Tax Law

Complying with the FBAR

If you have a foreign financial account, the federal Bank Secrecy Act may require you to report the foreign bank and financial account (“FBAR”) yearly to the I.R.S. by filing Form TD F-90-22.1.  The purpose of the FBAR is to help the U.S. government investigate persons who may be using foreign financial accounts for illegal purposes, including counter-terrorism, and to identify unreported income maintained in a foreign financial account.

What Constitutes a ‘Foreign Financial Account’?

A financial account includes a savings or checking account, securities or brokerage account, futures or options account, an insurance or annuity policy with a cash value, shares in a mutual fund or similar pooled fund, and other accounts maintained with a financial institution.  A financial account is “foreign” if the institution is physically located outside of the United States.  FBAR is not required for an account maintained with a branch, agency, or other office located in the U.S., even if the financial institution is foreign.  An account is not deemed foreign merely because it may contain holdings or assets of foreign entities, as long as the owner maintains the account with a financial institution located in the United States.

Who Qualifies as a ‘U.S. Person’?

A “U.S. person” must file an FBAR if (i) the U.S. person had a financial interest in or signature authority over at least one financial account located outside of the United States, and (ii) the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported.

For this purpose, a “U.S. person” means a U.S. citizen or a U.S. resident, as well as a corporation, partnership, limited liability company, and trust and estate formed under the laws of the United States or a state thereunder.

Generally, a U.S. person has a “financial interest” in a foreign financial account if she is the record owner or has legal title in the account, whether or not she is the beneficial owner.

Moreover, a U.S. person has a financial interest in a foreign account held by a nominee, if the beneficial owner of the foreign account is a U.S. person.  Also, a U.S. person has a financial interest in a foreign account where a corporation, partnership, or a trust is the record owner or has legal title in the foreign account, if a U.S. person owns more than 50% of the (i) total value of shares or voting stock of a corporation, (ii) partnership’s profits or capital, or (iii) the trust’s assets or income, as applicable.

A person has a “signature authority” if she has the authority to control the disposition of money, funds or other assets held in a financial account by direct communication (whether in writing or otherwise) to the person with whom the financial account is maintained.

Filing an FBAR

Exceptions to the FBAR reporting are found in the FBAR instructions, including participants in retirement plans that hold foreign financial accounts.

On the FBAR form, taxpayers must report their interest in the foreign financial account and identify the foreign country where the account is maintained.

The FBAR is not filed with the tax return and must be received by the IRS on or before June 30 of the following calendar year being reported.  A request for extension for filing the FBAR is not allowed.

Consequences of a Failure to File

A civil penalty not in excess of $10,000 per violation could apply to a failure to file an FBAR.  No penalty will be imposed if there is a reasonable cause for the failure and the balance in the account is properly reported.  Willful failure to file an FBAR may trigger a civil monetary penalty equal to the greater of $100,000 or 50% of the balance in the account at the time of the violation as well as criminal penalties.  Willfulness is generally determined by a voluntary, intentional violation of a known legal duty.

In the past few years, the Tax Division of the U.S. Department of Justice criminally indicted several taxpayers and advisors for activities associated with U.S. persons holding undeclared interests in foreign financial accounts, and many others are targets or subjects of ongoing federal criminal investigations.  In February 2009, UBS, under threat of criminal prosecution from the U.S. Department of Justice, turned over “secret” bank account information related to 280 of their U.S. clients and subsequently agreed to turn over information on many thousand more.

Credit Suisse reportedly started issuing letters to their US clients stating that a request for information on U.S. account holders has been received and that Credit Suisse has been ordered to turn over the information to the Swiss Federal Taxing Administration, which will then turn them over to the IRS, unless the US clients can demonstrate the turnover of information would violate Swiss law, including the U.S.-Swiss Tax Treaty.

