Q UA R T E R LY W E A LT H CO U N S E L
VOLUME 8 / NUMBER 4 DECEMBER 2014
IN THIS ISSUE
On Making The Transition To
ESTATE PLANNING / PAGE 4
WHAT TO DO
With An Asset Named DSUE / PAGE 6
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A Message of Thanks— And Excitement for the Future Brett Pinegar CEO, WealthCounsel Companies
Contents A Message of Thanks—And Excitement for the Future........ 2 On Making The Transition To Estate Planning.............................4
It’s the time of year for reflection. Everywhere I look, I am amazed by the gifts of leadership and encouragement that so many of you share with one another and with all of us at WealthCounsel. Whether teaching educational courses, heading up state forums, extending personal support, or advising us on content strategy, your generosity is truly inspiring.
What do you do with an asset named DSUE? Portability and Marital Deduction Planning.................................. 6
In the holiday spirit, I’d like to offer my own gift—of gratitude—by recognizing some of your special contributions.
Getting Appreciated Real Estate Out of C Corporations (Part I) ............................................12
HONORING EXTRAORDINARY EDUCATIONAL EFFORTS
Battle of the States: Dynasty Trusts............................. 14 The Surprising Connection between Marketing Your Law Firm and Weight Loss......16 Education Calendar....................18
When any of you stands up to share your expertise at a state forum, the annual symposium, or in a webinar, one thing is clear. Your real-world experience and insights are invaluable and tremendously beneficial to your fellow members. I give my deep thanks to the following individuals, and everyone else who ever took the microphone on behalf of our community. Heinz Brisske, for co-presenting our Estate Planning Essentials
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course and advising what it takes to practice estate law successfully in specific regions. Heinz is hard at work on new content for the upcoming year and always highly active in the Illinois Forum. Whitney Sorrell, for delivering a fantastic course at the Arizona Forum on how to provide great IRA asset protection solutions for clients. Sidney Kess, for offering important insights on income tax strategies in a webinar. Tom Fafinski, for significant assistance in developing and delivering our business law curriculum. Keith Davis, for diligently working on practice management curriculum for trust and estate courses, business law, and Advisors Forum courses. Matthew Tavrides, for leading his state forum and working hard to bring informative educational opportunities to fellow Floridians. Steve Franta, for helping to lead the Minnesota Agricultural Planning (Ag) meeting and his overall efforts to bring more Ag education to our members. Jonathan Mintz, for leading the Southern California Forum and
AS WE EXPRESS OUR GRATITUDE, WE MUST mentoring new or transitioning estate planning members in his area, including many one-on-one meetings. Patrick O’Brien, who contributes greatly to the New York Forum, with special attention to educating New York members on recent legislative changes that affect tax and estate planning. Dana Wine, who was a leader in the recently concluded Practice Building Coaching Program (PBCP). Dana has also stepped up to take the reins for the SC State Forum in 2015. Jeffrey Reisner, who also participated actively and motivated fellow participants in the Q2 PBCP. Martha Hartney and John Buckley, who together led a great state forum in July and who are actively are leading the charge to get WealthCounsel members in Colorado involved in the local bar committee that is shaping UTC developments. And finally my hearty thanks to all the following for presenting at one or more Advisors Forum events over the past few months: Doug Goldberg, Jeffrey Matson, Joe Strazzeri, Phillip Summers, and Donna Wilson.
THANKS FOR ALL YOUR LISTSERV PARTICIPATION The tremendous encouragement and support you provide one another in the more private venue of our listserv is no less astonishing. With over 2,000 member firms and many more attorneys participating in our online message board, your daily dialog is vital, collaborative, collegial, and a delight to witness.
MAKING A DIFFERENCE IN PRODUCT DEVELOPMENT WealthCounsel members play an important role in helping us determine how to improve our products to better support your practices. We are grateful for the time and thoughtfulness you bring to the cause, whether sharing your suggestions in person, on the phone, or via [this email] (and, please, keep those messages coming in!). You can see the results of your feedback in the recent releases of Wealth Docx and Business Docx… And, of course, if you haven’t yet downloaded the latest versions, you’re welcome to do so now.
HELPING ON CONTENT STRATEGY In addition to product input and recommendations, members also provide guidance on the bigger-picture perspective of how our content and community should evolve to be as current, relevant, and helpful to your practices as possible. For all this help, I also say thanks. For support in our content strategy development: Matt Brown, David Cahoone, Dan Capobianco, Matthew Grupp, Michael Rubenstein, Merek Rubin, Neel Shah, Scott Squillace, Matt Wiley, and Alan Yanowitz. For help in an advisory board on the topic of asset protection: Richard Foley, Jeff Matsen, and Chris Riser. For assistance in educating WealthCounsel team members in the Estate Plans for Employees program: Russell Blood, Antoinette Bone, Mark Bregman, Stephanie Edwards, Kirk Kaplan, Joseph Morton III, Mieko
NEVER FORGET THAT THE HIGHEST APPRECIATION IS NOT TO UTTER WORDS BUT TO LIVE BY THEM.” John F. Kennedy Shikuma, Matthew A. Tavrides, Wayne Wilson, and Sara Yen. Your content strategy guidance helped us develop a new Webbased delivery platform, currently in beta, that will be available for all Wealth Docx and Business Docx users in 2015.
LOOKING AHEAD I’m grateful to have met so many of you in person at the symposium and state events. I look forward to shaking even more of your hands next year. Meanwhile, please feel free to contact me at (888) 659-4069 ext. 870 or brett.pinegar@wealthcounsel.com with any general requests or feedback. I may be the CEO, but I am also just another member of the team. One of my favorite things about working at WealthCounsel is being privy to the passion you bring to the work of creating lasting legacies of financial safety for your clients. The kind of law that you practice makes a tremendous difference in people’s lives, and you inspire all of us at WealthCounsel to do our best. 2014…We couldn’t have done it without you…And I can’t wait to see what together we accomplish in 2015.
