your asset protection strategies as your situation or the laws change.

Liability insurance is your first and best line of defense
Liability insurance is at the top of any plan for asset protection. You should consider purchasing or increasing umbrella coverage on your homeowners policy. For business-related liability, purchase or increase your liability coverage under your business insurance policy. Generally, the cost of the premiums for this type of coverage is minimal compared to what you might be required to pay under a court judgment should you ever be sued.

A Declaration of Homestead protects the family residence
Your primary residence may be your most significant asset. State law determines the creditor and judgment protection afforded a residence by way of a Declaration of Homestead, which varies greatly from state to state. For example, a state may provide a complete exemption for a residence (i.e., its entire value), a limited exemption (e.g., up to $100,000), or an exemption under certain circumstances (e.g., a judgment for medical bills). A Declaration of Homestead is easy to file. You pay a small fee, fill out a simple form, and file it at the registry where your deed is recorded.

Dividing assets between spouses can limit exposure to potential liability
Perhaps you work in an occupation or business that exposes you to greater potential liability than your spouse's job does. If so, it may be a good idea to divide assets between you so that you keep only the income and assets from your job, while your spouse takes sole ownership of your investments and other valuable assets. Generally, your creditors can reach only those assets that are in your name.

Business entities can provide two types of protection--shielding your personal assets from your business creditors and shielding business assets from your personal creditors

Consider using a corporation, limited partnership, or limited liability company (LLC) to operate the business. Such business entities shield the personal assets of the shareholders, limited partners, or LLC members from liabilities that arise from the business. The liability of these owners will be limited to the assets of the business.

Conversely, corporations, limited partnerships, and LLCs provide some protection from the personal creditors of a shareholder, limited partner, or member. In a corporation, a creditor of an individual owner is able to place a lien on, and eventually acquire, the shares of the debtor/shareholder, but would not have any rights greater than the rights conferred by the shares. In limited partnerships or LLCs, under most state laws, a creditor of a partner or member is entitled to obtain only a charging order with respect to the partner or member's interest. The charging order gives the creditor the right to receive any distributions with respect to the interest. In all respects, the creditor is treated as a mere assignee and is not entitled to exercise any voting rights or other rights that the partner or member possessed.

Certain trusts can preserve trust assets from claims
People have used trusts to protect their assets for generations. The key to using a trust as an asset protection tool is that the trust must be irrevocable and become the owner of your property. Once given away, these assets are no longer yours and are not available to satisfy claims against you. To properly establish an asset protection trust, you must not keep any interest in the trust assets or control over the trust.

Trusts can also protect trust assets from potential creditors of the beneficiaries of the trust. The extent to which a beneficiary's creditors can reach trust property depends on how much access the beneficiary has to the trust property. The more access the beneficiary has to the trust property, the more access the beneficiary's creditors will have. Thus, the terms of the trust are critical.

There are many types of asset protection trusts, each having its own benefits and drawbacks. These trusts include:

· Spendthrift trusts
· Discretionary trusts
· Support trusts
· Blend trusts
· Personal trusts
· Self-settled trusts

Since certain claims can pierce domestic protective trusts (e.g., claims by a spouse or child for support and state or federal claims), you can bolster your protection by placing the trust in a foreign jurisdiction. Offshore or foreign trusts are established under, or made subject to, the laws of another country (e.g., the Bahamas, the Cayman Islands, Bermuda, Belize, Jersey, Liechtenstein, and the Cook Islands) that does not generally honor judgments made in the United States.

A word about fraudulent transfers: The court will ignore transfers to an asset protection trust if:

· A creditor's claim arose before you made the transfer
· You made the transfer with the intent to defraud a creditor
· You incurred debts without a reasonable expectation of paying them

Updated 12/7/2011

Determining the Tax

The next step is to understand some estate tax basics. First, you need to get an idea of what your estate is worth and whether you need to worry about estate taxes, both under today's rates and as exemptions increase under the Economic Growth and Tax Relief Reconciliation Act of 2001.

