HS330

3. Advanced Estate Planning Techniques Installment sale Self-canceling installment note (SCIN) Private annuity Family trust Grantor-retained annuity trust (GRAT) Grantor-retained unitrust (GRUT) Qualified personal residence trust (QPRT) Irrevocable life insurance trust (ILIT)

4. Installment Sales Sale with 1 or more principal payments in year other than year of sale Income tax treatment under installment accounting method Seller’s income tax gain recognized over each installment Used to freeze gift/estate value and remove appreciation potential Deferral of payments for buyer Estate inclusion of present value of remaining payments at seller’s death

5. Income Taxation of Installment Sales Seller 3 components of each installment payment Interest taxable as ordinary income Taxable gain Return of seller’s basis not taxable Buyer Interest paid may be deductible Principal payments constitute basis

6. Gift Taxation of Installment Sales No gift taxation if buyer pays fmv Related buyers: annual exclusion possible for forgiveness of some payments by seller-senior family member - IRS challenge if “pre-understanding” evident - Forgiveness in excess of annual exclusion = gift

7. Estate Taxation of Installment Sales Sale of property “freezes” value - future appreciation out of seller’s estate - shifted to buyer Inclusion of present value of any remaining payments in seller’s gross estate

8. Self-Canceling Installment Note (SCIN) Buyer: remaining principal payments canceled if seller dies prior to installment term period Buyer: pays increased price for seller bearing mortality risk - Price factor affected by seller’s age Seller: no estate inclusion of (canceled) remaining payments

9. Income Taxation of SCIN Seller: seller dies prior to installment term period: inclusion of gain on seller’s note in estate’s (fiduciary) income tax return Gain constitutes IRD No corresponding income tax deduction exists because remaining SCIN payments not included in seller’s gross estate

10. Gift Taxation of SCIN No gift taxation if buyer pays fmv Related buyers: annual exclusion possible for forgiveness of some payments by seller-senior family member - IRS challenge if “pre-understanding” evident - Forgiveness in excess of annual exclusion = gift

11. Estate Taxation of SCIN Sale of property “freezes” value - future appreciation out of seller’s estate - shifted to buyer No inclusion of present value of any remaining payments in seller’s gross estate

12. Private Annuity Seller: Senior family member sells property (family business) to buyer (junior family member) - appreciation out of estate Buyer: Makes unsecured agreement to pay seller periodic specified amounts for seller’s life No portion of payments deductible to buyer Payments terminate at seller’s death

13. Private Annuity(continued) Risks seller’s premature death - estate inclusion of only unconsumed payments seller’s longevity - buyer pays more than property value

14. Private Annuity Taxation Gift Taxation FMV valuation – no gift taxation (no annual exclusion) Estate Taxation FMV valuation - no inclusion of any remaining payments Improper valuation - (gift element) - inclusion of asset fmv Treated as retained life interest – Sec. 2036 Income Taxation After Oct. 18, 2006 Seller is required to realize full FMV (determined under Sec. 7520) at time of transaction. Seller cannot recognize gain with each annuity payment.

15. Grantor-Retained Annuity Trust (GRAT) Grantor’s right for a term of years to receive at least annually a stated dollar amount or stated percentage of the initial value of property transferred to an irrevocable trust

16. GRAT Example X’s contribution to an irrevocable trust $1.3 million Retained interest $80,000/year Term 10 years Remainder to grandchildren after 10 years Remainder value for gift tax purposes = $1.3 million minus actuarial value of 10-year $80,000 annuity

17. GRUT Example X’s contribution to irrevocable trust $1.3 million Retained interest $ 7% current trust value/year Term 10 years Remainder to grandchildren after 10 years Remainder value for gift tax purposes = $1.3 million minus actuarial value of 10-year unitrust interest

18. GRAT and GRUT Taxation Estate Taxation: - Survives term – no inclusion of corpus; appreciation out of grantor’s estate - Dies during term – some inclusion of corpus; (actuarial value of principal necessary to produce  annuity/unitrust payout) Gift Taxation: - Gift of remainder interest subject to gift tax Applicable credit may be used/no annual exclusion Income Taxation: - Trust income payments taxed to grantor

