Cutting Edge Strategies to Reduce Taxes Rick J. Taylor, CPA

1. Cutting Edge Strategies to Reduce Taxes Rick J. Taylor, CPA

2. Roadmap of Topics • General comments on current state of tax law • General tax planning principles • Why planning today is important • Current estate/gift tax rates—what it means... • Eight wonderful ideas for your clients • Many others available...

3. General Comments on Tax Law Today • Recent (frequent) tax legislation • Eleventh-hour tax bills • “Patches” and “sunsets” without permanent law • Political and economic instability • Often turns tax planning 101 on its head

4. General Tax Planning Principles Tax Planning 101 (Traditional Views): • Defer income • Accelerate deductions • Convert ordinary income to capital gain • Convert capital losses to ordinary losses • Maximize use of tax-free exchanges • Switch from taxable to tax-free income • Shift income between taxpayers • Use debt where possible • Alternative minimum tax (AMT) planning

5. Why Planning Today is Important • Very little certainty in tax law • Looming tax increases (one way or the other) • Depressed property values • Pending repeal or limitations on existing ideas: • Valuation discounts for intrafamily transfers • Grantor retained annuity trusts • Continued refinements of economic substance doctrine

6. Current Estate/Gift Tax Rates Federal Estate and GST Tax (Wisconsin repealed 12/31/07) YearExemption/PersonRate 2007-2008 $2,000,000 45% 2009 $3,500,000 45% 2010 $5,000,000* 35%* 2011-2012 $5,000,000** 35% 2013 $1,000,000 55% * Executor may instead elect no estate tax with modified carryover basis ** Indexed for inflation in 2012 Federal Gift Tax (Wisconsin does not impose gift tax) • $5,000,000 lifetime exemption through 2012 ($1,000,000 in 2013 =>) • Tax rate = 35% through 2012 (55% in 2013 =>) • $13,000 annual exclusion • Annual exclusion only applies to ‘present interest’ gifts (usually not trusts)

7. Current Estate/Gift Tax Rates • What does it mean today? • Larger (temporary?) exemptions available • Lower (temporary?) rates available • Valuation discounts (temporarily?) available • Favorable (temporary?) GST environment • Strike while the iron is hot!

8. Charitable Lead Annuity Trust A historic opportunity to: • Save income, gift, and/or estate taxes • Leave a legacy • Transfer significant wealth tax-free

9. CLT Conceptual Overview • Transfer of cash or property in trust for the benefit of charity for: • Fixed term of years • Lives of one or more noncharitable beneficiaries • Shorter of A or B or greater of A or B • Fixed-dollar payout determined on the basis of the trust’s fair market value at time of funding • Assets remaining in trust after expiration of annuity interest revert to donor or pass to heirs • Income, gift or estate tax deductions available

10. CLT Conceptual Overview (Continued) • Fixed-income stream transferred to charity satisfies donor’s charitable objectives • Tax savings: • Income tax deduction = value of charitable gift • Deduction can offset income in high-tax year • Removes property from donor’s estate • Gift/estate tax deductions = value of charitable gift • Future interest in property transferred to heirs at a significant wealth transfer tax discount due to historically low interest rates

11. CLT Conceptual Overview (Continued) • Irrevocable transfer to trust • Guaranteed annuity payable to charity at least annually: • Payments must be in cash and/or property only • Unlike CRTs, no required minimum or maximum payout rates or trust terms • If grantor CLAT, annual trust income and gains are taxed to donor (allows for further depletion of estate) • Additional transfers to CLAT prohibited • Certain private foundation rules apply

12. CLT Conceptual Overview (Continued) • Donor with significant charitable intent: • CLAT substitutes for donor’s annual gifts to charity • Family CLAT avoids percent of AGI limitations applicable to charitable gifts made directly by donor • Donor or heirs currently do not need the income from the property selected for transfer • Donor seeks a tax-efficient means of making a future transfer of property to heirs • Donor with significant estate and/or income tax exposure seeking tax-reduction techniques

