2017 Tax Cuts & Jobs Act Presentation

2017 Tax Cuts and Jobs Act: The Good, The Bad, & The Ugly June 7, 2018

M A R C P A © 2018 Hawaii Community Foundation

I L Y N

L L C

J . G

A G E N

,

Individual Provisions

Tax Brackets Expanded and Rates Lowered...

For Some

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Individual Provisions Tax Brackets Expanded and Rates Lowered – For Some Single Taxpayers 2017 Tax Law Rate

Taxable Income Over

Tax Cuts & Jobs Act (2018-2025) But Not More Than

Rate

Taxable Income Over

But Not More Than

10%

$0

$9,525

10%

$0

$9,525

15%

9,525

38,700

12%

9,525

38,700

25%

38,700

93,700

22%

38,700

82,500

28%

93,700

195,450

24%

82,500

157,500

33%

195,450

424,950

32%

157,500

200,000

35%

424,950

426,700

35%

200,000

500,000

39.6%

426,700

37%

500,000

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Individual Provisions Tax Brackets Expanded and Rates Lowered – For Some MFJ Taxpayers 2017 Tax Law Rate

Taxable Income Over

Tax Cuts & Jobs Act (2018-2025) But Not More Than

Rate

Taxable Income Over

But Not More Than

10%

$0

$19,050

10%

$0

$19,050

15%

19,050

77,400

12%

19,050

77,400

25%

77,400

156,150

22%

77,400

165,000

28%

156,150

237,950

24%

165,000

315,000

33%

237,950

424,950

32%

315,000

400,000

35%

424,950

480,500

35%

400,000

600,000

39.6%

480,500

37%

600,000

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Simplification? Some Yes…Some No •Personal exemptions repealed •AMT not repealed •Standard deduction increased •Itemized deductions limited © 2018 Hawaii Community Foundation

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Simplification? Some Yes…Some No •Personal exemptions temporarily repealed from 2018 through 2025 (not adopted for Hawaii) •AMT – not repealed ✓Exemptions increased from 2018 through 2025: ✓Phase-out of exemptions increased

•Standard Deduction – increased from 2018 through 2025 (not adopted by Hawaii) ✓$24,000 MFJ ✓$18,000 Unmarried with qualifying child ✓$12,000 Single © 2018 Hawaii Community Foundation

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Individual Provisions •Itemized Deductions Limited (Effective 2018 through 2025 unless otherwise noted) (not adopted by HI) ✓Mortgage interest deduction reduced ✓Miscellaneous itemized deductions subject to 2% limitation eliminated ✓Personal casualty losses eliminated except for federally declared disaster area ✓State and local income, sales and property taxes limited to $10,000 ✓Repeals moving expense deductions and exclusion from income for moving expense reimbursements except for active military © 2018 Hawaii Community Foundation

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Individual Provisions •A Few Itemized Deductions Increased ✓Unreimbursed medical and dental ✓Pease limitation for higher income taxpayers eliminated (not adopted by Hawaii) ✓Charitable contribution limitation on cash gifts increased from 50% to 60% of AGI

•Alimony Deduction and Income Inclusion Eliminated •Tax Brackets Expanded and Rates Lowered – For Some © 2018 Hawaii Community Foundation

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Individual Provisions • Miscellaneous Provisions – Generally Effective 2018 thru

2025 ✓Child tax credit doubled to $2,000 per child with $1,400 refundable ✓Carried interest holding period extended to 3 years to be taxed at long-term capital gains rates ✓Basis in life insurance policy upon sale of policy is not reduced by cost of insurance retroactive to transactions entered into after August 25, 2009 ✓Up to $10,000 per year per student of funds in §529 plan can be used for elementary or secondary public, private or religious school tuition or expenses – but not home schooling ✓Kiddie tax rate is now trust tax rate instead of parents’ top rate…may be lower! © 2018 Hawaii Community Foundation

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Individual Provisions •Miscellaneous Provisions – Generally Effective 2018 thru 2025 ✓Individual mandate penalty under ACA eliminated effective 2018 and permanent ✓Filing requirement clarification – individuals do not have to file a tax return if their income does not exceed the standard deduction. ✓Recharacterization cannot be used to unwind a Roth IRA, but can be used to recharacterize contributions to IRAs ✓Gambling losses not to exceed gambling winnings expanded to include any otherwise allowable deduction in carrying on gambling activity (ie. travel to and from casino) ✓Members of Congress no longer allowed to deduct up to $3,000 of expenses away from home effective for years beginning after December 22, 2017

