Insight on Estate Planning - January 2013

American Taxpayer Relief Act Addresses the "Fiscal Cliff"

The American Taxpayer Relief Act averts the United States' descent over the "fiscal cliff" - a combination of higher taxes and forced spending cuts scheduled to go into effect in 2013. The act prevents income tax rate increases for about 98% of taxpayers and makes other changes affecting individuals and businesses. Here's a brief summary of the most important provisions.Individual tax provisions

  • Makes permanent 2012 ordinary-income tax rates, ranging from 10% to 35%
  • Increases the top marginal tax rate to 39.6% on taxable income in excess of the applicable threshold of $400,000 (singles), $425,000 (heads of households) or $450,000 (married filing jointly)
  • Allows the scheduled 2013 return of the limits on certain itemized deductions and personal exemptions - setting limit thresholds of $250,000 (singles), $275,000 (heads of households) and $300,000 (married filing jointly)
  • Makes permanent 2012 long-term capital gains rates of 0% and 15%
  • Increases long-term capital gains rate to 20% for taxpayers with taxable income exceeding $400,000 (singles), $425,000 (heads of households) or $450,000 (married filing jointly)
  • Makes permanent long-term capital gains treatment for qualified dividends
  • Makes permanent (and retroactive to Jan. 1, 2012) alternative minimum tax (AMT) relief
  • Extends the deduction for state and local sales tax in lieu of state and localincome tax
  • Extends various child- and education-related credits and deductions
  • Extends the ability of taxpayers age 70½ or older to make a direct tax-free rollover from an IRA to charity
  • Extends certain home and energy-related breaks
  • Increases the top estate tax rate to 40%
  • Maintains the estate tax exemption amount at $5 million, inflation-adjusted annually

Business tax provisions

Several valuable tax breaks for businesses have been extended, such as:

  • Bonus depreciation
  • Enhanced Section 179 expensing
  • Accelerated depreciation for qualified leasehold, retail and restaurant improvements
  • The Work Opportunity credit
  • The research and development credit
  • Certain energy-related breaks


Be Prepared for a "Triggering" Event - If you Own Interests in a Closely Held Business, Consider a Buy-Sell Agreement

Brothers Bob, Doug and Bruce owned a chain of furniture stores. When Bruce died unexpectedly, Bob and Doug were unsure of how to handle Bruce's share of the family business. If the brothers had had a buy-sell agreement, the aftermath of Bruce's death wouldn't have been so complicated.

A buy-sell agreement provides for the disposition of each owner's business interest after a "triggering event," such as death, disability, divorce, termination of employment or withdrawal from the business. However, to be effective, the agreement must include the appropriate provisions.

A buy-sell agreement gives the company or the remaining owners the right or the obligation to buy a departing owner's interest. Properly structured, it restricts ownership or control to family members, management or some other select group, creates liquidity for a departing owner's family to pay estate taxes (if applicable) and other expenses, and provides a market for otherwise unmarketable interests.

A buy-sell agreement can also help avoid disputes over ownership and control of the company when an owner leaves the business. In addition, in some cases, a buy-sell agreement can establish an ownership interest's value for gift and estate tax purposes.

3 categories of agreements

A buy-sell agreement can fall into one of three general categories: redemption, cross-purchase or hybrid. A redemption agreement permits or requires the company to repurchase an owner's interest. A cross-purchase agreement permits or requires the remaining owners to purchase the interest, usually on a pro-rata basis.

A hybrid agreement involves some combination of redemption and cross-purchase features. For example, it might require a selling owner or his or her representatives to first offer the interest to the company. If the company declines, the remaining owners are required to purchase the interest.

Typically, buy-sell agreements are funded using life insurance. On the death of an owner, the insurance provides a ready source of funds to purchase his or her shares. A properly structured funding arrangement will also provide for the liquidity needed on the retirement or disability of the owner.

The right type of buy-sell agreement for your business and the specific provisions that should be included depend on several tax and practical business factors.

Tax issues

From a tax perspective, cross-purchase agreements have an advantage, particularly if your business is organized as a C corporation. If a redemption agreement is funded by life insurance, the company's receipt of insurance proceeds might trigger corporate alternative minimum tax.

Also, a redemption agreement boosts the value of the remaining C corporation owners' shares without increasing their basis, which may result in higher taxes if they sell their interests. A cross-purchase, on the other hand, does increase basis, because the owner is purchasing additional shares.

Another tax concern for C corporations is constructive dividends. If a buy-sell agreement requires the remaining owners to purchase a departing owner's shares, but they have the corporation redeem the shares instead, the purchase may be treated as a taxable dividend. You can avoid this result by making the corporation a party to the agreement and permitting, but not requiring, the remaining shareholders to buy back the stock.

For pass-through entities - such as S corporations or limited liability companies (LLCs) - the tax implications of redemption and cross-purchase agreements are usually roughly the same. Nevertheless, don't overlook potential issues that may give rise to additional liability.