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On Making The Transition To Estate Planning Shara Kamal, Esq. So, I finally decided to take a huge leap into the area of estate planning. It took months of
coaching from my husband, a financial advisor, and an introduction to the WealthCounsel community to help me make the decision. Sixty days later, I don’t know why I didn’t make the decision sooner.
One important consideration was whether I knew enough about the area of estate planning to be of service to prospective clients. Having practiced law in the areas of real estate and business for 12 years, I didn’t realize how much I already knew about asset protection, having advised thousands of clients on the most appropriate ways to title assets and the effective uses of entities and land trusts. Numerous consultations with clients about strategies for business succession planning also come to mind when I think of the knowledge base of experience that I had already been establishing. Having access to proven practice systems and access to a community of experienced legal practitioners have given me the confidence to not only explore the idea of estate planning as a new practice area but to center my entire practice around it. Here are several tips, which have been the keys to a smooth transition into the area of estate planning:
1
Build a referral network of professionals who are willing to support and promote your estate planning practice. Their support will be just the wind you need to lift you off the ground and to create the lasting momentum required to sustain your practice. Half the battle can be in securing
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the clients; so, take full advantage of the human resources that are willing to support you in that effort. I started my practice in 2003 with a referral network of real estate brokers and mortgage professionals. Working with this network caused for over 300 real estate transactions closed in just my second year. The business continued to grow with each new relationship and clients quickly became an integral part of that network.
2
Build strong relationships among your existing client base. These people will seek your advice in whatever area you practice in because of their loyalty to you. In my experience, if a client is served well, you will have a client for life. They will follow your activities, respond to your inquiries, refer you new business and come to you when they need you for future work. Why not strengthen your existing relationships? They can be a never-ending treasure right in your backyard.
3
Build a strong brand for your practice that stands for excellence. Your work speaks for itself and every little thing that you do should exude excellence such that your clients and your community of practitioners are proud to do business with you. Not only have I learned to pay close attention to detail to ensure that I deliver a product and provide a service that exceeds my client’s expectations, but I have also learned to follow-up and seek feedback from clients so that I am in a constant inquiry about how my practice can be improved.
4
Utilize the power of social media.
Social media is one of the easiest ways to connect with a wide range and large volume of people. Use it to create a buzz through piggyback marketing and commentary on trending current events. The momentum will carry you and will help spread the word about who you are and about your level of expertise. The key to social media success is consistency of messaging and staying relevant to your base of followers.
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Be willing to re-invent yourself until you become who you were meant to be. Very few attorneys begin practicing in an area of law and remain in that area for the life of their practice. With experience and new insights come new opportunities to develop ourselves into what we were destined to be. A willingness to submit to what will inevitably occur and having the courage to make a change when the time is right will serve you well in the larger scheme of your career. Had I not recognized the opportunity that estate planning provided for the growth of my practice, I would have been hanging on to practice areas that weren’t necessarily serving me well in terms of growth and revenues. I was able to connect the dots of my experience and I can see estate planning as more than a new focus but as an evolution in service.
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Capitalize on your experience in other areas. Use your specialized knowledge in any given area to set yourself apart and to be a resource for prospec-
8 NUMBER 4 / DECEMBER 2014
tive clients and for other members of the legal community. My experience in the area of real estate has not only made me a resource to the real estate community but also to a community of estate planning practitioners who require my assistance with the preparation of deeds and other documents commonly used in the area of real estate law.
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Use practice systems that work and avoid trying to re create the wheel. Had I not been introduced to WealthCounsel Practice Systems, my transition wouldn’t have been nearly as smooth and a great deal of my time would have been devoted to the creation of forms and tools that were already in existence and have been proven to work. I am certain that as my journey in practice continues I will have highlights to share of the success stories and solutions for the problems that may surface. While no transition is easy, it is necessary with appropriate timing and guidance and it has been the best business decision that I’ve made. Good luck to those of you who have recently made the transition and remember to keep an open mind and always be learning! ABOUT THE AUTHOR Shara Kamal is an Estate Planning Attorney with experience in the areas of residential real estate and business formation and succession planning. She is also active in the social media community and uses her experience to serve as a resource to clients and her colleagues. PAGE
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What do you do with an asset named DSUE? Portability and Marital Deduction Planning Matthew T. McClintock, J.D., Vice President, Education, WealthCounsel
BACKGROUND & CONTEXT: When first introduced as part of the 2010 Tax Act, portability was a temporary feature. The entire tax act was subject to a sunset provision that would cause the law to expire at the end of 2012. The prevailing wisdom – at least as proffered by us at WealthCounsel – was that planning with exemption portability didn’t make much sense. The operation of the portable exemption was unclear, and there were mathematical discrepancies in examples provided by the IRS and the Joint Committee on Taxation. Considering that the 2010 Tax Act was enacted during a period of significant uncertainty throughout the estate planning & tax industry, which itself was reflective of great volatility in the American economy. As America careened toward the “fiscal cliff” that drove so many headlines in late 2012 – precipitated in large part by a slow economy and the scheduled expiration of many “Bush-era tax cuts” – Congress and the President came to a 13th-hour agreement1 on taxes, the American Taxpayer Relief Act of 2012 (“ATRA 2012” or “ATRA”). While the debates continued through the third and fourth quarters of 2012, industry predictions ranged from the end of portability and fixed $3.5 million exemptions to an extension and modification of portability with up to $10 million exemptions. (Few thought seriously that we’d see a full repeal, considering the political climate and economic conditions at the time.) In the end, ATRA reunified the lifetime gift, estate, and GSTT exemptions and adjusted them to $5 million for each individual. The exemptions index up with inflation; for decedents dying in 2014 those exemptions are valued at $5,340,000 per individual.2 The tax rate
on transfers in excess of the applicable credit is 40%. Portability was extended for estate tax purposes (the GSTT exemption is not portable), and sunset provisions were removed. Portability is now here to stay – at least, says the cynic, until Congress revisits the transfer tax laws. But since ATRA did not contain a sunset provision, there is no built-in deadline for lawmakers to act. We must now get comfortable with portability and its role in modern estate planning, and understand how to design and position estate planning strategies in the new estate planning paradigm of high exemptions, portability, and permanence – especially now that estate tax-driven planning is not a concern for the vast majority of clients.