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Individual Provisions •Miscellaneous Provisions – Generally Effective 2018 thru 2025 ✓Pease limitation on itemized deductions eliminated ✓AMT exemption increased, and phase out of exemption substantially increased

• Provisions that didn’t make the final act - but watch out for these in the future ✓Requirements for $500,000 exemption for sale of personal residence – ownership and use increase to 5 out of 8 years ✓Requiring FIFO for sale of securities, lack of ability to identify lots to sell

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Planning for Changes •Multi-year planning is critical ✓Bunch itemized deductions to take advantage of higher standard deduction ✓Use donor advised funds to front load charitable contributions in one year to be paid out to charities over more than one year

•Rethink placement of assets in portfolios ✓Previously REITs were often held in qualified plan accounts due to high ordinary, non-qualifying dividends ✓With REITs qualifying for QBI deduction, may be better to hold in taxable accounts

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Planning for Changes •Managing brackets in retirement ✓For clients with large qualified plan assets, consider taking distributions before age 70 ½ to utilize lower brackets ✓Watch for opportunities to make Roth conversions in years with low income ✓But beware of triggering higher medicare premiums (which are based on income levels) and higher taxability of social security benefits

•AMT Credits ✓With far fewer taxpayers in AMT many will finally have an opportunity to utilize their AMT credit carryovers

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Example: The Squeeze...

H&W have two dependent children, make $3,000 in cash gifts to charity, $10,000 in deductible mortgage interest, and $30,000 in State and local taxes.

2017

2018

Cash Gift

$3,000

$3,000

Mortgage Interest

10,000

10,000

SALT

30,000

10,000

8,100

0

Total Itemized Deductions

$43,000

$23,000

Total Itemized Deductions & Exemptions

$51,100

$23,000

Standard Deduction

$12,700

$24,000

Personal Exemption

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Example: The Squeeze... (continued) Increased Tax and Reduced Withholding!

2017

2018

Wages - H

$75,000

$75,000

Wages - W

75,000

75,000

Tax

14,200

19,600

0

(1,000)

14,200

18,600

(13,900)

(11,600)

$300

$7,000

Child Credit – Children Over 16 Net Tax * Withholding (Single 0) Tax Due * Child credit would increase to $4,000 for qualifying children © 2018 Hawaii Community Foundation

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Example: Home Equity Loans In January, 2018, Taxpayer takes out a $500,000 mortgage to purchase a main home with a FMV of $800,000. The loan is secured by the main home and the Taxpayer pays $10,000 in mortgage interest. In February, 2018, the Taxpayer takes out a $250,000 home equity loan to purchase a vacation home. The loan is secured by the main home and the Taxpayer pays $7,000 in interest. What would be the difference in result, if any, if the same transaction occurred in 2017?

Mortgage Interest – Main Home HELOC Interest Deductible Mortgage Interest

2017

2018

$ 10,000

$ 10,000

7,000

-

$ 17,000

$ 10,000

IR-2018-32: The Tax Cuts and Jobs Act of 2017, enacted Dec. 22, suspends from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan. https://www.irs.gov/newsroom/interest-on-home-equity-loans-often-still-deductible-under-new-law

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Individual Provisions •What didn’t change? ✓Long-term capital gains rate at 20% ✓3.8% net investment income tax ✓0.9% FICA high tax rate ✓Exclusion of gain on the sale of principal residence ✓Contributions to 401K plans excluded from earned income ✓Cost basis of specified securities © 2018 Hawaii Community Foundation

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Main Entity Provisions •Corporate rate reduction •New Qualified Business Income Deduction for Pass-Through Entities •Accelerated cost recovery •Interest paid deduction limit •Loss deduction limits •Dividends received deduction

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Corporate Rate Reduction • 21% flat rate on corporate taxable income - Eliminates 15% to 35% tax brackets - Previously, one of the highest rates in the world (cf. Canada at 26.5%, England at 19%) • Applies to C corporations • Should reduce tax planning to outsource U.S. business income

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Qualified Business Income Deduction (§199A) • Deduction equal to 20% of domestic “qualified business income” from a pass-through entity • Effectively, a top marginal rate of 29.6% • Applies to trusts and estates as owners

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Choice of Entity?

Corp Business Income

Pass Through

$100,000

$100,000

-

(20,000)

$100,000

$80,000

(21,000)

(29,600)

79,000

70,400

Shareholder Income Tax (23.8%)

(18,800)

-

Net to Owner

$60,198

$70,400

Effective Tax Rate

39.80%

29.60%

QBI Deduction (20%)

Taxable Income Income Tax (21%|37%) Net Income

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LLC?