How Much Is Your Estate Worth?
The first step is to add up all of your assets and include cash, stocks and bonds, notes and mortgages, annuities, retirement benefits, your personal residence, other real estate, partnership interests, automobiles, artwork, jewelry, and collectibles. If you are married, also include your spouse's assets. If you own an insurance policy at the time of your death, the proceeds on that policy usually will be includable in your estate. Remember: That's proceeds. Your $1 million term insurance policy that isn't worth much while you're alive is suddenly worth $1 million on your death. If your estate is large enough, a significant share of those proceeds may go to the government as taxes, not to your chosen beneficiaries, though the estate tax impact will decrease gradually under EGTRRA.

How the Estate Tax System Works
Here's a simplified way to compute your estate tax exposure. Take the value of your estate, net of any debts. Also subtract any assets that will pass to charity on your death -- such transfers are deductions for your estate. Then if you are married and your spouse is a U.S. citizen, subtract any assets you will pass to him or her. Those assets qualify for the marital deduction and avoid estate taxes until the surviving spouse dies. The net number represents your taxable estate.

You can pass up to the exemption amount during your life or at death free of gift and estate taxes.

If your taxable estate is equal to or less than the exemption and you haven't already used any of the exemption on lifetime gifts, no federal estate tax will be due when you die. But if your estate exceeds this amount, it will be subject to estate tax.

Updated 6/3/2011

Tips for Reducing Estate Taxes

Here's a look at some of the most important estate planning tools and how you can use them to minimize taxes and maximize your estate's value as the tax rules change over the decade. You'll learn how these estate planning techniques can help you achieve specific financial goals. You will also see why it will be helpful to seek professional financial, tax and legal advice about ways to use these techniques effectively. Please let us know if you have any questions about how they might apply to your situation.

The Marital Deduction
The marital deduction is one of the most powerful estate planning tools available to you. Any assets passing to a surviving spouse pass tax-free at the time the first spouse dies, as long as the surviving spouse is a U.S. citizen. Therefore, if you and your spouse are willing to pass all your assets to the survivor, no federal estate tax will be due on the first spouse's death - even before the estate tax is scheduled to be repealed completely in 2010.

This doesn't solve your estate tax problem, however. First, if the surviving spouse does not remarry, that spouse will not be able to take advantage of the marital deduction when he or she dies. Thus, the assets transferred from the first spouse could be subject to tax in the survivor's estate, depending on when the surviving spouse dies. Second, from a personal perspective, you may not want your spouse to pass all assets to a second spouse even if it would save estate taxes.

How to Preserve Both Exemptions
Since assets in an estate equal to the exemption amount are exempt from estate taxes, a married couple can use their exemptions to avoid tax on up to double the exemption amount. And this amount will gradually increase until it reaches $7 million in 2009 -- the year before the estate tax repeal. An effective way to maximize the advantages of the exemption is to use a credit shelter trust, sometimes referred to as a bypass trust.

Let's look at an example: Mr. and Mrs. Jones have a combined estate of $4 million. At Mr. Jones' death in 2006, all of his assets pass to Mrs. Jones tax-free because of the marital deduction. Mr. Jones' taxable estate is zero. Shortly thereafter, and still in 2006, Mrs. Jones dies, leaving a $4 million estate. The first $2 million is exempt from estate tax (in 2006), but the remaining $2 million is subject to taxation, leaving the Jones' survivors with far less.

The problem? Mr. and Mrs. Jones took advantage of the exemption in only one estate.

Let's look at an alternative: Mr. Jones' will provides that assets equal to the exemption go into a separate trust on his death. This "credit shelter trust" provides income to Mrs. Jones during her lifetime. She also can receive principal payments if she needs them to maintain her lifestyle. Because of the trust language, Mr. Jones may allocate his $1.5 million exemption amount to the trust to protect it from estate taxes. If there were remaining assets (assets over $2 million), they would pass directly to Mrs. Jones.

Because the $2 million trust is not included in Mrs. Jones' estate, her estate drops from $4 million to $2 million. Thus, no tax is due on her estate because it does not exceed the exemption amount. By using the credit shelter trust in Mr. Jones' estate, the Joneses save hundreds of thousands of dollars in federal estate taxes.

