10 Best Ideas to Reduce Your Client’s Taxes and Keep You Busy Throughout the Summer

1. 10 Best Ideas to Reduce Your Client’s Taxes and Keep You Busy Throughout the Summer

2. Presented By: Robert S. Keebler, CPA MST, DEP Virchow, Krause and Company, LLP Phone: (920) 739–3345 E-Mail: rkeebler@virchowkrause.com

3. Actionable Ideas • 1) Roth conversions should be aggressively reviewed. • 2) Loss Harvesting, while remaining in the market, should be reviewed. • 3) GRATs to freeze (for tax purposes) the value of depressed stocks should be implemented. 3

4. Actionable Ideas • 4) Large gains should be taken under the 15% tax rate compared to a higher future tax rate. • 5) Tax-efficient asset allocation between Roth's, QPs and outside accounts should be reviewed. • 6) Parents should aggressively gift and sell closely held business interests to trusts for children and GC. • 7) Oil and Gas will continue to provide tax and financial planning opportunities. 4

5. Actionable Ideas • 8) Consider funding dynasty trusts today ($3,500,000) • 9) The Burn SCIN idea was briefly discussed and appears favorable. • 10) Dick Oshins BDIT strategy is gaining momentum. 5

6. Impending Change in U.S. Tax Policy • We expect changes given Democratic party control of the Presidency, the House, and the Senate. • Affluent taxpayers will most likely be affected to a greater extent under President Obama tax changes. • Expressed intention to maintain President Bush’s tax cuts except for taxpayers earning over $250,000 per year. 6

7. Impending Change in U.S. Tax Policy • Likely effect of tax policy change – especially since President Obama will be in office: • Increases in the Income Tax • Increases in the Capital Gains Tax • Near certainty that the Estate Tax will not be repealed in 2010 7

8. Tax Planning Opportunities and Strategies • In order to take advantage of the current lower tax rates and avoid unnecessary increased taxation, consideration should be given to the following strategies: • Sale of Tangible and Intangible Property • Triggering of Long-Term Capital Gains • Closely Held Business Sales • Charitable Remainder Trusts 8

9. Tax Planning Opportunities and Strategies • Consideration should be given to the following strategies - continued: • Dynasty Trusts • Valuation Adjustment Planning • Utilizing GRATs and IDGTs • Low Interest Rate Planning • Utilizing Gifting, Unified Credit, GRATs and IDGTs • Roth Conversions 9

10. Tax Planning Opportunities and Strategies - Timeline • For optimal tax savings, strategies should be implemented over the next several months • Prior to the implementation of a new tax policy. 10

11. Sale of Property • Taxpayers holding significant quantities of publicly traded securities may benefit by presently reviewing their overall investment strategy. • Sell all or a portion of investments in 2008 to obtain the favorable 2008 capital gain tax treatment. • 15% capital gain tax rate (0% capital gain tax rate for taxpayers in the 15% or 10% tax brackets) • The strategy should also be considered for closely held businesses and real estate holdings. 11

12. Sale of Property - Example • Steve owns 50,000 shares of Blue Corp. stock. His basis in the stock is $20 per share and the stock is currently trading at $45 per share. • Steve has an important decision to make. • Sell now and lock in the favorable 15% long-term capital gain tax rate, or • Continue to hold the stock and subject the investment to more risk and a potentially increased capital gain tax 12

13. Sale of Property – Example Continued • If Steve sells now he will incur a $187,500 long-term capital gain tax • (i.e. $45 - $20 = $25 * 50,000 = $1,250,000 * 15% = $187,500). • If he waits and his investment remains static, Steve may potentially expose himself to an additional $162,500 in capital gain tax (assuming the new capital gain tax rate is 28%) • (i.e. $45 - $20 = $25 * 50,000 = $1,250,000 * 28% = $350,000 - $187,500 = $162,500) 13