IRS Voluntary Disclosure Programs

Taxpayers with undisclosed foreign accounts can become compliant with the U.S. tax laws by directly participating in the IRS voluntary disclosure program or by merely filing an amended or delinquent returns and FBARs for prior years.  The IRS had issued voluntary disclosure programs in 2009 and 2011 for undeclared interests in foreign financial account.  Under the 2011 program, eligible taxpayer must contact the IRS Criminal Investigation to request participation in the program, must file all original and amended income tax return as applicable, and pay any taxes owed (including interest and penalties).  Under the IRS long-standing voluntary disclosure practice, taxpayers who voluntarily disclosed their foreign bank accounts under the voluntary program are able to avoid potential criminal prosecution.

On January 9, 2012, the IRS reopened the offshore voluntary disclosure program “to help people hiding offshore accounts get current with their taxes.”  The IRS announced that it received over 33,000 voluntary disclosures and collected more than $4.4 billion so far from the two previous voluntary disclosure programs.  Under the 2012 program, a single penalty of 27.5% of the highest aggregate balance in foreign bank accounts during the eight full tax years prior to the disclosure will apply, up from 25% in 2011.  Some taxpayers will be eligible for 5 or 12.5% penalties, same as 2011.

In addition, participants must file an original and amended tax return, pay back taxes and interest for up to eight years, and pay any applicable accuracy-related and/or delinquency penalties as applicable.  Unlike the 2011 program, there is no set deadline for people to apply, and the terms of the program (e.g., penalties may be increased for all or some taxpayers) could change at any time going forward.

Conclusion

Generally under the voluntary disclosure program, taxpayers can reasonably calculate the total cost of resolving all offshore tax issues and avoid potential criminal prosecution.  Taxpayers who do not make voluntary disclosure risk detection by the IRS, substantial penalties (including the civil fraud penalty and foreign information return penalties), and possible criminal prosecution.

How to Suvive an IRS Audit

Taxpayers in general have about a 1% chance of receiving an IRS audit each year.  You beat the odds and your tax return has been selected for an audit.  What does this mean and what do you do?

What is an IRS Tax Audit?

An IRS tax audit means that the IRS is examining your tax return carefully for the accuracy with intent to verify the correctness.  Your return may have been selected (i) based on the IRS’s computer program that scores returns based on certain red flags the IRS has identified (e.g., Schedule C filers, cash basis businesses, excessive deductions), (ii) based on information received from third-party documentation, such as Forms 1099 and W-2 that do not match the information reported on your return, or (iii) to address questionable treatment of an item and to study the behavior of similar taxpayers in that market segment in handling the tax issue.

It is helpful to understand the statute of limitation under which the IRS audit is conducted.  In most cases, the IRS has 3 years from the date the tax return is filed to assess any additional tax.  Typically, this means the IRS will issue an audit notice 12 to 18 months after the tax return is filed and have 1 to 2 years to complete the audit.  If the audit is not completed within the 3 year period and the IRS does not timely assess additional tax liability, the taxpayer is generally not liable for the additional tax.

However, if the taxpayer (is found to have) underreported income on the tax return by 25% or more, then the IRS has 6 years to audit and assess tax deficiency from the date the return is filed.  In the case of fraud, the IRS has unlimited time period to audit the tax return.

The Audit Process

The audit may be conducted by mail, in taxpayer’s place of business or preferably at its representative’s office (to minimize the IRS’s access to documents and information), or in the IRS offices.  The IRS will typically request information and documents to review, and may ask to interview the taxpayer.  The law requires you to retain records used to prepare your tax return, and generally you should keep them for three years from the date the tax return was filed.

During the audit process, taxpayers have certain rights:  (i) the right to professional and courteous treatment by the IRS employees, (ii) right to privacy and confidentiality about tax matters, (iii) right to know why the IRS is asking for information, how the IRS will use it and what will happen if the requested information is not provided, (iv) a right to representation by oneself or an authorized representative, and (v) right to appeal.

The audit may conclude with: (i) no change to the return because all of the items under review were substantiated, (ii) taxpayer agreeing with the IRS’s proposed changes to the tax liability, or (iii) taxpayer disagreeing with the IRS’s proposed changes.

Protesting IRS Proposed Changes

If you agree with the IRS proposed changes, you can sign the examination report, and if money is owed, several payment options may be available.

