Earlier in the year the Treasury announced that it would undertake a review of regulations issued since January 1, 2016. Recently, in Notice 2017-38, the Treasury identified eight regulations for burden reduction, including the controversial proposed regulations under Internal Revenue Code 2704. Those proposed regulations would have severely restricted the use of valuation discounts in family owned entities, such as family limited partnerships and limited liability companies, when they became final.
Given that estate tax repeal is becoming less and less likely, it would seem to be time to began consideration of discount planning again. Even if repeal occurs, there are non-tax reasons for moving wealth downstream, and it is possible that the political winds could shift significantly in the other direction soon and discount planning could be under attack again.
I learned a pitching technique that has really helped me, and want to pass it along.
As we watch Congress for clarity on tax reform, I am reminded of the Tom Petty song “The Waiting.” Many clients are frozen, unwilling to do any planning. However, the fact is tax law changes all of the time, and any “reform” today may be gone tomorrow. Life and death go on. The real reasons for planning transcend tax law.
You want to take care of your loved ones, and, if you have done well and have charitable goals, you want to leave something for the causes you care about. The basic structure of a will is not going to change much even if the transfer tax is repealed. You will still want to protect your loved ones from the uncertainties of this world, and possibly from themselves. So trusts will still be used for protection from lawsuits and divorce, and to create a protected family resource for lending and entrepreneurship.
In addition, I have found that, while clients may be motivated a bit by tax reasons for gifting during life, they often enjoy watching their loved ones enjoy the life experiences those gifts bring. The same is true for charitable giving.
Good planning should not be dependent on tax motivation. Good planning should not wait for tax motivation. So get on with it!
There are three basic types of intellectual property (IP): copyrights, trademarks and patents. Copyrights do not protect ideas, but do protect the way those ideas are expressed. Trademarks protect logos, slogans or other ways a business is identified. Patents protect inventions.
IP presents unique challenges for estate and business planning. It is a difficult asset to value. So before any arrangements are put in place, the client should engage an appraisal firm with IP expertise to assign a fair market value (FMV) for the IP. Once FMV is known the client can consider estate planning or financial transactions with the IP. For example, it is not unusual for a client to hold his IP in a separate entity from his business and enter into a license agreement with the business entity. The license agreement could be challenged as disguised salary if the licensing fee is not at FMV.
Copyrights and trademarks can last a long or indefinite amount of time, although, with respect to trademarks, they must be renewed every ten years. Patents, on the other hand, have a limited life, typically 20 years. These differences need to be taken into account when formulating planning ideas. A client with IP consisting largely of patents, for example, could license them to the business to provide retirement income, while the asset depreciates over time reducing his taxable estate.
In addition to the valuation difficulty, IP is an asset class that requires attention. Filings need to be renewed, and rights need to be defended if challenged. The client should identify people with knowledge of this area of the law during his life so that the value of the IP can be maintained after his passing. For example, probate alone will not transfer a patent. The executor must also file transfer documents with the USPTO.
Estate of Powell, http://ustaxcourt.gov/UstcInOp/OpinionViewer.aspx?ID=11260, is a recent Tax Court case that illustrates how not to do it. It involved perhaps the most aggressive deathbed planning I have ever read about. The decedent’s son, acting under a power of attorney that didn’t give him full authority to do the planning he undertook, transferred marketable securities to a new family limited partnership (FLP) in exchange for a 99% limited partnership interest. The son, then transferred the limited partnership interest to a charitable lead trust. Two of decedent’s sons transferred cash to the FLP for the general partner interest. The decedent died seven days later.
Given the facts is no surprise that the taxpayer lost this case, but Powell is significant because it extended Code Section 2036(a)(2) to a situation where the decedent only owned the limited partnership interests. The Court basically said the decedent’s lack of ownership in the general partner interest was illusory because the son acted for her under the power of attorney.
The majority opinion also, on its own accord, raised the possibility of double inclusion under Code Sections 2036, 2033, and Code Section 2043. That analysis is beyond the scope of this post.
Suffice it to say that just as Citizen Kane expressed regret about the road his life had taken on his deathbed by whispering “Rosebud,” aggressive deathbed estate planning can leave surviving family whispering their own words of regret…but those words probably are best left unsaid. And as planners we may be left whispering our own words of regret because often bad facts make for bad law, and this may be one of those times.
A colleague of mine, who was named as executor under the will, is faced with the not uncommon circumstance of managing the two children heirs who don’t like each other. He can’t yet act for the estate, but there is the real possibility that things could escalate into an ugly and unfortunate situation. In these situations it is imperative that the executor consult with counsel before communicating with the children.
For example, the named executor may need to block access to the home if the children are indicating a fight over personal property is possible. A suggestion of a sharing arrangement might be advisable for a vacation rental property that both children want to access immediately. Instructions may need to be given to the officers of a family business, if a child indicates he or she may disrupt the operation of the business.
Of course, the named executor should endeavor to admit the will to probate as soon as legally possible. Babysitting disgruntled heirs is an occupational hazard of serving as executor. It also may be helpful if the will has a no contest clause.