14. Concentrated Stock Positions Triggering of Long-Term Capital Gains • Taxpayers with concentrated stock positions in publicly traded companies may want to consider reducing those holdings before the end of the year. • For companies with considerable growth, care should be taken to bring the client’s financial advisor into the conversation at an early stage in that companies that have experienced substantial increase in value over the last five years may see market pressure on their price if sales supply exceeds demand (i.e. everyone desires to sell ACC corporation because it has run up in value over the last 24 months and the sales pressure outweighs the demand). 14

15. Concentrated Stock Positions Triggering of Long-Term Capital Gains - Example • Dan holds a 1% interest (15.2 million shares) in Widget Inc. Widget Inc. has 1.52 billion shares outstanding. The stock is currently trading at $20 per share ($304 million). • Dan may want to consider selling a portion of his stock interest, because when the “lay” investor becomes aware of the capital gains increase there may be a huge sell off. • If the stock is devalued by 35% in a short period of time, not only could Dan see higher capital gains rates when he sells the stock, but he could also have over $106.4 million (i.e. 35% * $304,000,000 = $106,400,000) of value pulled out from under his feet in a short period of time. 15

16. Closely Held Business Sales • Taxpayers that own large corporations who are looking to sell to third parties may be wise to conclude transactions soon - to lock in the favorable 15% capital gains tax rate. 16

17. Closely Held Business Sales - Example • Matt owns a closely held business that he can sell at a gain of $25 million. • If Matt sells the business in 2008, he will incur a $3,750,000 capital gain tax on the sale • (i.e. $25,000,000 * 15% = $3,750,000) • If Matt waits to sell the business, he may incur additional capital gains tax on the sale  assuming the capital gains tax rate increases to its former 20% or 28%. • A 5% increase in the capital gains tax rate equates to $1,250,000 (i.e. $25,000,000 * 5% = $1,250,000) of additional capital gains tax. • A 13% increase in the capital gains tax rate equates to $3,250,000 (i.e. 13% * $25,000,000 = $3,250,000) of additional capital gains tax. 17

18. Charitable Remainder Trusts • An increase in the capital gain tax rate will influence the utilization of Charitable Remainder Trusts (CRT). • As the capital gain tax rate increases, the use of CRTs will also increase • The use of CRTs declined recently due to the lower capital gains tax rates. 18

19. Charitable Remainder Trusts - Overview Taxpayer Contribution of highly appreciated assets CRT Taxpayer For life or a maximum fixed term of 20 years At taxpayer’s death or end of fixed term Charity 19

20. Charitable Remainder Trusts • CRTs enable a taxpayer to: • Diversify a highly concentrated, appreciated asset position without incurring an immediate capital gains tax on the sale, • Receive a stream of income during the trust’s term, • Increase income by generating income from a previously non-income-producing asset, • Obtain a charitable income tax and an estate tax deduction, • Maximize overall wealth transfer to family and charity 20

21. Charitable Remainder Trusts - Example • Mike holds a $500,000 concentrated portfolio of highly appreciated stock (basis of $100,000) that he would like to diversify in a tax-efficient manner. Mike is also charitably inclined and could benefit from an annual stream of income. • By transferring the stock to a CRT, which in turn sells the stock to a third party, Mike diversifies his portfolio while paying no immediate income tax on the sale. He receives back a $30,000 annual stream of income during the trust term and at the end of the trust term, the $500,000 remaining balance of trust assets is transferred to a named charity. 21

22. Mike CRT - Highly appreciated stock is sold - Cash is reinvested for greater diversity & income without any income tax being imposed - Annual stream of income is received Charity Heirs Charitable Remainder Trusts – Example Continued • $500,000 gift of highly appreciated stock to CRTMike receives a $61,817 charitable income tax deduction when stock is gifted$600,000 annuity stream received by Mike over 20-year trust term (i.e. $30,000 per year)$500,000 remainder transferred to charity at the end of the 20-year trust termHeirs receive nothingAssumptions:Charitable Remainder Annuity Trust6% payout percentage6% growth rate of trust3.2% 7520 rate20-year trust term 22