If you disagree with the IRS findings based on the tax law, a conference with a manager may be requested for further review of the issue.  If an agreement cannot be reached with the examiner’s supervisor, the examiner will forward your case for processing and you will receive a letter (known as a 30-day letter) notifying you of your right to appeal the proposed changes within 30 days.

A formal written protest within 30-days is usually required to appeal the case to the IRS Appeals division.  The IRS Appeals division is separate and independent of the IRS Examination division which conducts the audit, and is designed to settle most disputes without going to court.  If is important to respond timely to the 30-day letter if you want to appeal your case.

If you do not respond to the 30-day letter (or if you do not reach an agreement with the IRS Appeals Officer), the IRS will send you a letter (known as a 90-day letter), notifying you of your right to file a petition with the United States Tax Court within 90 days.  Alternatively, you may take your case to the United States Court of Federal Claims or the United States District Courts.

Taking your Case to Court

Generally, the Tax Court hears your case before any tax has been assessed and paid.  If you do not file your Tax Court petition on time, the proposed tax will be assessed, a bill will be sent to you and you have to pay your taxes or collection can proceed.

The District Court and the Court of Federal Claims hear tax cases only after you have paid the tax and filed a claim for a credit or refund with the IRS on Form 1040X.  Generally, you must file a claim for a credit or refund within 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later.

If the IRS rejects your claim, you can file suit for a credit or refund in the District Court or in the Court of Federal Claims within 2 years from the date IRS rejects your claim.  You can also file suit for credit or refund if the IRS has not delivered a decision within 6 months since you filed a claim.

The IRS Appeals Office will normally consider any case petitioned to the United State Tax Court for settlement before the Tax Court hears the case.  You may be able to recover reasonable litigation or administrative expenses to defend your position with the IRS if you are the prevailing party, exhaust all administrative remedies within the IRS, your net worth is below certain limit and other requirements are met.

Potential Penalties

If you owe any additional taxes, you must pay interest on the additional tax, and interest is generally calculated from the due date of your return to the date of your payment.  Interest, however, may be suspended or abated under certain specific circumstances.

If you owe any additional taxes, various civil tax penalty provisions could apply, including the 20% accuracy related penalty on the total understatement of tax, failure to file penalty, failure to pay penalty, and civil fraud penalties equal to 75% of any federal tax due to fraud, plus interest on penalties.  Worst case, possible criminal charges (misdemeanors and felonies) could arise in applicable cases.

When faced with an IRS (or a state) audit, the goal is to limit the scope of the auditor’s review and limit your financial impact, and settle any disputes as early as possible during the examination or appeals process.  The first thing you should do is consult a tax counsel who can assist you, especially if you have complex or sensitive issues, since settlements of disputes often involve legal analysis of the tax law and an in-depth understanding of the tax procedure.  You should consult a tax counsel if you have potentially sensitive tax issues that might involve criminal tax matters.

What is the Gift Tax and How Does it Work?

The Gift Tax

The federal gift tax applies to gifts of property or money while the donor is living. The federal estate tax, on the other hand, applies to property conveyed to others (with the exception of a spouse) after a person’s death.

The gift tax applies only to the donor. The recipient is under no obligation to pay the gift tax, although other taxes, such as income tax, may apply. The federal estate tax affects the estate of the deceased and can reduce the amount available to heirs.

Exceptions

In theory, any gift is taxable, but there are several notable exceptions. For example, gifts of tuition or medical expenses that you pay directly to a medical or educational institution for someone else are not considered taxable. Gifts to a spouse who is a U.S. citizen, gifts to a qualified charitable organization, and gifts to a political organization are also not subject to the gift tax.

You are not required to file a gift tax return unless any single gift exceeds the annual gift tax exclusion for that calendar year. The exclusion amount ($14,000 in 2013) is indexed annually for inflation. A separate exclusion is applied for each recipient. In addition, gifts from spouses are treated separately; so together, each spouse can gift an amount up to the annual exclusion amount to the same person.