C-Corp vs. S-Corp?

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How to Qualify for 20% QBI Deduction?

• • • •

Qualified Business Qualified Business Income W-2 and Property Limitations Taxable Income Limitations

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Step 1: Qualified Business?

• Any “trade or business” other than a corporation (including a sole proprietorship) QUERY: What is the standard for determining which activities constitute a trade or business? Section 162? Case law?

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Step 2: Qualified Business Income?

• Must be “effectively connected” to U.S. trade or business • Interest, dividends, capital gains are excluded • Salaries or partnership guaranteed payments are excluded (i.e., wages and guaranteed payments are taxed at ordinary rates and not eligible for the deduction) • Specified service businesses qualify unless “taxable income” is too high Specified service business (§1202(e)(3)(A)): -Health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services; or any trade or business where the principal asset … is the reputation or skill of 1 or more of its employees or owners; or investing and investment management.

Say What?? Architects and engineers specifically excluded from this definition... © 2018 Hawaii Community Foundation

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Step 3: W-2 and Property Limitations?

Specified Service

Non-Specified Service

If Taxable Income is less than $157,000 single; $315,000 MFJ

20% of QBI

20% of QBI

If Taxable Income is in the range of $157,000 $207,500 single; $315,000 $415,000 MFJ

Deduction is the lesser of A or B, as adjusted.

A = 20% of QBI B = The greater of (1) 50% of the W-2 wages; or (2) 25% of the W-2 wages + 2.5% of unadjusted (original) basis of qualified property.

The deduction is the lesser of: A = 20% of QBI; or B = The greater of (1) 50% of the W-2 wages; or (2) 25% of the W-2 wages + 2.5% of unadjusted (original) basis of qualified property.

A and B are adjusted by the applicable percentage, or 100% minus % of the excess taxable income (over the threshold) divided by the range ($50K single; $100K MFJ).

If A is greater than B, then find 1 = The difference between A and B 2= The excess taxable income (over the threshold) divided by the range ($50K single; $100K MFJ).

3 = Multiply 1 and 2 The deduction is the 20% of QBI reduced by the results of 3

If Taxable Income is greater than $207,500 single; $415,000 MFJ

There is no deduction

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Deduction is the lesser of A or B. A = 20% of QBI B = The greater of (1) 50% of the W-2 wages; or (2) 25% of the W-2 wages + 2.5% of unadjusted (original basis) of qualified property.

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Step 4: Taxable Income Limitation?

• Deduction cannot exceed the lesser of - Combined QBI amount, or - 20% x (total taxable income – capital gain) • Combined QBI amount = deduction for each qualified trade or business + 20% of REIT dividends and publicly traded partnership (PTP) income

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Example 1 – Non-Specified Service ▪ ▪ ▪ ▪ ▪ ▪

Sole Proprietorship Lei Maker Filing status is single No employees $100,000 taxable income $100,000 qualified business income ▪ No W-2 wages ▪ No capital gains ▪ Business asset acquired for $100,000

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QBI BELOW THRESHOLD A

Qualified Business Income

B

20% QBI Deduction

C

50% W-2 Wage Limitation

N/A

D

25% of W-2 Wage + 2.5% of Basis Limitation

N/A

E

Greater of C or D

N/A

F

Actual QBI Deduction: Lesser of B or E

(20,000)

G

Taxable Income: A minus F

$80,000

H

Income Tax at 24%

$19,200

Effective Tax Rate

19.20%

$100,000 (20,000)

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Example 2 – Specified Service ▪ ▪ ▪ ▪ ▪

S-Corporation Attorney Filing status is single $200,000 taxable income $100,000 qualified business income ▪ W-2 wages of $100,000 ▪ No capital gains ▪ Business asset acquired for $100,000

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QBI ABOVE THRESHOLD & W-2 WAGES A

Qualified Business Income

$100,000

B

Tentative QBI Deduction ($100,000 x 20%)

(20,000)

C

50% W-2 Wage Limitation ($100,000 x 50%)

(50,000)

D

25% W-2 Wage + 2.5% of Basis Limitation

(27,500)

E

Excess of taxable income over $157,500 threshold divided by Range ($42,500/50,000)

85%

F

Applicable phase-out percentage (100% – E)

15%

G

Adjusted 20% QBI Deduction ((15% x $100,000) x 20%)

(3,000)

H

Adjusted 50% W-2 Wage Limitation ((15% x 100,000) x 50%)

(7,500)