Variable prepaid forward contracts (VPFC) are used to diversify a concentrated position in a publicly traded stock, and defer tax on the sale. Here is how they work: taxpayer (i) pledges the stock to a counterparty, (ii) receives cash equal to a percentage of the fair market value of the stock (typically 75-85% of the stock), and (iii) agrees to transfer to the counterparty cash or a variable number of shares of the stock at expiration of the contract. In Rev. Rul. 2003-7, http://www.unclefed.com/Tax-Bulls/2003/rr03-07.pdf, the IRS ruled that, since it was uncertain what the taxpayer would settle the contract with cash or a variable number of shares, the transaction could not be taxed until contract expiration based on the open transaction doctrine. Thus the taxpayer has use of cash during the contract period, but is not taxed until the contract expires.
VPFCs got a big boost from the Tax Court in McKelvey v. Commissioner recently, https://www.ustaxcourt.gov/UstcInOp/OpinionViewer.aspx?ID=11187. McKelvey involved a typical VPFC entered into by the founder of Monster Worldwide, Inc. in 2007. The IRS did not challenge the original VPFC. Instead what was at issue in McKelvey was whether an extension of the VPFC in 2008 was a taxable exchange. More interesting is that taxpayer died shortly after entering into the extension, which resulted in a step up in the basis of the Monster stock. Accordingly, since the stock had appreciated, income tax on the increase in the stock price would be permanently avoided. The IRS argued that the extension was a taxable exchange of the original VPFCs for new ones under Code Section 1001. The Tax Court disagreed holding that Code Section 1001 applies only to “property” and that the VPFCs were an “obligation” instead of property. The implications of McKelvey are fascinating…indefinite extension of VPFCs until death to obtain basis step up. The IRS has not yet indicated whether it will appeal.
VPFCs should be given consideration to someone with a concentrated stock position. Care must be exercised in structuring the VPFC. For example, coupling the VPFC with a lending transaction will cause the VPFC to be taxable, see Anschutz, http://www.ustaxcourt.gov/InOpHistoric/anschutz.TC.WPD.pdf. And, of course, the transaction costs of a VPFC can be substantial.
I was recently at Bandon Dunes Golf Resort, a great golfing experience. I have been there a few times, and every time the course and the weather present unique challenges. This time I was hit with cold, high wind and rain. I thought of my practice and the many issues that I face, often being hit from several different sides-tax considerations, charitable desires, economic realities or fears about the future and how to treat different children fairly. Those complexities make a particularly good golf analogy to the situation to which I was confronted on the 15th tee of Pacific Dunes-brutal wind into me but a bit from the left as well, pot bunkers to the right and left of me and gorse to the left of me. The solution is to stay steady and level, advice that holds for both estate planning and golf. We often want to lean forward and move faster, but that is only going to send us into the weeds.
Charitable remainder trusts (“CRTs”) are split interests trusts, with the taxpayer retaining an income interest and charity receiving the remainder. The CRT often is used to defer gain on the sale of highly appreciated property. The taxpayer receives an income deduction for the value of the remainder interest going to charity and defers the capital gain on the sale of the property until he or she receives distributions from the CRT. The administration of the CRT can be tricky, however, since the private foundation rules on self-dealing apply to a CRT.
The IRS recently issued PLRs 201713002 and 201713003 in which the IRS ruled that a CRT that qualifies under Code Section 664 as a charitable remainder trust so that a deduction is available but where the taxpayer fails to take the deduction is not subject to the self-dealing rules.
Since the income tax deduction typically is not significant, a client may be willing to forgo the deduction so that he or she is not subject to the onerous self-dealing rules while still achieving tax deferral. Forgoing the deduction could create estate and gift tax issues, and PLRs are not binding on anyone other that the taxpayer who sought and received the ruling. Still, the rulings are fascinating and present an interesting planning option to pursue with tax counsel.
Time to Lighten Up
With markets, both private and public, at all time highs, a lot of people are coming to me for ideas to mitigate the income tax hit of selling an appreciated asset. There are a number of charitable structures that a client may want to consider (i) charitable remainder trusts, (ii) donor advised funds, (iii) charitable lead trusts and (iv) pooled income funds.
Pooled Income Fund-What is it?
This post will introduce an old idea that is finding a new life, the pooled income fund (“PIF”). The concept of a PIF is quite simple. The client gives an appreciated asset to a PIF, the PIF sells the assets and invests the proceeds, and the client receives the income generated by the fund for life. PIFs have been around a long time, but, for various reasons, had gone out of favor. Recently, given the low interest rate environment, PIFs have made a comeback. Here is why.
Why is it Popular Again?
Given the low interest rate environment coupled with the rule that a PIF that is less than three years old can use the average of the last three years AFRs to calculate the charitable deduction means the charitable deduction for a PIF is substantially greater than a charitable remainder trust. This is because the deduction is for the value of the assets remaining at the end of the term, and using a low interest rate to determine that value means that the discount for time is smaller. When you couple this with the fact that most state laws allow the PIF to define income to include not only interest, dividends, rents and royalties, but also short and some long term capital gains, you have a very powerful income tax planning strategy. We are finding charities very interested in working with us to create these donor friendly PIFs.
A PIF can (i) produce an income tax deduction of 60-80% of the value of the substantially appreciated asset depending on the client’s age, (ii) avoid taxation of the sale of the substantially appreciated asset, and (iii) pay the client a lifetime income interest enhanced by a definition of income that includes some capital gain. If the client takes a bit of the tax savings and purchases an insurance policy to cover the amount passing to charity and mitigate the risk of a premature death, he or she has all the bases covered.
About Grady Dickens
I created this blog to comment on items of current interest regarding trusts, estate planning, charitable planning and tax law, and share my knowledge and over thirty years of experience as an attorney practicing in Dallas, Texas.