Determining the Gift Tax

Gift taxes are determined by calculating the tax on all gifts made during the tax year that exceed the annual exclusion amount, and then adding that amount to all the gift taxes from gifts above the exclusion limit from previous years. This number is then applied toward an individual’s lifetime applicable exclusion amount. If the cumulative sum exceeds the lifetime exclusion, you may owe gift taxes.

Tax Relief Act

The 2010 Tax Relief Act reunified the estate and gift tax exclusions at $5 million (indexed for inflation), and the American Taxpayer Relief Act of 2012 made the higher exemption amount permanent while increasing the estate and gift tax rate to 40% (up from 35% in 2012). Because of inflation, the estate and gift tax exemption is $5.25 million in 2013. This enables individuals to make lifetime gifts up to $5.25 million in 2013 before the gift tax is imposed.

Contact Managing Partner Joseph Maya and the other experienced estate law attorneys at Maya Murphy, P.C. today at (203) 221-3100 or by email at JMaya@Mayalaw.com, to schedule a free initial consultation.

Joseph Maya selected to 2022 Edition of Best Lawyers in America

FOR IMMEDIATE RELEASE

 

Westport, CT

 

Maya Murphy, P.C. is pleased to announce that Joseph Maya has been included in the 2022 edition of The Best Lawyers in America®. Since it was first published in 1983, Best Lawyers has become universally regarded as the definitive guide to legal excellence.

Joseph Maya, a Connecticut and New York-based litigation attorney, was recognized in The Best Lawyers in America© 2022 edition. He has been rated Best Lawyers in America and ranks among the top private practice attorneys nationwide. Attorneys listed in this edition of The Best Lawyers in America were selected after an exhaustive peer-review survey that confidentially investigates the professional abilities and experience of each lawyer. Recognition in Best Lawyers® is widely regarded by both clients and legal professionals as a significant honor.

Mr. Maya has been practicing law in Connecticut for more than 25 years. He has been a licensed attorney in New York for more than 30 years.

“Best Lawyers was founded in 1981 with the purpose of highlighting the extraordinary accomplishments of those in the legal profession,” said Best Lawyers CEO Phillip Greer. “We are proud to continue to serve as the most reliable, unbiased source of legal referrals worldwide.”

Lawyers on The Best Lawyers in America list are divided by geographic region and practice areas. They are reviewed by their peers based on professional expertise, and undergo an authentication process to make sure they are in current practice and in good standing.

 

Maya Murphy, P.C. has offices in Westport, CT and New York City. For additional information on Joseph Maya or Maya Murphy, P.C., please visit its website at https://mayalaw.com, or call 203-221-3100.

 

What happens if I die without a will in Connecticut?

After someone dies, attention naturally shifts to the decedent’s survivors, property and wishes. A probate court (also called a surrogate court) is a specialized court that handles distribution of the decedent’s property and ensures that any debts, funeral expenses and taxes are paid prior to distributing the remaining assets. If there is a will, the decedent’s wishes are carried out and the process is typically straight forward. However, if there isno will, distribution of property is awarded to survivors in accordance with the state’slaws of “intestacy.”

In Connecticut, if you are survived by a spouse and children, your spouse takes the first $100,000 plus half of the remainder and your children take the other half of the remainder. If you are survived by a spouse and children who are not your spouse’s children, your spouse takes half and the children share the other half equally. If you are survived by a spouse and parent(s) but no children, your spouse takes the first $100,000 plus three quarters of the remainder and the parent(s) takes the other one quarter. If you are survived by a spouse only, your spouse takes it all. If you are survived by children only, your children take it all. If you are survived by parent(s) only, your parent(s) take it all. If you are survived by brother(s) and sister(s) only, your brother(s) and sister(s) take it all. If you are survived by next of kin only, your next of kin takes it all. If there is no next of kin but there is a step-child, your step-child takes it all. If there is no step-child, it all goes to the State of Connecticut.

Regardless of the value of your property, it is always in your best interest to have a will.If you have a will, it may be possible to reduce the amount of tax payable on the inheritance. If you die without a will, your money and property may not be distributed as you had wished. If you are unmarried but have a partner, he or she cannot inherit your property without a will. If you have children who are minors, you will need a will so that living and financial arrangements are as you had wished in the event of your death. If youor your former partner’s circumstances have changed and there is a new partner in the picture, you may want to have a will to ensure your property is distributed as you’d wished.