23. Roth Conversions • Taxpayers who are eligible to execute a Roth conversion (i.e. Modified Adjusted Gross Income under $100,000), may have converted a Traditional IRA into a Roth IRA prior to year-end 2008. • Executing a timely Roth conversion may provide for significant tax savings • Potential increase in income tax rates under a new administration may make the execution of a Roth conversion in the future less beneficial • Significant tax planning tool, especially for clients with large IRAs. 23

24. Roth Conversions • Clients who converted by the end of the year 2008 have until October 15, 2009, to recharacterize the Roth IRA back into a Traditional IRA. • Allows the client hindsight view of market activity and changes in tax policy (which almost certainly will be implemented before October 15, 2009). 24

25. Roth Conversions • Roth conversion is a “heads you win, tails you tie” strategy. • If the market increase and tax rates increase, the client will have saved significant income tax and executed a powerful tax planning strategy. • If the market continues to decrease and tax rates remain static or decrease, the client will be able to recharacterize back to a Traditional IRA and pay tax on future distributions. • Virtually no risk. 25

26. Roth Conversions - Example • Joe has a Traditional IRA with a balance of $1 million and an outside brokerage account with a balance of $400,000. His current marginal income tax rate is 30%. • Assume under new administration Joe’s marginal income tax rate increases to 40%, executing a Roth IRA conversion in the current year enables Joe to amass over $1.5 million of additional wealth in a 30-year period! 26

27. Roth Conversions - Example (Lower Tax Rate in Conversion Year)

28. Planning Tools Which May Be Eliminated Under New Administration • Dynasty Trusts • Valuation Adjustment Planning • Utilizing GRATs and IDGTs • Low Interest Rate Planning • Utilizing Gifting, Unified Credit, GRATs and IDGTs 28

29. Dynasty Trusts • Tax law currently allows a taxpayer to create a trust that will exist in perpetuity. • One of the most powerful estate planning strategies available today  may be disallowed under a new administration. • Taxpayer can transfer up to $7 million into a trust in the current year and the assets of the trust will never be subject to federal estate tax at any point in the future. • The income from the trust could be distributed to children, grandchildren, and future generations on an estate tax-free basis. • Wisconsin, South Dakota, Delaware and a few other states currently have no rule against perpetuities, thus allowing the establishment of dynasty trusts. 29

30. Dynasty Trusts • Type of trust which benefits multiple generations where none of the assets held by the trust are included in either the grantor’s taxable estate or any of the beneficiaries’ taxable estates. • However, under the tax law, whenever a transfer is made by the grantor to a “skip person” (e.g., grandchild, great-grandchild, etc.) or a trust for their benefit (e.g., dynasty trust), a second level of tax is imposed on the transfer (in addition to gift tax). • This is known as the generation-skipping transfer (GST) tax. • Notwithstanding, a grantor is allowed a lifetime GST exemption on the first $2,000,000 of taxable transfers to “skip persons.” • Thus, if the grantor allocates all or a portion of his/her GST exemption to the entire transfer, none of the transfer will be subject to GST tax either in the current year or future years. 30

31. Dynasty Trust - Overview Joe Smith Dynasty Trust Gift* No transfer tax paid. Discretionary Distributions to Children for Life • Advantages • Creditor protection • Divorce protection • Estate tax protection • Direct descendent protection • Spendthrift protection • Consolidation of capital No transfer tax paid. Discretionary Distributions to Grandchildren for Life No transfer tax paid. Discretionary Distributions to Great-Grandchildren for Life No transfer tax paid. Future Generations * Gift should take advantage of any remaining lifetime gift exclusion and lifetime GST exclusion

32. Dynasty Trust - Example

33. Valuation Adjustment Planning • Discounts for minority interests and marketability are provided for in the Code. • Not uncommon to see 25-40% combined discounts when the correct conditions are present. • These discounts could be on the “chopping block” for the new administration. 33