13. CLT Tax Treatment • Income tax: Trust is not a tax exempt entity (unlike CRT’s) • Grantor CLAT: Grantor/donor taxed on all trust income and capital gains • Family CLAT: Taxable entity entitled to annual charitable deduction for payments to charity • In-kind distributions may trigger capital gains • Wealth transfer tax: • Taxable transfer offset by value of charitable gift • Value of generation-skipping transfer exemption is indeterminable until triggering event

14. CLT Tax Treatment (Continued) • Grantor CLAT: Donor’s up-front income tax deduction = present value of lead interest • Can elect to use section 7520 rate for month of funding or either of two preceding months • Deductions limited to % of adjusted gross income • Death during CLAT term may require partial recapture • Family CLAT • Trust’s annual income tax deduction = payments to charity, so “excess” income taxed at trust level • Donor’s gift (inter vivos) or estate (testamentary) tax deduction = present value of lead interest

15. Leverage Low Interest Rates IRC Section 7520 Rate • All-time low: 1.4% in October and November 2011; All-time high: 11.6% in April 1989 • Functions as hurdle rate for economic success • Released each mid-month by IRS for following month • CLTs use rate for month of transfer or either of 2 preceding months: • September rate good through November 30, 2011 • Will know December rate on or before November 17, 2011

16. Interest Sensitive Techniques

17. CLT Example: $500,000 - Ten-Year Term $500,000 gift & income tax deduction Irrevocable Trust Client 2.Trust income on Client’s 1040 3.$55,663/yr for 10 yrs. Charity 4.Tax-free Remainder* • Notes: • Not ideal for GST planning • Optional grantor tax trust status for income taxes: • Deduction • Recapture possible • Charity can be specific or determined annually • Annuity stream can be level or increase up to 20% per year: • Initial payment would be $22,062; last would be $113,836 Beneficiary orTrust(s) FBOBeneficiary Value of Remainder Growth Level >20% 3% $33,800 $42,800 5% $114,300 $143,300 7% $214,500 $266,600

18. Important Considerations • Trustee selection and succession • Income taxes on trust earnings • Charitable beneficiary(ies) • Type of payment (level or increasing) • Death prior to expiration of term (if grantor trust) • Power of substitution holder (if grantor trust) • Month to create and fund • Property used to fund trust

19. Summary • CLATs are tax-efficient planned giving vehicles • Enables a donor to make a significant transfer to charity in the form of a guaranteed annuity interest • Trust assets revert to grantor or pass to heirs following expiration of the charity’s annuity interest • Value of charity’s lead interest is deductible for income, gift or estate tax purposes • Depending on donor’s objectives, different CLAT variations may be utilized • Grantor CLAT for income tax planning • Family CLAT for estate freeze planning

20. Client CLT Success Stories…Since 2008 • Over $21 million donated to CLTs • Over $8 million income tax savings • Over $12 million potential estate tax savings • Over $25 million paid to multiple charities by Feb 2031 • Charities include • Local colleges • Local hospitals • Donor-advised funds with 2 local community foundations • Existing private foundations • Others to be determined annually • Over $9.8 million potential tax-free remainder to children

21. Roth IRAConversions 2010 was a historic year, butNOT the end of discussion

22. Roth IRA Contributions • No age limit - Continue after 70½ • Can participate in employer plan and Roth IRA • 2011 limits: $5,000, $6,000 age 50 and over • Must have earned income (great for kids!) • Bought with after-tax dollars • Reduced by contributions made to traditional IRAs • 2011 phase-outs based upon MAGI: • Full - Single < $107,000; MFJ < $169,000 • Partial - Single >= $107,000 and <= $122,000; MFJ >= $169,000 and <= $179,000 • None - Single > $122,000 and MFJ > $179,000 • Used for first home purchase, lifetime limit $10,000