Maya Murphy Attorneys at Law can provide you with estate planning with artfully crafted trusts and tax avoidance. We know that clients want peace of mind for the future. Our experienced attorneys will help you map out a plan so that your family is properly cared for in the event of your death. Please call us at 203-221-3100, or email us at Ask@Mayalaw.com to schedule a free consultation.

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What happens if I die without a will in Connecticut?

After someone dies, attention naturally shifts to the decedent’s survivors, property and wishes. A probate court (also called a surrogate court) is a specialized court that handles distribution of the decedent’s property and ensures that any debts, funeral expenses and taxes are paid prior to distributing the remaining assets. If there is a will, the decedent’s wishes are carried out and the process is typically straight forward. However, if there isno will, distribution of property is awarded to survivors in accordance with the state’slaws of “intestacy.”

In Connecticut, if you are survived by a spouse and children, your spouse takes the first $100,000 plus half of the remainder and your children take the other half of the remainder. If you are survived by a spouse and children who are not your spouse’s children, your spouse takes half and the children share the other half equally. If you are survived by a spouse and parent(s) but no children, your spouse takes the first $100,000 plus three quarters of the remainder and the parent(s) takes the other one quarter. If you are survived by a spouse only, your spouse takes it all. If you are survived by children only, your children take it all. If you are survived by parent(s) only, your parent(s) take it all. If you are survived by brother(s) and sister(s) only, your brother(s) and sister(s) take it all. If you are survived by next of kin only, your next of kin takes it all. If there is no next of kin but there is a step-child, your step-child takes it all. If there is no step-child, it all goes to the State of Connecticut.

Regardless of the value of your property, it is always in your best interest to have a will.If you have a will, it may be possible to reduce the amount of tax payable on the inheritance. If you die without a will, your money and property may not be distributed as you had wished. If you are unmarried but have a partner, he or she cannot inherit your property without a will. If you have children who are minors, you will need a will so that living and financial arrangements are as you had wished in the event of your death. If youor your former partner’s circumstances have changed and there is a new partner in the picture, you may want to have a will to ensure your property is distributed as you’d wished.

Maya Murphy Attorneys at Law can provide you with estate planning with artfully crafted trusts and tax avoidance. We know that clients want peace of mind for the future. Our experienced attorneys will help you map out a plan so that your family is properly cared for in the event of your death. Please call us at 203-221-3100, or email us at Ask@Mayalaw.com to schedule a free consultation.

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Utilizing Valuation Discounts for Gift Tax Savings: The Family LLC

This memorandum discusses the advantages of using gifts of fractional ownership interests in a family limited liability company (“LLC”) to defer or reduce gift and estate taxes. A family limited liability company can be used as an estate planning tool to “leverage” gifts to the next generation. The leverage is created by valuation discounts that apply to gifts of interests in a family LLC.

For gift tax purposes, the value used in determining the amount of a gift is fair market value, generally defined as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of the facts. Ownership of an interest in an entity such as a family LLC, whether a majority or minority interest, generally will result in a lower valuation for estate and gift tax purposes than the outright ownership of assets outside of the entity. Lower valuations result because minority interest and lack of marketability valuation discounts are allowed for transfers of interests in closely held corporations and limited partnerships.

A minority interest is any ownership interest in an entity such as a family LLC that lacks voting control over the entity, such that the member has no unilateral power to determine the timing of distributions, to force a liquidation of the LLC, or to control the management of the LLC. A marketability discount generally applies to majority and minority interests in a LLC due to the illiquid nature of such interests. A combined marketability and minority interest discount may approach fifty percent.