I

Adjusted 25% W-2 Wage + 2.5% of Basis Limitation ((15% x 100,000) x 25%) + ((15% x 100,000) x 2.5%)

(4,125)

J

Greater of H or I

(7,500)

K

Actual QBI Deduction: Lesser of G or J

(3,000)

L

Taxable Income: A minus K

$97,000

M

Income Tax at 35%

$33,950

Effective Tax Rate

33.95% 28

Accelerated Cost Recovery • Bonus depreciation expanded: Immediate 100% expensing of capital investments (before 2023; phase-out through 2026): - 9/17/17 – 2022 100% - 2023 80% - 2024 60% - 2025 40% - 2026 20% • Expanded to include used property (vs. only new) © 2018 Hawaii Community Foundation

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Accelerated Cost Recovery (cont’d) • Expanded §179 expenses for small businesses: $1M (phase-out starts at $2.5M) - New and used property - Expands definition of qualified tangible personal property and qualified real property to include: * TPP used predominantly in connection with furnishing lodging * Improvements to nonresidential real property placed in service after first placed in service (e.g., roofs; heating, ventilation and A/C; fire protection and alarm systems; and security systems © 2018 Hawaii Community Foundation

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Accelerated Cost Recovery (cont’d) • Real property trade or business electing out of new limit on deduction of interest paid must use ADS, with following recovery periods: - Qualified improvement property – 20 years (vs. 39) - Nonresidential real property – 40 years - Residential real property – 30 years (vs. 40)

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Accelerated Cost Recovery (cont’d) • Consolidates qualified leasehold improvement, qualified restaurant and qualified retail improvement property - “Qualified improvement property” - 15-year general recovery period; 20-year ADS - Generally, 10-year straight line depreciation; ½ year convention - Most §179 expensing remains © 2018 Hawaii Community Foundation

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Business Interest Deduction • Businesses with average gross receipts for 3-year prior period <$25M are exempt • Interest expense >30% of “adjusted taxable income” disallowed • “Adjusted taxable income” computed without regard to depreciation, amortization or depletion

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Business Interest Deduction (cont’d) • Disallowed interest carried forward indefinitely • Determined at entity level (e.g., testing at partnership and consolidated return level for corporations • Certain real property and construction businesses and farm may be exempted at taxpayer’s election (but must use ADS).

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Loss Deduction Limits â&#x20AC;˘ Net operating loss (NOL) carry-forward - Deduction limited to 80% of taxable income (90% for AMT) - Unused NOLs carried forward indefinitely - NOL carry back eliminated - Tax years beginning after 2017

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Loss Deduction Limits (cont’d) • New subsection 461(l) • Excess business losses disallowed - Carried forward - Taxpayers with income >$500K - Applies at partner or shareholder level - In addition to basis, at-risk, and passive loss limits

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Dividends Received Deduction • Deduction for corporate shareholders of domestic corporations reduced - From 70% and 80% to 50% and 65% • 100% deduction for dividends from affiliated group members retained • Separate DRD rules for international tax provisions

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Miscellaneous • Corporate alternative minimum tax (AMT) repealed - Expanded utilization of existing AMT credits against regular tax liability

• Deduction for local lobbying expenses repealed • As of 2022, R&D expenses amortized over 5 years - But software development expenses treated as R&D

• Allows TPs with average gross receipts <$25M to use cash method and not keep inventories © 2018 Hawaii Community Foundation

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Estate & Gift Tax • Basic Exclusion Amount Increases to $1OM per individual, $11.18M indexed for inflation NOTE: This expires on 12/31/2025 • Annual Exclusion Increases to $15,000 • Inflation adjustment Remains, but CPI changes • Stepped-Up Basis Remains • 40% Tax Rate Remains • Portability Remains NOTE: Exclusion amount increase NOT adopted for Hawaii © 2018 Hawaii Community Foundation

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Estate (Tax) Planning for Families W and H have estates that are equal in value.

Neither has made any taxable gifts. Both have A/B plans that leave their estates to benefit each other first. At the death of the surviving spouse, the amount of the estate over the exclusion amount would go to charity, with the remainder to their children.

In light of the tax reform, how is planning affected if their estates are each worth: ▪ $3M each ($6M combined)?

▪ $6M each ($12M combined)?

▪ $12M each ($24M combined)?

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Other Considerations • • • • •

Type of assets (cash, appreciated, closely-held) Disclaimers GPOA/LPOA Asset protection (blended family; family business) Charitable intent

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Planning Conundrum ESTATE VALUE 2017 PLANNING

2018 PLANNING?

Large Estates

Combined estate > $10.98M

Combined estate > $22.4M

Flexible planning around minimizing estate taxes

???