KEY POINTS ABOUT DSUE PORTABILITY Permanent DSUE portability has changed the calculus for estate planning for married couples. A few critical items to bear in mind… •
Portability is an ELECTION! It isn’t an automatic “allocation.” To claim DSUE Amount portability the election must be made on a timely-filed federal estate tax return (Form 706).3
•
For purposes of understanding “timely-filed”, an estate claiming DSUE Amount portability is treated as an estate for which a Form 706 is due according to IRC §6018(a)4. That deadline is 9 months after the decedent’s date of death, plus any extensions granted by the Service.5
•
The DSUE Amount is the value of the decedent’s Applicable Exclusion Amount as reduced by trans-
will not index DOWN.
1 Congress passed ATRA 2012 on January 2, 2013 and it
3 Regs. §20.2010-2T
was signed by President Barack Obama on January 3rd. The
4 In other words, it’s treated like an estate on which a re-
act was effective retroactively to midnight, January 1, 2013.
turn is due based on the estate’s value.
2 Under ATRA exemptions may go UP with inflation, but
5 Regs. §20.2010-2T(a)(1)
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fers that do not qualify for the marital or charitable deductions. In other words, the decedent’s AEA is first used for gifts to a funded bypass trust or to nonmarital or noncharitable beneficiaries. The remaining AEA after those nondeductible transfers is the DSUE Amount. •
•
deduction trust provides only slightly better protection. IRC §2056(b)(5) provides that, in order to qualify for the marital deduction:
The value of the DSUE Amount is fixed upon the decedent’s death; unlike the surviving spouse’s own AEA, the DSUE Amount does not index for inflation in subsequent years. The DSUE Amount is calculated based on the remaining exemption of the “last deceased spouse.” Subsequent remarriage to a second spouse who has used all or a part of his or her own AEA (and who predeceases) may reduce the available DSUE Amount of the surviving spouse.
•
GSTT exemptions are NOT portable.
•
Except in Delaware and Hawaii, state estate tax exemptions are not portable.
•
Perhaps most importantly, only those assets that are later included in the surviving spouse’s gross estate will receive a basis adjustment for capital gains tax purposes under IRC §1014.
•
THE CONTINUING CASE FOR A BYPASS TRUST Because portability makes the transfer tax side of estate planning so “easy6”, what is the value of the bypass trust? Are there situations where bypass trust planning still makes sense for clients who are well below the estate tax threshold? The quality of asset protection afforded by funding a bypass trust is certainly greater than many alternatives: •
•
An outright gift of property to the surviving spouse provides virtually no protection. Creditors or subsequent unsuccessful relationships may alienate the survivor from the property. There is also no “legacy protection” to ensure that the surviving spouse ultimately disposes of the property in a manner consistent with the decedent’s objectives. Funding a general power of appointment marital
6 At least in perception, if not in reality.
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•
The surviving spouse must have the right to receive all income, and must be able to appoint income from the entire trust corpus to the surviving spouse (or his or her estate)
•
Distributions of principal may be limited during the spouse’s life, but there may be no limitations on distributions of income – all income must be distributed at least annually, and the spouse must be able to compel the trustee to convert non income-producing property into productive property.
•
Finally, there can be no other beneficiaries under the GPOA trust, otherwise the marital deduction will fail. As a result, the trustee has no other permissible beneficiaries among whom beneficial interests may be diffused.
Funding a QTIP trust is about as effective as funding a GPOA trust. More limiting, a QTIP trust requires the preparation of a Form 706 with the marital deduction election made on Schedule M of the return. If there is no return filed, no QTIP election is made, and thus there is no estate inclusion for the surviving spouse under IRC §2044 when the spouse later dies. But the spouse is still the only permissible beneficiary under the “QTIPable” trust, so the trustee’s ability to diffuse beneficial interests among multiple beneficiaries is not available as a potential asset protecting device.
By comparison to the various marital deduction trust models above, the bypass trust contains no such limitations. •
The spouse need not be entitled to any distributions of income.
•
The spouse need not be entitled to any distributions of principal.
•
The spouse’s beneficial interests in the trust can change over time as determined by an independent trustee or trust protector.
•
The spouse may be among a class of permissible beneficiaries entitled to receive distributions, diffusing the beneficial interest and avoiding an argument that the surviving spouse has a “property
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right” subject to creditor attachment. •
•
The trustee may choose to make distributions to some, any, or none of the beneficiaries during any given year. (Bear in mind that the trustee will need competent counsel to properly balance protection issues with the desire to minimize income tax inside the trust.) A trustee who is not “related or subordinate”7 to a beneficiary may have a purely discretionary distribution authority. (An interested trustee – one who has a beneficial interest in the trust, or one who is related or subordinate to a beneficiary under the trust must be bound to an ascertainable standard to avoid transfer tax inclusion issues under IRC §2041.)
PLANNING WITH THE MARITAL DEDUCTION There are several options worth considering for leveraging the marital deduction and playing the portability joker, depending on client objectives and the size and composition of clients’ estates. Mandatory method: all to the bypass trust By forcing all of the deceased spouse’s assets into a mandatory bypass trust, the plan runs the risk of exceeding the decedent’s federal AEA or state death tax exemption (if applicable). For this reason, an “all to bypass” approach must ONLY be used for estates that are safely below the exemption amount of one of the spouses. It is also the kind of approach that requires regular contact between the attorney and client to ensure that the method continues to make sense considering the clients’ gross estate values. This approach ensures at least partial use – and minimum wasting – of the decedent’s AEA, allowing a later decision of whether to port any of the decedent’s unused exemption (DSUE Amount) through the estate administration process. It also allows allocation of at least a portion of the decedent’s GSTT exemption, if desirable.