The Joneses do give up something for this tax advantage. Mrs. Jones doesn't have unlimited access to the funds in the credit shelter trust because if she did, the trust would be includable in her estate. Still, Mr. Jones can give her all of the trust income and any principal she needs to maintain her lifestyle. However, the outcome would be quite different if both spouses didn't hold enough assets in their own names.

Control Assets with a QTIP Trust
A common estate planning concern is that assets left to a spouse will eventually be distributed in a manner against the original owner's wishes. For instance, you may want stock in your business to pass only to the child active in the business, but your spouse may feel it should be distributed to all the children. Or you may want to ensure that after your spouse's death the assets will go to your children from a prior marriage.

You can avoid such concerns by structuring your estate plan so your assets pass into a qualified terminable interest property (QTIP) trust. The QTIP trust allows you to provide your surviving spouse with income from the trust for the remainder of his or her lifetime. You also can provide your spouse with as little or as much access to the trust's principal as you choose. On your spouse's death, the remaining QTIP trust assets pass as the trust indicates.

Thus, you can provide support for your spouse during his or her lifetime but retain control of the estate after your spouse's death. Because of the marital deduction, no estate taxes are paid on your death. But if your spouse dies while the estate tax is in effect, the entire value of the QTIP trust will be subject to estate tax

Of course, as with all estate planning strategies, these trusts are complex. Consider enlisting the advice of a qualified estate planning professional before proceeding further. 

How the Generation-Skipping Tax Works

Perhaps you're one of the lucky people who are not only financially well off yourself, but whose children are also financially set for life. The down side of this is that they also face the prospect of high taxes on their estates. You may also want to ensure that future generations of your heirs benefit from your prosperity. To reduce taxes and maximize your gifting abilities, consider skipping a generation with some of your bequests and gifts.

But your use of this strategy is limited. The law assesses a generation-skipping transfer (GST) tax equal to the top estate tax rate on transfers to a "skip person," over and above the gift or estate tax, though this tax is being repealed along with the estate tax. A skip person is anyone more than one generation below you, such as a grandchild or an unrelated person more than 37-1/2 years younger than you are.

Fortunately, there is a GST tax exemption. Beginning in 2004, this exemption was equal to the estate tax exemption for that calendar year. Each spouse has this exemption, so a married couple can use double the exemption. If you exceed the limit, an extra tax equal to the top estate tax rate is applied to the transfer -- over and above the normal gift or estate tax.

Outright gifts to skip persons that qualify for the annual exclusion are also exempt from GST tax. A gift or bequest to a grandchild whose parent has died before the transfer is not treated as a GST.

Taking advantage of the GST tax exemption can keep more of your assets in the family. By skipping your children, the family may save substantial estate taxes on assets up to double the exemption amount (if you are married), plus the future income and appreciation on the assets transferred. Even greater savings can accumulate if you use the exemption during your life in the form of gifts.

If maximizing tax savings is your goal, consider a "dynasty trust." The trust is an extension of this GST concept. But whereas the previous strategy would result in the assets being included in the grandchildren's taxable estates, the dynasty trust allows assets to skip several generations of taxation.

Simply put, you create the trust, either during your lifetime by making gifts, or at death in the form of bequests. The trust remains in existence from generation to generation. Because the heirs have restrictions on their access to the trust funds, the trust is sheltered from estate taxes. If any of the heirs have a real need for funds, however, the trust can make distributions to them.

Special Strategies for Family-Owned Businesses

Few people have more estate-planning issues to deal with than the family-business owner. The business may be the most valuable asset in the owner's estate. Yet, two out of three family-owned businesses don't survive the second generation. If you are a business owner, you should address the following concerns as you plan your estate:

Who will take over the business when you die? Owners often neglect to develop a management succession plan. It is vital to the survival of the business that a successor, whether within the family or out, be ready to take over the reins.