For example, if your S corporation used to be a C corporation and has accumulated earnings and profits, there could be some undesirable tax consequences. So, it's important to review the specifics of your situation to ensure there are no lurking issues.

Valuation provisions

A buy-sell agreement's valuation provision is critical. It sets the price - or establishes a method for calculating the price - that will be paid for a departing owner's interest.

The most effective approach is to conduct regular appraisals to ensure that the price is fair and accurately reflects the value of the interest at the time it's transferred. Some companies use valuation formulas tied to book value or earnings, but these formulas often lead to skewed results if the valuation is done at a time when the business is doing particularly well or, conversely, is going through a particularly difficult stretch.

Can a buy-sell agreement benefit you?

If you own interests in a family or closely held business, a buy-sell agreement may be right for you. Your estate planning advisor can give you more details.


Is Your IRA Safe From Creditors?

If a substantial portion of your wealth is in one or more IRAs, protecting the assets in those accounts is critical to your estate plan. IRAs provide significant benefits, including tax-deferred wealth accumulation during your life and, with proper planning, during the lives of your beneficiaries.

Asset protection during your life

The extent to which IRAs are protected against creditors' claims first depends on whether the claims are brought in a bankruptcy context. In bankruptcy, federal law controls.

Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, IRAs are exempt from creditors in bankruptcy up to $1 million (in contrast to qualified retirement plans, which are fully exempt). The $1 million limit doesn't apply, however, to amounts rolled over from a qualified plan, including earnings on those amounts. So, for example, if you roll over $2 million from a 401(k) plan into an IRA, the full $2 million, plus all future earnings, is exempt.

To ensure that rollover IRAs are fully protected, maintain documentation of the rollover transaction. It's also a good idea to include "rollover" in the account name and to segregate rollover IRAs from other IRAs.

Outside of bankruptcy, the answer depends on state law. Most states offer some level of asset protection for IRAs, a majority offering full protection. Some states exempt only a portion of an IRA, such as the amount reasonably necessary for the owner's support. Even in states that offer a complete exemption, the IRS can reach IRA assets to satisfy a federal tax lien.

Asset protection for your heirs

If you name your spouse as beneficiary of your IRA, he or she can roll the funds over into his or her own IRA after you die. Although nonspousal beneficiaries can take a lump sum distribution or distribute the funds over five years, typically they choose to hold the funds in an "inherited IRA," which allows them to maximize tax deferral by spreading distributions over their life expectancies.

Unfortunately, there's some uncertainty about whether the asset protection available to IRAs extends to inherited IRAs. In bankruptcy, the courts are divided on this issue. Outside of bankruptcy, some states expressly apply their exemptions to inherited IRAs, but most simply exempt "IRAs" without specifying how inherited IRAs are treated. In those states, courts have gone both ways, some finding that inherited IRAs are exempt and some finding that they aren't.

If you're concerned about creditor protection for an heir who lives in (or might move to) a state with unfavorable or uncertain asset protection laws for inherited IRAs, consider alternative strategies. For example, you might set up a spendthrift or asset protection trust for the heir and name the trust as beneficiary of your IRA. If the trust is designed properly, it will allow distributions to be spread out over your heir's life expectancy while protecting the trust assets against creditor claims.

Act now

If you have large balances in one or more IRAs, consult your estate planning advisors to discuss strategies for protecting these funds from creditors and preserving as much of the wealth as possible for future generations. If you need to set up trusts or change beneficiary designations, the sooner you do so, the better.

Estate Planning Pitfall - You're Unsure Whether you Need to File a 2012 Gift Tax Return

If you transferred anything of value to another person during 2012, consider whether you need to file a gift tax return. Some transfers require a return even if you don't owe tax. And, in some cases, it's desirable to file a return even if it's not required.Generally, you'll need to file a gift tax return for 2012 if, during the tax year, you:

  • Made gifts that exceeded the $13,000-per-recipient gift tax annual exclusion (other than gifts to your spouse that qualify for the marital deduction),
  • Made gifts that exceeded the $139,000 annual exclusion for gifts to a noncitizen spouse,
  • Made gifts of future interests - such as remainder interests in a trust - regardless of amount,
  • Contributed to a Section 529 college savings plan for your child, grandchild or other loved one and wish to accelerate up to five years' worth of annual exclusions ($65,000) into 2012,
  • Made gifts that you wish to split with your spouse to take advantage of your combined $26,000 annual exclusions, or
  • Made gifts of jointly held or community property.

No return is required if your gifts for the year consist solely of annual exclusion gifts, present interest gifts to a U.S. citizen spouse, qualifying educational or medical expenses paid directly to a school or health care provider, and political or charitable contributions.

If you transfer hard-to-value property, consider filing a gift tax return even if the transfer isn't taxable. Adequate disclosure of the transfer in a return triggers the statute of limitations, preventing the IRS from challenging your valuation more than three years after you file.