Mandatory method: fractional marital It’s hard to go wrong with the fractional formula approach to funding a marital and bypass trust. In sim7 This term is defined in IRC §672(c)
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plest terms, the formula operates to first fund the bypass trust with the decedent’s assets, with any amounts passing into a share that qualifies for the unlimited marital deduction. For the small estate, this approach works functionally the same as the “all to bypass” method, but it includes a “safety valve” of sorts to make sure that the bypass is not inadvertently overfunded, and accidentally and unnecessarily triggering an estate tax in the estate of the first spouse to die. The formula may also be written in a way that maximizes the use of a state death tax exemption in a decoupled state, ensuring that the estate of the first spouse to die pays neither state nor federal estate tax.
Mandatory method: all to a QTIP (or “QTIPable”) trust An analog to the “all to bypass” trust, an approach that sends all of the decedent’s assets into a trust that will (if elected) qualify for the unlimited martial deduction as a QTIP trust provides a modicum of asset protection and significant after death planning flexibility. It’s important to point out that in order for a QTIPable trust to qualify for the unlimited marital deduction, the election must be made on a timelyfiled 706 with marital assets listed on Schedule M. If no 706 is filed (and thus no marital deduction election made), the trust operates as a bypass trust and will use part of the decedent’s AEA, reducing the amount of DSUE Amount available for portability. If the decedent’s state of residence imposes a state estate tax and allows a partial QTIP election, after death planning may include making a stateonly QTIP election to avoid state death tax, or separate state and federal QTIP elections to also strategically leverage the decedent’s AEA. Because the trust is designed in a way that will qualify as a QTIP if the marital deduction election is made, the trust does not enjoy the same level of asset protection that the bypass trust provides, but it’s better than allowing an outright distribution of assets to the surviving spouse.
Flexible method: Clayton election
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The Clayton election approach to marital deduction planning allows a fiduciary to determine the amount of the marital deduction after the death of the first spouse to die, in order to facilitate tax planning with a measure of hindsight. Named after the Fifth Circuit Court of Appeals case on which the strategy is based, the Clayton election distributes all of the deceased spouse’s property to the Marital share in a QTIP trust. Any property for which the marital deduction is not elected – either because no return was filed or because property was listed on schedules other than Schedule M – is allocated to the Non-Marital share. •
Of note, the Clayton election method doesn’t face the same restrictions or limitations that the disclaimer method has:
•
A disclaimer must be made within 9 months, no extensions allowed. The Clayton election is made on the 706, which may be extended be-
8 NUMBER 4 / DECEMBER 2014
yond the 9-month filing due date; •
A disclaimer requires that the surviving spouse not receive any benefits of the property before a disclaimer is exercised. This requirement doesn’t apply to property subject to the Clayton election;
•
The Clayton election may be made by a disinterested third party (the trustee, or the executor of the estate) and as elected on the 706. While the surviving spouse will be involved in those discussions, making a Clayton election may be less emotionally challenging for the surviving spouse. (If the decedent has children from a prior relationship, it may also be appropriate to have an independent fiduciary make the QTIP/Clayton election to avoid accusations of a breach of fiduciary duty.)
Each of these approaches will, by default, send at least part of the deceased spouse’s assets into a bypass
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trust. Doing so allows for strategic use of at least part of the decedent’s AEA and GSTT exemption, allowing the remaining DSUE Amount (remember, the remaining AEA only, not any leftover GSTT exemption) to be ported to the surviving spouse on a timely-filed 706. This leverages the asset and inheritance protection of the bypass trust, but traps the assets in the trust in a way that doesn’t allow a §1014 basis adjustment when the surviving spouse later dies. That is, unless we get a little creative.
CREATING THE “ESTATE TAX-DEFECTIVE BYPASS” TRUST The bypass trust has historically been designed to leverage part of all of the deceased spouse’s AEA, keeping the bypass trust assets outside of the surviving spouse’s gross estate when he or she later dies. Now that federal estate tax planning is irrelevant for the vast majority of American families – with capital gains tax basis management of increased importance
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– should we consider ways to get the protection of a bypass trust, leverage portability decisions, and get a basis adjustment when the surviving spouse later dies? There are a few methods worth considering, each of which is worthy of deeper analysis and discussion than space permits here. Among the options on the table:
Formula General Power of Appointment over bypass assets Many commentators have floated the possibility of a formula clause that would grant the surviving spouse a general power of appointment over a portion of the bypass trust. The formula would be written in such a way as to only trigger estate inclusion over enough of the bypass assets to use the surviving spouse’s AEA without causing estate tax liability, and the power would be applicable to those assets with the greatest amount of unrealized capital gains.
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The obvious purpose is to allow the assets in the bypass trust that have appreciated the most during the surviving spouse’s remaining life to be included in the survivor’s estate at death, allowing those assets to get a basis step up and wash out as much of the bypass trust’s unrealized capital gains as possible.
distribute trust principal to the surviving spouse. The surviving spouse may then establish a trust in a manner that causes estate tax inclusion (perhaps under §§2036-2038). Failing that, the assets would be in the surviving spouse’s individual name and subject to probate proceedings when the spouse dies.
Critics have expressed concern about this approach, pointing out that the value over which the surviving spouse has a general power of appointment – when limited by the survivor’s AEA – cannot be ascertained during the survivor’s life. The value of the surviving spouse’s estate and the size of his or her available AEA is measured at death, making the formula clause illusory. Others believe this concern is unmerited, and many authors are exploring drafting approaches that seek to accomplish the formula power.