Who should inherit your business? Splitting this asset equally among your children may not be a good idea. For those active in the business, inheriting the stock may be critical to their future motivation. To those not involved in the business, the stock may not seem as valuable. Perhaps your entire family feels entitled to equal shares in the business. Resolve this issue now to avoid discord and possible disaster later.

How will the IRS value your company? Because family-owned businesses are not publicly traded, determining the exact value of the business is difficult without a professional valuation. The value placed on the business for estate tax purposes is often determined only after a long battle with the IRS. Plan ahead and ensure your estate has enough liquidity to pay estate taxes and support your heirs.

The law currently provides two types of tax relief for business owners:

1) Section 303 redemptions -- your company can buy back stock from your estate without the risk of the distribution being treated as a dividend for income tax purposes. Such a distribution must, in general, not exceed the estate taxes, funeral and administration expenses of the estate. One caveat: The value of your holdings must exceed 35% of the value of your adjusted gross estate. If the redemption qualifies under Section 303, this is an excellent way to pay estate taxes.

2) Estate tax deferral -- normally, your estate taxes are due within nine months of your death. But if closely held business interests exceed 35% of your adjusted gross estate, the estate may qualify for a deferral of tax payments. No payment other than interest is due until five years after the normal due date for taxes owed on the value of the business. The tax related to the closely held business interest then can be paid over 10 equal annual installments. Thus, a portion of your tax can be deferred for as long as 14 years from the original due date. Interest will be charged on the deferred payments.

Estate Planning and 529 Plans

When you contribute to a 529 plan, you'll not only help your child, grandchild, or other loved one pay for college, but you'll also remove money from your taxable estate. This will help you minimize your tax liability and preserve more of your estate for your loved ones after you die. So, if you're thinking about contributing money to a 529 plan, it pays to understand the gift and estate tax rules.

Overview of gift and estate tax rules
If you give away money or property during your life, you may be subject to federal gift tax (and, in certain states, state gift tax). The money and property you own when you die may also be subject to federal estate tax and some form of state death tax.

Federal gift tax generally applies if you give someone more than the annual gift tax exclusion amount, currently $13,000, during the tax year. (There are several exceptions, though, including gifts you make to your spouse.) That means you can give up to $13,000 each year, to as many individuals as you like, gift tax free. In addition, you're allowed a gift tax credit, which effectively exempts from gift tax up to $5 million in gifts that you make during your lifetime which would otherwise be subject to tax.

When you die, your estate will be entitled to a tax credit for federal estate tax purposes. In 2011, the credit is effectively equal to a $5 million exemption. However, the estate tax credit will be reduced by the amount of any gift tax credit used during your lifetime. Because the credit works this way, it is often referred to as the "unified credit," but the amount effectively exempted from tax is more properly known as the "applicable exclusion amount."

Note: Since state tax treatment may differ from federal tax treatment, look to the laws of your state to find out how your state will treat a 529 plan gift.

Contributions to a 529 plan are treated as (federal) gifts to the beneficiary
A contribution to a 529 plan is treated under the federal gift tax rules as a completed gift from the donor to the designated beneficiary of the account. Such contributions are considered present interest gifts (as opposed to future or conditional gifts) and qualify for the annual federal gift tax exclusion. This means that you can contribute up to $13,000 per year to the 529 account of any beneficiary without incurring federal gift tax.

So, if you contribute $15,000 to your daughter's 529 plan in a given year, for example, you'd ordinarily apply this gift against your $13,000 annual gift tax exclusion. This means that although you'd need to report the entire $15,000 gift on a federal gift tax return, you'd show that only $2,000 is taxable. Bear in mind, though, that you must use up your applicable exclusion amount of $5 million (in 2011) before you'd actually have to write a check for the gift tax.

Special rule if you contribute over $13,000 in a year
Section 529 plans offer a special gifting feature. Specifically, you can make a lump-sum contribution to a 529 plan of up to $65,000, elect to spread the gift evenly over five years, and completely avoid federal gift tax, provided no other gifts are made to the same beneficiary during the five-year period. A married couple can gift up to $130,000.