The following example illustrates the advantages of utilizing valuation discounts
in gifts of Family LLC interests:

Suppose Mom and Dad own real estate worth $1,000,000.00. They wish to make partial gifts of this real estate to their four children to take advantage of the $13,000.00 annual exclusion under Internal Revenue Code § 2503(a). Mom and Dad decide to establish a family LLC to own the real estate. Each receives a 50% interest in the LLC upon contribution of the real estate to the LLC. Mom and Dad are appointed managers, which gives them the power to make all decisions regarding the management and operation of the LLC. After establishing the LLC for substantial business reasons, and after the LLC has been in existence for some time, Mom and Dad make a gift of 19.2% of their interests in the LLC, by giving a 4.8% interest to each of their four children.

Each gift of an interest in the LLC is entitled to a minority interest discount, because each child lacks control of the entity. Each gift is also entitled to a lack of marketability discount because each interest in the LLC is highly illiquid, and no child has the power to liquidate the LLC. Assuming for purposes of this example a total discount of fifty percent, the fair market value of the 4.8% gift made to each child is only $24,000.00, even though 4.8% of the underlying assets in the LLC is $48,000.00. Thus, the gift tax exclusion has been “leveraged” using the LLC because $48,000.00 in underlying asset value has been transferred to each child without gift tax cost and without using any unified credit.

As the real estate owned by the LLC increases in value, such increase in value
will be reflected in Mom’s and Dad’s estates only to the extent of their remaining interest in the LLC. Furthermore, after the gifts Mom and Dad each owns only a 40.4% minority interest in the LLC. Each such interest lacks the power to liquidate the LLC, and would also be entitled to minority interest and lack of marketability discounts. Thus, significant gift and estate tax savings can be achieved by using a family LLC, although at the “cost” to Mom and Dad of foregoing the income that otherwise would have been received on the 19.2% that has been given away to the children.

Because of many recent court cases involving the use of family limited liability companies and family limited partnerships, a careful analysis in each instance is needed before interests in a family entity are gifted. Moreover, in most situations a professional appraisal is needed to value both the company’s underlying assets and the fair market value of the interests gifted. The cost of such appraisals must be considered when a decision is make to implement the use of family entities as a part of one’s estate plan.

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Use a Irrevocable Life Insurance Trust (ILIT) to Shield Your Policies From Estate Tax

Many clients are surprised to learn that the death proceeds of their life insurance are subject to estate taxation. They believe that life insurance escapes estate taxes and passes to their loved ones intact.

This confusion probably began when the client was told that life insurance is income tax-free. For married clients, the confusion is compounded by the belief that the unlimited marital deduction somehow magically insulates the client’s death proceeds from ever being taxed. Often the marital deduction merely postpones the heavy tax burden on such death proceeds until the second spouse dies.

For clients who have taxable estates, estate taxes may consume up to fifty-five percent of their life insurance proceeds.

The proceeds from your life insurance are generally includable in your taxable estate if you owned the policy or had any “incidents of ownership.” (as defined by the IRS) This is true for term insurance, cash value insurance, and even insurance provided by your employer.

“Incidents of ownership” which will cause life insurance death proceeds to be taxed as part of the insured’s taxable estate include not just policy ownership, but also the right to borrow the cash value, the right to change beneficiaries, and the right to change how the proceeds are ultimately distributed to the beneficiaries.

The Irrevocable Life Insurance Trust (or “ILIT” as it is frequently called) has proven to be a highly effective method of avoiding estate taxes without the many problems of transferring ownership of the policy to the client’s children or other heirs. An ILIT is created to own one or more policies insuring your life. The ILIT is irrevocable, meaning you cannot generally change the terms once it has been signed. You must also choose someone else as trustee of the ILIT besides you and your spouse (a knowledgeable professional is the ideal choice).

You cannot be a beneficiary of the trust, but your children may be (and usually are) beneficiaries. Quite often, the ILIT parallels the dispositive provisions of your revocable living trust or other estate planning documents, although there is no legal requirement for the ILIT to do so.

Moreover, the ILIT cannot be payable to your estate or to your revocable living trust, as your ability during lifetime to change your will or trust would result in your ability to change the beneficial enjoyment of the policy proceeds, thus bringing the policy back into your taxable estate. In addition, if you die within 3 years of placing an existing policy into the trust, it will be brought back into your estate. Hence, it is more favorable for the trust to the insurance on your life than you placing an existing policy in.