23. Roth IRA Contributions • No RMDs • Income tax-free - Planning opportunity: • Reduce amount of taxable social security benefits • Reduce impact of income-sensitive thresholds • 59½ and five-year holding period: • Five-year begins on January 1 of first year a contribution to a Roth • Income tax-free to beneficiaries

24. Roth IRA Conversions • Planning topic ‘du joir’ in 2010 • After January 1, 2010, anyone can convert to a Roth, regardless of income level or filing status • 2010 conversions: • Income reported 100% in 2010 or one-half in 2011/2012 • 2011 conversions: • All in 2011

25. Roth IRA Conversions (Continued) • Potential good candidates for conversions: • Long-term planning horizon (>7 years) • Expect same or higher tax bracket later in life • Can pay tax on the conversion from non-IRA assets • Intend to transfer balances to family member (“stretch” IRA) • Poor candidates: • Intend to give IRA to charity • Consume majority of distributions already • Expect lower tax rate later in life

26. Roth IRA Recharacterizations • Recharacterization rules (heads-you-win, tails-you-tie): • Can undo any or all of conversion for any reason • Must be by October 17, 2011, for 2010 conversions • Re-conversions, must wait until later of: • January 1 of year following year of conversion, or • 31 days after date of recharacterization • Consider impact of market losses in 2011

27. Net GiftStrategy Shift Gift Tax Liability to Donee

28. General Gift Tax Rules (Review) • Annual exclusion - $13,000/donee (unlimited): • Must be present interest gift • Tuition and medical payments NOT gifts (if direct) • Lifetime exemption/person: • 2011: $5,000,000 • 2012: $5,000,000 plus COLA • 2013: $1,000,000 • Tax rate: • 2011-2012: 35% • 2013: 55%

29. General Gift Tax Rules (Review) • Donor primarily liable for payment of gift tax: • Gift tax is tax-exclusive: • Gift of $6M by single person in 2011 creates $345,450 in gift tax • Total transfer = $6,345,450 • Estate tax is tax-inclusive: • Estate transfer of $6M in 2011 creates $350,000 in estate tax • Tax paid from assets transferred • Total transfer = $5,650,000 • Gift tax is cheaper • Donee secondarily liable for payment of gift tax

30. Net Gift Strategy • Make gift with agreement that donee will pay tax • Net gift formula: • Tax payable to the IRS equals: Tentative Tax (1 + Tax rate)

31. Net Gift Example Regular GiftNet Gift 2011 gift value (taxable gift) $1,000,000 $1,000,000 Gift tax* $350,000 $259,259 Reduction in tax $90,741 Effective tax rate 35% 26% *Assumes no annual exclusion or lifetime exemption available

32. Net Gift Considerations • Donee’s capacity to pay • Type of assets gifted • Irrevocable transfer • Donor still liable if Donee fails to pay

33. PlanningforAMT A Parallel Universe

34. Alternative Minimum Tax (AMT) • “Patched” through 2012 • Without fix, >25 MILLION subject to AMT • Exemption amounts: • $48,450 (single) • $74,450 (MFJ) • Query - Permanent solution? • Difficult to plan when the law is not solidified

35. AMT (Continued) • Top 10 reasons for AMT: • Exemptions • Standard deductions • State and local taxes • Interest on home equity debt • Medical expenses • Miscellaneous itemized deductions • Various credit incentives • Incentive stock options • Long-term capital gains • Tax-exempt interest

36. AMT (Continued) • Planning in an AMT world: • Manage payment of state and local taxes • Timing of stock options and available elections • Investment expenses (timing and source of funds) • Medical expenses (timing and source of funds) • Timing of IRA distributions • Distributions to charity from IRAs • Depreciation incentives • Timing of long-term capital gains: • Installment sales • Gifting to family or charities • Timing of compensation (bonuses, qualified plans, etc.)

37. Single Person401(k) Plans Outside-The-BoxSolution forTax Savings andRetirement

38. Single Person 401(k) Plans • Retirement plan options for self-employed: • Simple • SEP • IRA • Roth IRA • Keogh • Good candidates: • Self-employed • Directors!!!! • Even if officer in same corp.

