Archive for Estate – Page 2

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.

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice.  Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. Source: Financial Visions, Inc.

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.

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice.  Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. Source: Financial Visions, Inc.

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.

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice.  Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. Source: Financial Visions, Inc.

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.

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice.  Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. Source: Financial Visions, Inc.

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.

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice.  Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. Source: Financial Visions, Inc.

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.

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice.  Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. Source: Financial Visions, Inc.