While this may be an inelegant approach, it would nonetheless serve to get assets out of the bypass trust and included in the surviving spouse’s estate, causing a basis adjustment at the survivor’s later death.
Strategically granted General Power of Appointment over bypass assets An alternative to a complicated formula approach involves allowing a disinterested third party to grant the surviving spouse (or one or more other beneficiaries) a testamentary general power of appointment over assets in the bypass trust. This power would most likely be held by a trust protector, with language guiding the protector to strategically grant the power of appointment over assets or trust shares that have the greatest unrealized capital gains, allowing those assets to receive a basis adjustment when the power holder dies. Wealth Docx has included this option for a few years, and the approach seems to be gaining in popularity. As an additional safeguard, the power may be drafted in such a way as to require the consent of a nonadverse party before the power could be exercised. This strategy would trigger inclusion, but would effectively prevent the power holder from exercising the power in a manner that frustrates the original settlor’s intent.
Strategically distributing principal from bypass When the governing trust document does not afford the flexibility to add powers of appointment, an independent trustee may choose to simply
Does portability make planning easier, harder, or just more interesting? Higher, indexing exemptions and DSUE Amount portability have indeed changed the game for estate planning. Attorneys can no longer simply be concerned with the cumulative value of the assets in clients’ estates but we must now conduct an assetby-asset analysis, taking into consideration the value, basis, appreciation, and income tax nature of each asset subject to the estate plan. Not only will this guide the marital deduction design choices during the planning phase, it will also guide estate administration decisions after the first spouse dies. For clients of all wealth strata, building the right type of marital deduction and portability strategy into the estate plan is essential. To effectively help those clients, attorneys and advisors need a new perspective on the balance between asset and inheritance protection for a surviving spouse and other beneficiaries on the one hand, and effective leverage of income tax planning opportunities with proper basis management on the other. ABOUT THE AUTHOR Matt McClintock joined the team at WealthCounsel in 2006 and currently serves as Vice President of Education and Supplemental Legal Content. His personal mission as the leader of the WealthCounsel Institute is to help attorneys be better attorneys by growing in knowledge and understanding, help them serve clients better by implementing more complete planning strategies, and enjoy their work more by deepening client relationships and building strong practices. Matt received his JD from the University of Oklahoma College of Law. PAGE
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Getting Appreciated Real Estate Out of C Corporations (Part I) Jeramie Fortenberry, J.D., LL.M. (Taxation) Corporations are taxed under subchapter C of the Internal Revenue Code unless the shareholders elect to be taxed under subchapter S. Of these two tax regimes, subchapter C is more onerous. It taxes all income twice: once when it is earned and again when it is distributed to shareholders. If a corporation taxed under subchapter C (C corporation) sells appreciated property, the corporation must pay income tax on the difference between the amount received and the corporation’s tax basis in the property. When the sales proceeds are distributed to the shareholders as dividends, the shareholders must pay income tax on the distribution. This double taxation makes C corporations the most tax-inefficient form of business. Like partnerships and limited liability companies (LLCs) taxed as partnerships, corporations that are governed by subchapter S (S corporations) do not pay an entity-level tax. All items of income, deduction, and loss are reported to the shareholders. Because these “pass-through entities” can provide liability protection without double taxation, most small businesses today are organized as PAGE
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S corporations or LLCs taxed as partnerships. Just a few decades ago, though, LLCs had not been widely adopted and S corporations were more restrictive than they are under current law. At that time, C corporations were often the go-to entity for liability protection. Many of these older C corporations—as well as some new ones that were formed for various reasons—now own appreciated assets. This legacy of tax inefficiency creates challenges for planners. In the small business context, real estate is perhaps the most common appreciated asset owned by C corporations today. The general increase in real estate values over time, coupled with a depreciated tax basis, can create significant built-in tax liability for C corporations. When appreciated real estate is sold, the corporation will pay Federal tax at the corporate tax rates (which range from 15 percent to 39 percent) on the gain from the sale. When that gain is distributed to the shareholders as a dividend, it will be taxed again at the shareholder level. When it comes to getting appreciated real estate out of a C corporation, there are no quick and easy solutions. But the tax problem usually gets worse if it is not
addressed. The best time to deal with the issue is ten years ago; the second best time is usually now. Fortunately, today’s market is generally favorable for moving real estate out of C corporations. Real estate values have dropped significantly in many markets. Although we are in what appears to be a recovery, the upward trend is relatively recent. In many markets, we may be as close to the bottom as we will be for some time. This gives taxpayers the opportunity to transfer real estate out of a corporation at a relatively low tax cost. If the business owners act now, future appreciation of the real estate as the market improves can escape double taxation. There are three ways to deal with appreciated real estate owned by a C corporation: 1. Distribute appreciated real estate to the shareholders; 2. Sell appreciated real estate to shareholders or third parties; or 3. Convert the C corporation into a pass-through entity. Part I of this article discusses the first two strategies. Conversion of a C corporation to a pass-through entity is covered in Part II. More advanced strategies, such as taxfree 1031 exchanges or classifica-
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tion as a real estate investment trust (REIT), are of limited usefulness to most small business owners and will not be discussed in this series.