For example, if you contribute $65,000 to your son's 529 account in one year and make the election, your contribution will be treated as if you'd made a $13,000 gift for each year of a five-year period. That way, your $65,000 gift would be nontaxable (assuming you didn't make any additional gifts to your son in any of those five years). A married couple can make a joint gift of up to $130,000.

If you contribute more than $65,000 ($130,000 for joint gifts) to a particular beneficiary's 529 plan in one year, the averaging election applies only to the first $65,000 ($130,000 for joint gifts); the remainder is treated as a gift in the year the contribution is made.

What about gifts from a grandparent?
Grandparents need to keep the federal generation-skipping transfer tax (GSTT) in mind when contributing to a grandchild's 529 account. The GSTT is a tax on transfers made during your life and at your death to someone who is more than one generation below you, such as a grandchild. The GSTT is imposed in addition to (not instead of) federal gift and estate taxes. Like the basic exclusion amount, though, there is a GSTT exemption ($5 million for 2011). No GSTT will be due until you've used up your GSTT exemption, and no gift tax will be due until you've used up your basic exclusion amount.

If you contribute no more than $13,000 to your grandchild's 529 account during the tax year (and have made no other gifts to your grandchild that year), there will be no federal tax consequences--your gift qualifies for the annual federal gift tax exclusion, and it is also excluded for purposes of the GSTT.

If you contribute more than $13,000, you can elect to treat your contribution as if made evenly over a five-year period (as discussed previously). Only the portion that causes a federal gift tax will also result in a GSTT.

Note: Contributions to a 529 account may affect your eligibility for Medicaid. Contact an experienced elder law attorney for more information.

What if the owner of a 529 account dies?
If the owner of a 529 account dies, the value of the 529 account will not usually be included in his or her estate. Instead, the value of the account will be included in the estate of the designated beneficiary of the 529 account.

There is an exception, though, if you made the five-year election (as described previously) and died before the five-year period ended. In this case, the portion of the contribution allocated to the years after your death would be included in your federal gross estate. For example, assume you made a $50,000 contribution to a college savings plan in Year 1 and elected to treat the gift as if made evenly over five years. You die in Year 2. Your Year 1 and Year 2 contributions of $10,000 each ($50,000 divided by 5 years) are not part of your federal gross estate. The remaining $30,000 would be included in your gross estate.

Some states have an estate tax like the federal estate tax; many states calculate estate taxes differently. Review the rules in your state so you know how your 529 account will be taxed at your death.

When the account owner dies, the terms of the 529 plan will control who becomes the new account owner. Some states permit the account owner to name a contingent account owner, who'd assume all rights if the original account owner dies. In other states, account ownership may pass to the designated beneficiary. Alternatively, the account may be considered part of the account owner's probate estate and may pass according to a will (or through the state's intestacy laws if there is no will).

What if the beneficiary of a 529 account dies?
If the designated beneficiary of your 529 account dies, look to the rules of your plan for control issues. Generally, the account owner retains control of the account. The account owner may be able to name a new beneficiary or else make a withdrawal from the account. The earnings portion of the withdrawal would be taxable, but you won't be charged a penalty for terminating an account upon the death of your beneficiary.

Keep in mind that if the beneficiary dies with a 529 balance, the balance may be included in the beneficiary's taxable estate.

Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about specific 529 plans is available in the issuer's official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.

Updated 12/7/2011

Gifting Strategies for Estate Planning 

The federal government imposes a substantial tax on gifts of money or property that exceed certain levels. Without such a tax, someone with a sizable estate could give away a large portion of his or her property before death and escape death taxes altogether. For this reason, the gift tax acts more or less as a backstop to the estate tax. And yet, few people actually pay a gift tax during their lifetime. A gift program can substantially reduce overall transfer taxes; however, it requires good planning and a commitment to proceed with the gifts.