19. QPRT Taxation Gift Taxation Present value remainder interest (no annual exclusion) - Highest value of retained income interest reduces remainder value Estate Taxation No inclusion if grantor survives retained-interest term Full fmv inclusion if grantor dies during retained term Income Taxation Grantor has income taxation during retained term (ex.: residence is rented) Grantor can deduct expenses incurred during term Mortgage may impact grantor’s income taxation

20. Life Insurance in Estate Planning Essential estate planning component Large estates – liquidity at death of insured Modest estates – estate enhancement for heirs

21. Basic Life Insurance Products Term Single Life Policies Renewable/Conversion provisions possible Used for temporary coverage need

22. Basic Life Insurance Products (continued) Permanent Cash value/accumulation build-up Fixed premium - Constant guaranteed premium for specific face coverage amount Flexible premium (universal life) - Policyowner determines premium amount after 1st year’s premium - Cash value growth/shrinkage determined by premiums paid Variable life - Owner selects cash value investment - Fixed and flexible premium terms

23. Basic Life Insurance Products (continued) Permanent Multiple Life Policies Survivorship (2nd/last-to-die) Coverage on 2 lives/payable at survivor death Joint (1st-to-die) Coverage on 2 lives/payable at 1st death Used in buy-sell agreements

24. Gross Estate Inclusion of Life Insurance What causes inclusion of life insurance in decedent-insured’s estate? Estate/executor is policy beneficiary Incident(s) of ownership Third-party ownership inclusion FMV of policy owned on lives of others

25. Gross Estate Inclusion of Life Insurance (continued) Why inclusion of life insurance in decedent-insured’s estate is generally not a good idea Proceeds included in gross estate-federal estate taxation Probate costs apply Possible state death taxation Proceeds reachable by creditors

26. Incidents of Ownership (most common) Rights of insured or insured’s estate in economic benefits of policy: power to name/change beneficiaries/ beneficial interests right to assign policy right to revoke an assignment right to surrender/cancel policy right to pledge policy for a loan right to obtain a loan against surrender value of policy

27. Inclusion of Life Insurance

28. Removal of Life Insurance from Estate Get It Out!!!….(of the estate) Cross Ownership between Spouses Avoids incidents of ownership/inclusion at death Problems: Restructuring if divorce Unpredictable orders of death Irrevocable Life Insurance Trust (ILIT) Liquidity Avoids: Transfer/income taxation; Probate; Incidents of ownership

29. Irrevocable Life Insurance Trust Trust must not have direct or indirect responsibility to pay insured’s estate expenses Grantor must not have incidents of ownership within 3 years of death

30. ILIT Benefits Gift tax avoidance for premiums annual exclusion Estate tax avoidance of proceeds GSTT avoidance if exemption allocated Estate liquidity Income tax avoidance on corpus buildup/proceeds Probate publicity/expenses avoidance Grantor control of proceeds disposition thru trust terms

31. Taxation of Life Insurance Estate Taxation: Inclusion of death benefit: - Incidents of ownership - Estate/executor beneficiary - Proceeds used to pay estate settlement costs Ownership on life of another (3rd party ownership)

32. Taxation of Life Insurance (continued) Gift Taxation: Annual exclusion available At transfer of policy Continued donor premium payments In trust: Crummey powers Gift splitting available Section 2035 3-year rule applies

33. Taxation of Life Insurance (continued) Generation-skipping Transfer Taxation: When proceeds payable directly to or may benefit skip person(s) Annual gift/GSTT exclusions available At transfer of policy Continued donor premium payments In trust: Crummey powers GSTT exemption available

34. Practical Life Insurance Uses - Revocable Life Insurance Trusts (RLITs) -- Estate enhancement - Irrevocable Life Insurance Trusts (ILITs) - Grandparent-grandchild trusts -- Life insurance on parent for grandchild benefit - Inheritance equalization - Nonemployed spouse insurance

36. Postmortem Devices Disclaimer Special-use valuation - Sec. 2032A Estate tax installment payments- Sec. 6166 Section 303 stock redemption Alternate valuation date QTIP election Gift splitting Family allowance Election against the will Deductions on appropriate tax forms