39. Single Person 401(k) Plans (Continued) • Two components: • EE deferral (max of 16,500 or 22,000 if 50 or older) • ER contribution (25% of comp, or 20% of net S/E) • Maximum total contribution is lesser of: • 100% of comp, or • 49,000 (54,500 if 50 or older) • Catch-up (5,500): • Simple is only 2,500 • N/A with SEP

40. Single Person 401(k) Plans (Continued) • Loans available (N/A with SEP) • Additional employees • Administration requirements and costs • Due dates for creation • Due dates for funding • More flexible than SEP • Less advantageous at higher levels of S/E income • Could make Roth or pretax deferrals

41. Example of Single Person 401(k) Plan Facts: • Age 50 by end of 2011 • S/E income (net of S/E tax) = $145k Maximum Contribution is $51,000: ER contribution (20% * $145k) $29,000 EE deferral 16,500 Catch-up 5,500 $51,000

42. Intentionally Defective Grantor Trusts Transfer Future Appreciation (and available discounts) in Excess of the AFR Rate

43. Introduction to IDGTs • Sale to irrevocable trust in exchange for interest-bearing note • Trust treated differently for income and transfer tax purposes • Interest-bearing note • Interest-only with balloon payment • Interest & principal • No prepayment penalty • Small up-front gift of cash (or personal guarantee) • More flexible than a grantor retained annuity trust (GRAT); no requirement to survive trust term.

44. Low Rates = Once in Lifetime Opportunity • Interest rate = applicable federal rate; dramatic drop in rates increases benefit to your heirs.

45. Sale to IDGT – Profile of Suitable Asset • Appreciating estate with significant estate tax exposure • Senior family member motivated to make lifetime transfers to younger generations • Senior family member desires source of liquidity during note term (payments can vary based on need) • Ask: Is the property sold to the trust expected to outperform AFR (.19%; 1.20%; 2.67%) during note term?

46. Tax Treatment of Sale to IDGT Tax • Estate and gift tax • Property removed from senior family member’s estate, along with future appreciation • Only the outstanding note included in the senior family member’s gross estate (given the low interest rates, essentially freezes value at today’s depressed amounts) • Income tax • No gain/loss on sale to trust • Grantor taxed on trust earnings until note paid off • Further reduction of estate with NO gift tax

47. Advantages of Sale to IDGT • Significant estate tax savings • Valuation discounts provide extra leverage; 10 - 35% is normal discount for a noncontrolling interest in a privately held operating business • Higher discounts in current economic environment • Note issued by trustee can be interest-only • Easier to satisfy debt service requirements • Enables more property to grow in trust for heirs • Flexibility can provide cash flow to grantor as needed • Efficient GST planning vehicle • Grantor trust for income tax purposes

48. Drawbacks of Sale to IDGT • Legal, administrative, and appraisal fees • Trust must outperform the AFR during note term • Because of valuation discounts and depressed market, it is virtually assured that the trust will outperform the AFR • Carryover basis for heirs; this may increase future income tax, but only by 20-25% of the GAIN, while avoiding a 45% tax on the FMV of the asset. That is a 44% reduction in tax. • Green Book proposal would eliminate argument that property is stepped up for income tax purposes at death.

49. Sale to IDGT Enhancers • Rapid appreciation during note term is virtually guaranteed • FMV of property temporarily depressed due to current economic climate • Trust property generates cash flows • Cash flows should more than satisfy note payments • Valuation discounts increase leverage by reducing required note payments • Guarantee of debt by heirs

50. IDGT Flowchart Step 1: Senior creates an irrevocable grantor trust. Step 2: Senior sells property to trust in exchange for a promissory note with interest at applicable federal rate. Step 3: Senior contributes ‘seed money’ to trust (or personal guarantee by juniors). Property (e.g., LLC interest) Senior IDGT Seed money gift (or guarantee) Promissory note