DISTRIBUTING APPRECIATED REAL ESTATE TO SHAREHOLDERS One option is for the corporation to simply deed the appreciated real estate to one or more shareholders. The transfer is treated as a deemed sale that is taxable to both the corporation and the shareholders. At the corporate level, the distribution is treated as a sale to the shareholder for fair market value.1 To the extent that the fair market value exceeds the corporation’s basis in the real estate, the corporation will have taxable gain. The shareholders that receive the property will be taxed on the full amount of the distribution. To the extent that the corporation has current or accumulated earnings and profits, the distribution will be treated as a dividend.2 Whether this deemed-sale treatment will be feasible depends on the circumstances. If the corporation has a low basis in the real 1 I.R.C. § 311(b).
estate due to depreciation deductions, the built-in gain may be substantial. To make matters worse, there is no actual infusion of cash to the corporation in connection with the transfer. Unless the corporation has a cash surplus, this can leave a shortage of corporate funds to pay the taxes on the deemed sale. In these situations, an in-kind distribution may not be a viable alternative. On the other hand, if the property has not appreciated substantially, or if the corporation has a net operating or capital loss to offset the corporation’s gain, the deemed sale may not create a significant tax problem. In that case, the shareholders may decide to “bite the bullet” and make the distribution now, before the real estate market fully rebounds.
SELLING APPRECIATED REAL ESTATE TO C CORPORATION SHAREHOLDERS OR THIRD PARTIES A second option is to actually sell the real estate. The sale of the real estate will be taxable to the corporation. But unlike the deemedsale treatment that applies to inkind distributions of real estate to shareholders, an actual sale will generate cash for the corporation to pay the tax incurred on the sale. Although the proceeds from the sale will ultimately be taxed when they are distributed, there is no immediate tax to the shareholders on the sale. It will often make sense for a
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shareholder to purchase the property from the corporation and rent it back to the corporation. The shareholder will take a cost basis in the property, allowing the shareholder to take increased depreciation deductions. In some situations, depreciation deductions can help offset the rental income from the property. (A sale-leaseback between a C corporation and its shareholder implicates several rules that are beyond the scope of this article. It is important to work through these rules carefully when considering this structure.) Whether a sale of real estate will be a good alternative depends on the situation. At a minimum, the shareholder (or other buyer) must have the ability to fund the purchase. And, like a distribution of real estate in kind, this transaction does not avoid double taxation. The appreciation in the property will still be taxed twice: once to the corporation at the time of the sale and again to the shareholders when the proceeds are distributed. Part II of this article will explore the tax consequences of converting C corporations to pass-through entities. We will look at both subchapter S elections, which require no change in the corporate form, and conversions to LLCs.
About the Author Jeramie J. Fortenberry is a tax, business, and estate planning attorney and the Executive Editor of WealthCounsel. He obtained his J.D. from Tulane University Law School and his LL.M. (Taxation) from New York University.
2 I.R.C. §§ 301(c)(1), 316.
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Battle of the States: Dynasty Trusts Steven J. Oshins, Esq., AEP (Distinguished) Alaska, Delaware, Nevada and South Dakota (in alphabetical order) have not-so-quietly battled each other for trust business over the years. Much of this trust business is a result of the growing popularity of Dynasty Trusts. Although there are a few other states with favorable trust laws, these four states receive nearly all of the out-of-state Dynasty Trust business and therefore are the only states profiled in this article.
WHAT IS A DYNASTY TRUST? A Dynasty Trust is an irrevocable trust that is drafted to avoid estate taxes for as many generations as applicable state law allows. Depending upon how it is drafted and in which jurisdiction it is sitused, the trust assets can also be protected from creditors, including divorcing spouses and bankruptcy. Many Dynasty Trusts are drafted as Beneficiary Controlled Trusts which are trusts in which the primary beneficiary is either (i) the sole trustee, or is (ii) the investment trustee and serves with a co-trustee who has the power to make distributions and who the primary beneficiary has the power to fire and hire. The Beneficiary Controlled Trust is designed to provide the primary beneficiary with all of the rights, benefits and control over the trust property that he would have had if he owned it outright, in addition to tax, creditor and divorce protection benefits that are not obtainable with outright ownership. This concept should not only be applied to the children’s generation, but also to the grandchildren’s generation, the great-grandchildren’s generation and more remote generations depending upon the applicable state perpetuity restrictions. Many clients will choose to domicile the Dynasty Trust in the client’s home state, while others will select a superior state by adding a co-trustee from that jurisdiction. The superior state might include a longer perpetuities period, stronger creditor protection laws, state income PAGE
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tax savings, more flexible decanting statutes and/ or other more flexible laws. In order to domicile the Dynasty trust in another state, the trust agreement should include a co-trustee from that state. In many cases, this co-trustee will be a trust company or bank.
ALASKA/DELAWARE/NEVADA/SOUTH DAKOTA Alaska, Delaware, Nevada and South Dakota handle a very large majority of the out-of-state Dynasty Trust business. Although there are differences among the four states, each of these states provides favorable laws for Dynasty Trusts. This article will illustrate some of the differences among these states. Rule against Perpetuities – A favorable Dynasty Trust state will have a long perpetuities period. Alaska allows a trust to continue perpetually, except that the trust is limited to 1,000 years if a beneficiary exercise a power of appointment. Delaware allows a trust to continue perpetually as to personal property, but limits a trust to 110 years as to real property. Nevada allows a trust to continue for 365 years. South Dakota allows a trust to continue perpetually. State Income Tax – All four of these states have no state income tax on trusts, except that Delaware has a state income tax if there is a Delaware beneficiary (which is unlikely given the tiny Delaware population). Third-Party Spendthrift Trust Provisions Effectiveness against Divorcing Spouses – Alaska, Nevada and Nevada third-party irrevocable spendthrift trusts are all protected from divorcing spouses of the beneficiaries. Delaware third-party spendthrift trusts are not protected from divorcing spouses under Garretson v. Garretson, 306 A.2d 737 (1973), a case decided in the Supreme Court of Delaware. However, the trust scrivener can draft around this problem in Delaware by draft-
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ing the trust as a discretionary trust rather than as a support trust. In other words, the scrivener would avoid using the more prevalent “health, education, maintenance and support” type of trust if using Delaware law. Decanting – A trust is decanted by having the distribution trustee make distributions to another trust for the benefit of one or more beneficiaries of the initial trust. It is often important for a Dynasty Trust jurisdiction to have flexible decanting statutes in order to give the distribution trustee flexibility to make changes, especially given the long duration of the trust. Delaware, Nevada and South Dakota have an advantage over Alaska in that Delaware, Nevada and South Dakota do not require the trustee to give notice to beneficiaries, whereas Alaska does unless the settlor exempts notice. Nevada and South Dakota have an advantage over Alaska and Delaware in that a Nevada or South Dakota trust with an ascertainable standard can be decanted into a discretionary trust (in order to give the trust stronger creditor protection), whereas Alaska and Delaware do not allow for this type of decanting. Delaware and South Dakota have an advantage over Alaska and Nevada in that Delaware and South Dakota allow a mandatory income interest to be removed in a decanting, whereas Alaska and Nevada do not. Overall, all four of these jurisdictions have strong decanting statutes, but some of the material differences have been noted herein.