Your contribution to the ILIT represents gifts which you cannot get back. The gifts are usually used to pay the premiums on one or more policies insuring your life and which are owned by the trust. Because you cannot reclaim the policies, or receive any benefit from the trust, it would be inappropriate to have the trust own policies whose cash values you had planned to use for retirement income.

Currently, you may gift up to $14,000 per year per donee (recipient) without any gift tax implications. This exclusion is only available to gifts of a present interest, which is something you may enjoy or use now, and gifts in trust generally do not qualify, as they are gifts of a future interest, or one that will be enjoyed or used later. To avoid this limitation, your ILIT should provide that each lifetime beneficiary (who must also be beneficiary or contingent beneficiary at your death) has the right to withdraw his or her proportionate share of the contribution for a limited period of time after each contribution is made. This is known as a Crummey power and is named after a famous tax law case. A Crummey power forces what would otherwise be a future interest into a present interest that will fit the annual exclusion if the beneficiary has been given notice of a right to a withdrawal period that lasts at least 30 days.

After the expiration of the withdrawal period, the trustee may use the contribution to pay the premium on a life insurance policy. The IRS has approved the ILIT concept when all the technical requirements are met, but the IRS is notorious for challenging ILITs when the requirements are not met. Even the order in which the documents are signed is critical.

The trustee receives the death benefit upon your death. These proceeds may be distributed to your family, held in trust, or used to purchase assets from your estate or from your revocable living trust. This last option would be important if your estate had insufficient liquid assets to pay estate taxes.

The tax on your estate is due nine months after the date of death. Those with large estates often do not have sufficient cash or other assets which could be easily converted to cash within the nine month time frame. The need to pay estate taxes has caused many a farm, family business, or major real estate holding to be sold at discounted prices to pay the estate tax.

Life insurance may provide the money needed to pay the estate tax, and by having the policy purchased and held in an ILIT, the proceeds may be used to provide the needed liquidity for your estate and yet not be subject to estate tax on your death.

Married couples may wish to consider using a “second-to-die” policy which pays the death benefit only after both spouses are deceased. That is usually the exact time that the proceeds are needed to pay the estate taxes. Because no death benefit is paid on the first death, the premium is much lower than purchasing a policy which insures just one life.

Often clients try to accomplish similar results to the ILIT by having, say, their two children own the policy equally. Many problems may arise under such an arrangement. A child may predecease the parent; the policy may be attached and liquidated by a child’s creditors; the policy could be considered as the child’s property in the event of a divorce; one child may refuse to pay the premiums or may wish to borrow the cash value. The outright gift of a policy makes no provisions for your children or grandchildren. These and other issues may be addressed in a properly drafted ILIT.

If you have a taxable estate and own a large insurance policy, or are contemplating purchasing one, you would be well advised to consider how the ILIT might benefit you and your family.

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Zeroed-Out GRATs: A Must For Those With Substantial Assets

Under a GRAT, a grantor creates a trust and transfers property to the trust and retains an annuity payable for a term of years. At the end of the term, the trust property will go to the trust’s beneficiaries (either outright or in trust for their benefit). The initial transfer of property to the trust constitutes a gift for tax purposes which will eat up a person’s lifetime exemption amount. The value of the gift, however, is calculated based on actuarial tables based on the life of the grantor and based on interest rates published by the IRS (also known as the “hurdle rate”). Because of this, if assets transferred to the trust appreciate at a rate faster than the hurdle rate the grantor can transfer the excess appreciation, free of gift tax, to the grantor’s heirs. The major downside is that if the grantor dies before the GRAT terms expires, all trust assets are included in the grantor’s estate–thereby causing the grantor to lose the opportunity to do other estate planning that might have successfully removed the property from the estate.