37. Types of Powers of Attorney General Durable Power of Attorney - Powers remain effective throughout incapacity - Valuable estate planning document Special/limited Power of Attorney - Powers only for specific time or transaction(s) Springing Durable Power of Attorney - Operative at specified time/event – usually physical or mental incapacity -- Careful definition of event triggering power

38. Powers of Attorney The “Lingo” - Person executing the power of attorney document = Principal - Person(s) holding the powers = Attorney-in-fact / Agent

39. Power of Attorney Advantages Principal’s alter ego (some limitations) Privacy Flexibility Inexpensive Estate planning tool Viable despite disability Avoids incompetency proceedings Acceptance over living will Simplicity – no asset re-titling/transfer No recordation generally required (real estate possibly)

40. Power of Attorney (continued) Retirement Planning Uses - Exercise options under retirement plans - Change beneficiary designations - Elect payout options - Borrow from plan - Spousal waiver

41. Power of Attorney (continued) Estate Planning Uses - Make gifts (annual exclusion) -- Appreciation out -- Meet Sections 303, 2032A, 6166 requirements - Marital deduction transfers - Disclaimers - Generation-skipping transfers - Medicaid qualification

42. Health Documents Advance Medical Directives Durable power of attorney for health care Medical durable power of attorney Health care proxy Health care surrogate CPR/DNR Directives Five Wishes Living Will

43. Health Documents (continued) Advance Medical Directives - Durable power of attorney for health care - Medical durable power of attorney - Document providing terms of principal’s medical treatment wishes upon incapacity - Broad or limited powers/discretion - Nonterminal and terminal conditions - HIPAA compliance

44. Health Documents (continued) Advance Medical Directives - Health care proxy/surrogate - No advance medical directive and agent - Knows patient well/medical wishes - Often close family member - Chosen by patient/patient’s family - HIPAA compliance

45. Health Documents (continued) Advance Medical Directives - CPR/DNR Directives - Cardiopulmonary resuscitation/Do Not Resuscitate -- Refusal of heart and lung resuscitation -- Usually within medical facility -- Necklace/bracelet for outside medical facility -- Other medical procedures not restricted

46. Health Documents (continued) Advance Medical Directives - Five Wishes - Recognized by majority of states/medical care providers - Expression of end-of-life wishes by seriously ill -- Name health care agent -- Medical treatment wanted/not wanted -- Personal care/comfort wishes -- Information for loved ones to know: --- Funeral/burial wishes

47. Health Documents (continued) Advance Medical Directives - Living Wills - Operative for terminal condition, imminent death only - Generally – no prolongation of life - No artificial life support - Moral issues - Right to privacy/self-determination v. medical preservation of life objectives --- Name health care agent --- Medical treatment wanted/not wanted --- Personal care/comfort wishes --- Information for loved ones to know -

48. Third party necessary Can cover broad spectrum of matters Effective upon mere incompetency

49. Special Groups Planning Elderly and Incapacitated - Long Term Care Insurance - Retaining control -- Trusts -- Durable powers of attorney -- Guardianship/conservatorship --- complete loss of control - Medicaid issues -- Ethical considerations -- Spend-down

50. Special Groups Planning Married Couples - Share same objectives/interests? --Separate representation? - Tax benefits – marital deduction/joint returns - Separation/Divorce possibilities -- Irrevocable life insurance trusts used to provide for less wealthy spouse/children

51. Special Groups Planning Singles (divorced, never married,widow, widower, parent) - Each type within single person group requires different planning approach - General characteristics/needs -- May feel alone/vulnerable/less trusting -- Durable power of attorney -- Disability insurance -- Long-term care insurance -- Different planning if there are minor children

52. Nontraditional Living Arrangements - Cohabitation/Commitment/Domestic Agreements - No marital deduction - No gift-splitting - Planning devices -- Joint tenancy -- Gifting -- Testamentary bequest -- Revocable/irrevocable trust -- Life insurance trust --- Overcomes insurability issue