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some of the material differences among these favorable Dynasty Trust states. All four of these states – Alaska, Delaware, Nevada and South Dakota – have strong Dynasty Trust laws. There are other states, such as Tennessee, Ohio and Wyoming, that don’t have the same pedigree and mystique as the “Big Four”, but yet are also strong Dynasty Trust states. The practitioner should seek out a good trust company or bank relationship in the jurisdiction of choice and take advantage of this golden opportunity for their clients.
About the Author: Steven J. Oshins, Esq., AEP (Distinguished) is an attorney at the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada, with clients throughout the United States. He is listed in The Best Lawyers in America®. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011 and was named one of the 24 Elite Estate Planning Attorneys in America by the Trust Advisor. He has authored many of the most valuable estate planning and asset protection laws that have been enacted in Nevada. He can be reached at 702-341-6000, ext. 2, at soshins@oshins.com or at his firm’s website, www.oshins.com.
SUMMARY Alaska, Delaware, Nevada and South Dakota have been battling for business for many years. Certainly there is enough trust business to pump plenty of revenue into the economies of all four of these states. Dynasty Trusts have been at the forefront of this battle for supremacy. While many estate planning practitioners have made use of these Dynasty Trust states, there are still many who have not yet expanded their practices to include out-of-state Dynasty Trusts as a regular part of their practices. One of the purposes of this article is to introduce the Dynasty Trust concept to those who have not used them, but another purpose is to illustrate PAGE
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IENT IDEAL CL
RELATIONSHIPS
The Surprising Connection between Marketing Your Law Firm and Weight Loss Patrick Carlson, J.D., LL.M. As we close out 2014, you’re probably starting to ponder New Year’s resolutions. If you believe the statistics, weight loss and financial goals often top the lists for New Year’s resolutions. So, how do you go about successfully achieving your resolutions? Most people approach weight loss from a dieting perspective. By dieting perspective, I mean a quick fix like a fad diet or some pill. But, if these quick fixes actually worked, why do so many people fail at their New Year’s resolutions? Are you approaching marketing your law business from a dieting perspective? When business is slowing down or you’re looking to grow, do you try “quick fixes” like poorly planned and inconsistently execut-
ed knee-jerk marketing efforts (like randomly scheduled seminars, aimless advertising campaigns, or haphazard referral relationship building) to move you forward?
will most likely become a healthy weight. In the same way, attorneys who integrate marketing into their business habits will develop a successful and profitable law business.
The problem is that quick fixes in marketing, like those in weight loss, don’t work in the long-term. A quick fix simply is not a path to sustainable profitability for your law business.
A change to a marketing lifestyle is what’s needed to have long-term, sustainable success in building your law business.
If a quick fix won’t work, what will?
A marketing lifestyle involves consistently and routinely doing activities that move you towards your ideal law business. It means knowing where you’re going and building relationships to get you there. It means making marketing your business a routine habit, like checking your email and attending client meetings.
Lifestyle change works. The word lifestyle is defined by Miriam Webster’s online dictionary as “a particular way of living.” I think of lifestyle – a particular way of living – as the group of daily, weekly, or monthly habits that you consistently and routinely keep. In the weight loss world, people who adopt healthy habits, like eating appropriately and exercising,
So, what does the marketing lifestyle look like?
It doesn’t mean dropping everything and having a singular focus
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on marketing. But marketing must be a priority on par with client service and being home for dinner with your family. And yes, if you market your law business consistently and focus on the fundamentals, you’ll be home for dinner.