A Zeroed-Out GRAT comes into play when the value of what the grantor gets back in the form of the annuity (actually the present value of the annuity interest) is equal to the value of the property transferred. In this situation the grantor makes a large gift of property to the GRAT, but sets the annuity at an amount so that, for gift tax purposes, there will be nothing left to pass to the heirs at the end of the term. However, if the trust’s assets appreciate above the hurdle rate, there will be value and appreciation that will pass tax free to the children. By utilizing a Zeroed-Out GRAT, a grantor can pass large amounts of value to their children gift and estate tax free.
GRAT
But what if the assets you own have a volatile value and there is no guarantee that over many years there will be a net amount of appreciation? In this case, one can utilize what is called a series of Zeroed-Out “rolling” GRATs. Generally, this entails establishing a series of consecutive 2-year GRATs. Because the terms are so short, it reduces the likelihood of dying during the term. In addition, if there is a down swing in value it will only affect the GRAT for the 2 year term. If there is a subsequent upswing in value that exceeds the hurdle rate the value can be passed on to the heirs. In a sense, it is a one way ratchet that will pass on value to heirs when the assets appreciate.

As with all estate planning techniques, one must consider their unique family circumstances, their assets, and current law to determine whether a GRAT makes sense.

The helpful info graphic above visually explains the use of the rolling GRAT technique, making references to billionaire Sheldon Adelson (via Bloomberg News). Credit: Jared Callister

Keywords- GRATs, estate planning techniques, ct estate planning, trust and estates, tax free wealth transfer, tax free appreciation, grantor retained annuity trust

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Rolling GRATs: A Low Risk High Reward Estate Planning Tool

A Grantor Retained Annuity Trust (GRAT) can be an effective wealth transfer technique without incurring a gift tax or utilizing one’s lifetime gift tax exemption. A risk, however, with a long-term GRAT is if the Grantor dies prior to the expiration of its term. Death of the Grantor would subject the trust assets, including any income and appreciation, to estate tax. To reduce the mortality risk (especially for elderly clients or for those with health concerns), there is an estate planning technique that utilizes shorter-term GRATs.

The “Rolling GRAT” technique involves creating a series of consecutive short-term GRATs (typically 2 to 3 years) with each successive GRAT funded by the previous trust’s annuity payments. Rolling GRATs minimize the risk of mortality during the term and thereby increases the success of transferring wealth. Two years is the shortest amount allowable by the IRS according to recent revenue rulings. These short-term GRATs can take advantage of asset volatility by capturing rapid appreciation in assets such as a rapid increase in stock value (i.e. Tesla). In fact, research on GRATs funded with publicly traded stock showed that a series of rolling GRATs outperformed an identical long-term GRAT, regardless of the 7520 rate at time of creation. The study showed that the short-term GRAT strategy minimized the risk that good investment performance in one year would be offset by poor performance in another year. Rolling GRATs also keep more funds committed to the estate planning strategy.

If the short-term GRAT strategy is effective (assets appreciate faster than the IRS Section 7520 rate within the trust term), wealth is removed from the taxable estate and transferred to beneficiaries at little cost. If the strategy is not effective (assets did not outperform the IRS Section 7520 rate), all of the assets would go back to the Grantor in form of the annuity payments and none of the lifetime gift tax exemption would be wasted. Thus, almost no risk, but the potential for very high reward.

Rolling GRATs also offer the advantage of plan and strategy flexibility. The Grantor can stop the rolling process at any time and for any reason. For example, the Grantor may wish to stop if he or she needs the income from the trust assets, no longer has an estate tax concern, wants to transfer wealth to the beneficiaries sooner, the assets’ growth rate drops too low, or his or her health has deteriorated and is not expected to live for another 2 or 3 years. The disadvantage of a short-term GRAT is that a particularly low Section 7520 rate will not be locked in long-term.

While Rolling GRATs offer advantages for liquid assets, such as publicly traded stock, illiquid or hard-to-value assets are better suited for long-term GRATs. In particular, illiquid assets would require frequent valuations that may be subjective, cumbersome and costly.
It is important to note that a provision in the President Obama’s 2014 Budget seeks to eliminate the use of short-term GRATs. The proposal would require that any new GRAT have a minimum term of 10 years and would require that the remainder interest have a value greater than zero at the time the interest is created. This minimum 10 year term would not eliminate the use of GRATs, but it would increase the risk that the grantor would fail to outlive the GRAT term and lose the anticipated transfer tax benefit.

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