Advantages of Gift Giving
You may have many reasons for making gifts -- for some gift giving has personal motives, for others, tax planning is what motivated them. Most often, you will want your gift-giving program to accomplish both personal and tax motives. A few reasons for considering a gift-giving plan include:

  • Assisting someone in immediate financial need
  • Providing financial security for the recipient
  • Giving the recipient experience in handling money
  • Seeing the recipient enjoy the property
  • Taking advantage of annual exclusion allowance
  • Paying gift tax now to reduce overall taxes later
  • Giving tax advantaged gifts to minors

Gift and Estate Taxes

If you give away money or property during your life, those transfers may be subject to federal gift tax and perhaps state gift tax. The money and property you own when you die (i.e., your estate) may also be subject to federal estate taxes and some form of state death tax. You should understand these taxes, especially since the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (the 2001 Tax Act) and the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Act). The 2001 and 2010 Acts contain several changes that are complicated and uncertain, making estate planning all the more difficult.

Federal gift tax and federal estate tax--background
Under pre-2001 Tax Act law, no gift tax or estate taxes were imposed on the first $675,000 of combined transfers (those made during life and those made at death). The tax rate tables were unified into one--that is, the same rates applied to gifts made and property owned by persons who died in 2001. Like income tax rates, gift and estate tax rates were graduated. Under this unified system, the recipient of a lifetime gift received a carryover basis in the property received, while the recipient of a bequest, or gift made at death, got a step-up in basis (usually fair market value on the date of death of the person who made the bequest or gift).

The 2001 Tax Act and the 2010 Tax Acts substantially changed this tax regime.

Federal gift tax
The 2001 Tax Act increased the applicable exclusion amount for gift tax purposes to $1 million. The 2010 Act increased the applicable exclusion amount for gift tax purposes to $5 million in 2011 and 2012 (plus indexing in 2012). The top gift tax rate is 35 percent in 2010 to 2012 (the top marginal income tax rate in 2010 to 2012 under the 2001 Tax Act and the 2010 Tax Act). In 2013, the gift tax rates are scheduled to revert to pre-2001 Tax Act levels, with a top gift tax rate of 55 percent. In 2013, the applicable exclusion amount is scheduled to be $1 million. The carryover basis rules remain in effect.

However, many gifts can still be made tax free, including:

· Gifts to your U.S. citizen spouse (you may give up to $136,000 (in 2011, $134,000 in 2010) tax free to your noncitizen spouse)
· Gifts to qualified charities
· Gifts totaling up to $13,000 (this figure is indexed for inflation so it may change in future years) to any one person or entity during the tax year, or $26,000 if the gift is made by both you and your spouse (and you are both U.S. citizens)
· Amounts paid on behalf of any individual as tuition to an educational organization or to any person who provides medical care for an individual

A small number of states also impose their own gift tax.

Federal estate tax
Under the 2010 Tax Act, the applicable exclusion amount is $5 million in 2011 and 2012 (plus indexing in 2012), and the top estate tax rate is 35 percent. In 2011 and 2012, the unused basic exclusion amount of a deceased spouse is portable and can be used by the surviving spouse. In 2013, the applicable exclusion amount is scheduled to be $1 million and the top estate tax rate is scheduled to be 55 percent.

Note: Under the 2001 Tax Act, the federal estate tax was scheduled for repeal for one year in 2010. The 2010 Act reinstated the tax in 2010 with an applicable exclusion amount of $5 million and a top tax rate of 35 percent. An estate of a decedent dying in 2010 can elect to have the estate tax not apply, but a modified carryover basis would then apply instead of the step-up in basis.

Federal generation-skipping transfer tax
The federal generation-skipping transfer tax (GSTT) taxes transfers of property you make, either during life or at death, to someone who is two or more generations below you, such as a grandchild. The GSTT is imposed in addition to, not instead of, federal gift tax or federal estate tax. You need to be aware of the GSTT if you make cumulative generation-skipping transfers in excess of the GSTT exemption, $5 million in 2011 and 2012 (plus indexing in 2012), scheduled to be $1 million as indexed in 2013. A flat tax equal to the highest estate tax bracket in effect in the year you make the transfer (35 percent in 2011 and 2012, scheduled to be 55 percent in 2013) is imposed on every transfer you make after your exemption has been exhausted.