How to Live the Marketing Lifestyle by Implementing Three Marketing Fundamentals The first marketing fundamental is to develop a clear vision. You must know what your ideal business looks like and who your ideal client is. Having a vision is vitally important because you must know where you want to go to develop a workable roadmap. If you don’t start with a clear vision of your ideal business and ideal client, then your marketing message will be unfocused and less effective. If you’ve never thought about what you truly want out of your business, then now is the best time to get started by writing down your big picture goals. Here are a few questions you should ask yourself when thinking about your big picture goals: what does your business look like in terms of number of clients, amount of revenue, and amount of time off for you? Another key component of vision is describing your ideal client. Your ideal client is the person you most enjoy working with, needs the services you offer, and is able to pay you a reasonable fee for what you do. If you’re new to this process, here’s a tip to get you started: write down characteristics, like age, marital/family status, amount
of wealth, planning goals, etc., that your ideal client possesses. The way you live the marketing lifestyle is to consistently direct your marketing messages to your ideal client. Each blog post, website page, Facebook comment, direct mail piece, or seminar directed to your ideal client moves you one step closer to attracting your ideal client and ultimately achieving your vision. The next marketing fundamental that requires consistent, dedicated effort is relationship building. This means creating meaningful, mutually beneficial relationships with advisors and other wealth professionals in your community as well as with your clients. Actively using social media, sending newsletters and marketing kits, posting videos, holding seminars, and giving outstanding client service all contribute to building relationships. Every interaction you have with a client, before, during, and after representation, is an opportunity for you to build a relationship of trust and concern – in essence an opportunity to market yourself and your law business. One easy way to live the marketing lifestyle (and fulfill your ethical obligations) is to earnestly fulfill the promises you make to your clients. The third marketing fundamental that must become a habit is promoting yourself as an expert. As a WealthCounsel member, you have the educational resources and document drafting solutions to handle virtually any wealth planning opportunity out there. Writing, speaking engagements, seminars, and media appearances are activities that enhance your expert
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status in the eyes of your clients and with wealth professionals in your community. Incorporating these activities into your business routine will result in a big payoff. It’s easy to get caught up in the minutia of client matters and the other aspects of running a business. But, if you consistently carve out time every day to work on implementing your vision, attracting your ideal client, building relationships, and promoting yourself as an expert, you might discover that it becomes the most valuable time you spend at work. Like achieving health and fitness (and a weight loss goal!), successfully marketing your law business takes work and dedication. You can’t skip workouts and there are no quick fixes. But the reward of a successful, profitable law business awaits you if you’re determined and willing to put in the effort. About the Author After starting up his own law firm in 2011, Patrick quickly uncovered a passion for legal marketing and law practice management. This passion for legal marketing and practice management led him to the Advisors Forum, where he joined as a Law Business Mentor in September 2014. His mission at the Advisors Forum is to empower WealthCounsel members to create their ideal law business. Patrick received his undergraduate degree in economics from the University of Oklahoma, his JD from the University of Oklahoma College of Law, and his LLM in Taxation from the University of Florida Levin College of Law. PAGE
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Education Calendar Q1 JAN 5 Advisors Forum Legal Marketing Quick Start Program - January (90-day program, sessions held weekly) JAN 6
Advisors Forum Advanced Mentoring: How to Build Your Business with Stealth Webinars (90-day program, sessions held weekly)
JAN 20-30 RLT Drafting Intensive virtual course JAN 22
JAN 27
JAN 29
Word on the Street – Heckerling Recap webinar How to Market Your Business Planning Practice webinar Advisors Forum Legal Marketing Showcase webinar
FEB 5
Advisors Forum Legal Marketing Quick Start Program - February (90-day program, sessions held weekly)
FEB 10
Closing the Deal: Conducting Business Planning Interviews webinar
FEB 19 Word on the Street – Incapacity Planning FEB 19-20 Estate Planning Essentials in-person course
FEB 23-26 SRT Mini-Intensive virtual course FEB 26
Advisors Forum Legal Marketing Showcase webinar
MAR 3
Thought Leader Series webcast
MAR 4
Business Planning webinar
MAR 9-20 Trust Administration Intensive virtual course
MAR 19
Word on the Street – Asset Protection Planning webinar
MAR 23- APR 3
Estate Planning Essentials II – Expanding Your Toolkit virtual course
MAR 24
Practical Implications of Dealing with Diminished Capacity webinar
MAR 26 Advisors Forum Legal Marketing Showcase webinar
Q2 APR 6-17
RLT Drafting Intensive virtual course
MAY 21
APR 14
Business Planning webinar
MAY 26-29 Wills Mini-Intensive virtual course
APR 16
Word on the Street webinar
MAY 28
APR 23
Advisors Forum Legal Marketing Showcase webinar
Word on the Street webinar
Advisors Forum Legal Marketing Showcase webinar
JUN 9
Business Planning webinar
APR 27-30 Funding Mini-Intensive virtual course
JUN 15-26 LLC Intensive virtual course
MAY 11-15 Ancillaries Mini-Intensive virtual course
JUN 18
Word on the Street webinar
MAY 12
Business Planning webinar
JUNE 23
Joint Webinar with FSP
MAY 19
Thought Leader Series webcast
JUN 25
Advisors Forum Legal Marketing Showcase webinar
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SAVE THE DATE Experience the Extraordinary Learning Environment at Symposium in San Diego Join WealthCounsel, ElderCounsel, and Advisors Forum in San Diego next July for a learning event unlike any other you’ve experienced as an attorney. You can deepen your expertise through both plenary and breakout sessions covering estate planning, business planning, elder law, and special needs planning while you learn how to grow your practice with the latest legal mar marketing strategies. But you won’t just sit in classrooms. You’ll hear thought provoking and motivational talks from bold business leaders, brainstorm with your peers in group workshops, and maybe even venture off-site for some unique learning in a uniquely San Diego location. When it’s over, you’ll be fired up and ready to put your learning into action.
Register now! Early registrants will enjoy discounted tuition.
2015Symposium.com
JULY 13 - 17, 2015
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Call for articles: The WealthCounsel Quarterly is published four times a year. It is a communication platform though which WealthCounsel members can share legal expertise with their colleagues while enhancing their professional exposure within the estate planning community. Members are invited to contribute a legal/technical article or a column on practice-building strategies for the next issue. Article length should be an average of 800-1000 words.
02-09-14: Publish-ready article manuscripts due
The WealthCounsel Quarterly is published four times a year. It is a communication platform though which WealthCounsel members can share legal expertise with their colleagues while enhancing their professional exposure within the estate planning community. Members are invited to contribute a legal/technical article or a column on practice-building strategies for the next issue. Article length should be an average of 800-1000 words.
Want to reserve your space for the next issue? Have a question about the process? Send an email to newsletter@wealthcounsel.com to reach
Publishing deadlines for the next issue of the WealthCounsel Quarterly:
Publishing deadlines for the next issue of the WealthCounsel Quarterly: 01-25-14: Please submit your topic idea to reserve a space in the layout
the editorial review board.
01-25-14: Please submit your topic idea to reserve a space in the layout 02-09-14: Publish-ready article manuscripts due Want to reserve your space for the next issue? Have a question about the process? Send an email to newsletter@wealthcounsel.com to reach the editorial review board.