34. Valuation Adjustment Planning - Example • Mike and Molly are husband and wife. They own MM Co., which is valued at $150 million. MM Co. is controlled 50% by Mike and 50% by Molly. • For estate tax purposes, when applicable discount are used, MM Co. would have a value of only $100 million (i.e. $150,000,000 * 33.33% discount = $50,000,000). • $50,000,000 effectively removed from Mike and Molly’s taxable estates • Note - this is a simplified example 34

35. Valuation Adjustment Planning • A client with an estate in excess of $7 million should be “locking in” discounts today. • Sell and/or gift property to trusts including: • Grantor Retained Annuity Trusts (GRATs) and • Intentionally Defective Grantor Trusts (IDGTs) 35

36. Valuation Adjustment Planning - GRATs • A type of trust that benefits the grantor’s future generations (i.e., children) without the imposition of estate or gift tax. • To the extent that the actual rate of return on the trust’s assets exceeds the IRS’s rate (a.k.a. IRC §7520 rate), the “excess” is transferred to the trust’s beneficiaries free of any estate and/or gift tax. • All income earned by the trust is taxed to grantor because the trust is “defective” for income tax purposes, thus allowing for a “tax-free” gift to the trust’s beneficiaries. NOTE: The IRC §7520 rate for February 2009 is 2.0%.

37. Grantor Retained Annuity Trust (GRAT) - Overview Joe Smith (Lead Beneficiary) Transfer of assets GRAT Annuity payments over a fixed term Payment of gift tax on present value of remainder interest transferred to children (should be at or near $0) At end of term, any residual assets remaining in the trust pass to the children free of any gift tax IRS Smith Children* (Remainder Beneficiaries) * Instead of naming the children as outright remainder beneficiaries of the GRAT, a grantor trust could be used (thus producing a greater estate tax benefit)

38. Grantor Retained Annuity Trust (GRAT) - Example Amount passing to beneficiaries free of estate and gift tax

39. Intentionally Defective Grantor Trust (IDGT) • An IDGT is a type of dynasty trust where all income earned by the trust is taxed to the grantor because the trust is “defective” for income tax purposes, thus allowing for a “tax-free” gift to the trust’s beneficiaries. 39

40. Installment Sale to an IDGT • A type of transaction whereby a grantor sells a highly appreciating asset to an IDGT in exchange for an installment note. • Note, however, that the grantor should make an initial gift (at least 10% of the total transfer value) to the trust so that it has sufficient capital to make its payments to the grantor. • To the extent that the growth rate on the assets sold to the IDGT is greater than the interest rate on the installment note taken back by the grantor, the “excess” is passed on to the trust beneficiaries free of any gift, estate and/or GST tax. • No capital gains tax is due on the installment sale to the trust because the trust is “defective” for income tax purposes. • Interest income on installment note is not taxable to the grantor because the trust is “defective” for income tax purposes. 40

41. Installment Sale to an IDGT - Overview Gift & sale of highly appreciating assets Joe Smith IDGT Installment note(s) Discretionary distributions of income and principal during the lifetime of the trust’s beneficiaries Assets outside of the taxable estates of beneficiaries Children, Grandchildren, Great-Grandchildren & Future Generations

42. Installment Sale to an IDGT - Example Amount passing to beneficiaries free of estate and gift tax

43. Low Interest Rate Planning • Due to low interest rates and a weak economy, today’s financial environment is advantageous for the transfer of property into a trust for one’s family. • Married couples with assets in excess of $7 million and/or any individual with assets in excess of $3.5 million should take aggressive steps to take advantage of the low interest rate environment. 43

44. Low Interest Rate Planning • Determine a client’s living expense needs and isolate “excess capital.” • Transfer out excess capital utilizing unified credit, GRATs and sales to entities for the benefit of children, grandchildren and great grandchildren. • Also removes asset growth from estate • The most prevailing techniques that exist today are dynasty trusts, defective trusts sales, and grantor retained annuity trusts. • These strategies can be used in conjunction with the valuation adjustment strategy for an even more effective end result. 44

45. THANK YOUTo be added to our IRA update newsletter, please email rkeebler@virchowkrause.com 45