Note: Under the 2001 Act, the GSTT was scheduled for repeal for one year in 2010. The 2010 Tax Act reinstated the GSTT for 2010 with a GSTT exemption of $5 million, but applied a zero percent tax rate to GSTs in 2010. GSTT exemption should generally be allocated to generation-skipping trusts created in 2010 if the trust will have GSTs in years after 2010.

Note: The GSTT exemption is the same amount as the applicable exclusion amount for estate tax purposes in 2011 and 2012.

Some states also impose their own GSTT.

State death taxes
The three types of state death taxes are estate tax, inheritance tax, and credit estate tax, which is also known as a sponge tax or pickup tax.

Updated 12/7/2011

Charitable Remainder Trusts

A Charitable Remainder Trust normally is used as a strategy for converting highly appreciated assets into income producing assets, without income tax liability. The Charitable Remainder Trust is an irrevocable trust with both charitable and non-charitable beneficiaries.

The donor transfers highly appreciated assets into the trust and retains an income interest. Upon expiration of the income interest, the remainder in the trust passes to a qualified charity of the donor’s choice.

If properly structured, the CRT permits the donor to receive income, estate, and/or gift tax advantages. These advantages often provide for a much greater income stream to the income beneficiary than would be available outside the trust.

Unitrust vs. Annuity Trust

There are two types of CRT the Unitrust and the Annuity Trust.  The main difference between the two is the way your annual income, paid to you by the trust, is calculated. 

Under the provisions of a Unitrust, the annual payment to you must be a fixed percentage of the market value of a trust's assets as determined each year or, alternatively, the lesser of 5 percent of such value or the trust's income. You can see that there are no guarantees of the specific amount you will receive. Your payments will depend upon the changing values of the trust property or income from year to year.

Using an Annuity trust, the trust specifies an annual amount to be paid to you.  This guarantees that you will receive a specific amount which you can depend upon every year.

Charitable Remainder Trust - Potential Benefits

  • Eliminate Capital Gains Tax
  • Tax deductible transfers to trust
  • Trust income can be significantly greater than income generated outside trust
  • You choose duration of income from trust
  • Increased retirement income
  • Eliminate estate tax on trust assets
  • Preserve estate for family & heirs through survivorship policy funded with added income
  • Provide charitable bequests to the causes of your choice

Those Who Would Benefit Most From a CRT May Have Some of the Following Characteristics

  • Own highly appreciated assets
  • Would like to reposition such assets
  • Are in a high income tax bracket
  • Are subject to estate tax at death
  • Have philanthropic desires 

Gifting Stock

One key to reducing estate taxes is to limit the amount of appreciation in your estate. We talked earlier about giving away assets today so that the future appreciation on those assets will be outside of your taxable estate. There may be no better gift than your company stock - it could be the most rapidly appreciating asset you own.

For example, assume your business is worth $500,000 today, but is likely to be worth $1 million in three years. By giving away the stock today, you will keep the future appreciation of $500,000 out of your taxable estate.

A flexible strategy for the business owner was reinstated in late 1990 when Congress retroactively repealed the estate freeze provisions that became law in 1987. Before 1987, business owners commonly recapitalized their businesses, retained preferred stock interests and gave some or all of the common stock to their beneficiaries. This way, they retained control of their companies and froze the value of their stock for estate tax purposes. All future appreciation affected only the common shares, not the owners' preferred stock.

Congress saw the loophole and created Section 2036(c) in an attempt to prevent future estate freezes. The section had been under constant attack since its creation and was finally repealed retroactively in 1990. In its place, Congress passed legislation that once again permits estate freezes, but only if certain requirements are met.

Gifting family business stock can be a very effective estate tax saving strategy. Beware of some of the problems involved, however. The gift's value determines both the gift and estate tax ramifications. The IRS may challenge the value you place on the gift and try to increase it substantially. Seek professional assistance before attempting to transfer portions of your business to family members.

A recent law change requires the IRS to make any challenges to a gift tax return within the normal three-year statute of limitations, even though no tax is payable with the return.