Medium Estates

Combined estate from $5.49M to $10.98M

Combined estate from $11.18M to $22.4M

Flexible planning that minimizes either estate tax or income tax

???

Small Estates

Combined estate < $5.49M

Combined estate < $11.18M

Flexible planning around minimizing income taxes

???

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Top 5 Tax Changes Potentially Affecting Giving • Increased Standard Deduction (from $12.7K to $24K, married couple)

• New Limits on Deductible Items (SALT capped at $10K; Mortgage interest on $750K)

• Decreased Top Income Tax Rate (from 39.6% to 37%)

• Decreased Corporate Tax Rate (eliminates 15% to 35% brackets with 21% flat tax rate)

• Increased AGI Limit for Cash Gifts (from 50% to 60%. Yay!) © 2018 Hawaii Community Foundation

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What Might it Mean for Charitable Giving?

2017

2018

$ 100

$ 100

Less: Income Taxes Saved

(40)

(37)

Net Cost of Gift if Itemizing

$ 60

$ 63

Net Cost of Gift If Not Itemizing

$ 100

$ 100

Charitable Gift

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Indiana University Lilly Family School of Philanthropy concluded that increasing the standard deduction and decreasing the top marginal tax rate (from 39.6 percent to 37 percent) could decrease annual giving by $11 billion and $2 billion, respectively.

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At the End of the Day...What Matters?

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My Two Cents...

GIVING TYPE

SIGNIFICANTLY AFFECTED?

“Affinity” Giving

No

Individual Giving (Smaller Gifts)

No

Corporate Giving

Maybe, could increase

Major Gifts

Maybe, if tax driven

Capital Campaigns

Maybe, if tax driven

Give Now, Get Now Gifts (Planned)

Maybe, if tax driven

Bequests – Gifts at Death

Maybe, if tax driven

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Questions? Mahalo!

The Center for Professional Advisors TheCenterGurus@hcf-Hawaii.org Curtis K. Saiki, SVP of Development & General Counsel Jen-L W. Lyman, Director of Philanthropic Partnerships

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Who Are We? MARILYN J. GAGEN has over 46 years of experience in public accounting with Deloitte & Touche LLP. In 2002, Marilyn retired as the partner-in-charge of the Deloitte Hawaii tax practice but she still continues to work with a few long-time high net worth individuals, trust, estates, and family partnerships specializing in income tax planning, estate tax planning, and charitable giving.

MICHAEL J. O’MALLEY is the Managing Partner at the firm Goodsill Anderson Quinn and Stifel. He has over 37 yaers of experience representing for-profit, non-profit and health care clients in their initial organization and structuring of business dealings, M&A transactions, infrastructure, capital and other financings, regulatory compliance, tax planning and proceedings before tax authorities, and also addresses issues of corporate governance and fiduciary duty.

CURTIS K. SAIKI is Senior Vice-President of Development and General Counsel of the Hawai`i Community Foundation. He has 22 years of experience in taxes, estates, and trusts. He taught Trusts & Estates at the University of Hawai’i School of Law, launched First Hawaiian Bank’s Wealth Planning Department, and practiced for over 12 years in trusts & estates and taxation at Cades Schutte and Kobayashi, Sugita & Goda. Curtis is the President of the Hawai’i Gift Planning Council. Hawai`i Business Magazine has recognized him as one of Hawaii’s Best Wealth Managers and Top Executives.

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Disclaimer Neither the Hawai`i Community Foundation nor its representatives engage in the practice of law. The purpose of this presentation is for educational purposes only in regards to the subject matter covered. It is being provided with the understanding that the authors are not engaged in rendering legal, accounting or any other professional services. Due to the rapidly changing nature of the law, information contained in this presentation may become outdated.

Thus, this presentation should not be utilized as a substitute for your own research and analysis to update the information and ensure accuracy. If legal advice or other expert assistance is required, the services of a professional should be sought.

The authors specifically disclaim any liability, loss or risk incurred as a result of the use and application, either directly or indirectly, of any advice and information contained in this presentation, whether or not negligently provided. All examples, illustrations, tips and recommendations are suggestions only, and changes must be made depending on the specific circumstances in each case.

Any federal tax advice contained in this communication (including any attachments or enclosures) is not intended and cannot be used for purposes of avoiding penalties imposed by the IRS or to promote, market, or recommend to another party any tax related matter(s) addressed herein. Š 2018 Hawaii Community Foundation

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