Tennessee Estate Planning Law : Tennessee Estate Planning Lawyer & Attorney : Bryan Howard : Howard & Mobley Law Firm : Nashville, Chattanooga, Memphis

This is the fourth article of a series designed to provide guidance for those individuals who are considering making a large gift in 2012 to take advantage of the $5.12 million federal gift tax exemption that will expire at the end of the year. For the first three articles in the series, see:

          Part 1: Use It or Lose It,

          Part 2: Can You Afford to Make a Large Gift?, and

          Part 3: When Should You Make the Gift?

In addition to tax savings, gifts can provide a lot of positive benefits for the donees. For example, consider a child who is divorced and having to work two jobs to make ends meet. A gift might enable your child to give up the second job and spend more time with your grandchild.

Gifts also have potential downsides. A lot of our clients worry a great deal about the effect that a large inheritance will have on their children. They like the idea of their children being motivated to become productive members of society. They fear that their children may not reach their full potential if they do not have to work.

Heretofore, the primary time when this issue has been relevant was when our clients were planning their estates. Some clients create strict trusts in their Wills that match the child’s earnings from their work. Other clients choose to give most of their entire estate to charity, making only modest bequests to their children.

Our clients have not previously worried much about the effects of a large gift because federal and Tennessee gift taxes stopped them from making large gifts. However, the ability for a married couple to give $10.2 million without paying any federal or Tennessee gift taxes in the calendar year 2012 has caused our clients to focus on this issue.

If you are concerned that a large gift might negatively impact your children, you should make the gift to a trust and/or give noncontrolling interests in business entities. A trust helps in several regards. First, the trustee will be in control of investing the funds and making distributions. Second, Tennessee allows “secret” trusts. Your children do not have to know about the existence of the trust or the assets owned by the trust. You can designate a representative to receive any required notices concerning the trust. Third, if you are married, you should consider making your spouse the primary beneficiary of the trust. Your spouse can also be the trustee of the trust. Your children do not have to receive distributions from the trust. Fourth, your spouse or some other person can be given a power of disappointment that can be used to make changes to the trust in the future. For example, if one of your children “leaves the reservation”, that child could be disinherited as a beneficiary of the trust. Fifth, we generally recommend making the trust a grantor trust for income tax purposes. Even if your child receives a distribution from the trust, he or she will not receive a K-1 which might reveal information about the trust.

Another method for limiting the consequences of a gift is to give nonvoting stock, nonvoting interests in a limited liability company, or limited partnership interests. These assets are difficult to sell. Furthermore, the owners with voting control will determine the distribution policy of the company and the level of salaries paid to key officers. Your children may be rich on paper, but they will need to keep working if they want to put food on the table.  Incidentally, these types of assets typically receive valuation discounts of 35% or more due to illiquidity and lack of control.  The discount allows you to make a larger gift.

Making a large gift may lead to unintended consequences. You can minimize these consequences by giving particular types of assets or by making the gift to a properly designed trust.

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In a surprising move, the Tennessee legislature has repealed Tennessee gift taxes, effective for gifts made on or after January 1, 2012. This is welcome news for a lot of our clients who plan to make a $5.12 million gift later this year. Our clients have been considering various ways to make their gifts without paying Tennessee gift tax. They will no longer have to worry about the gift tax.

Some of our clients knew that a change in the gift tax might occur later this year and have made large loans to their children. These clients will now consider forgiving the loans or giving other assets to their children.

Tennessee’s repeal of its gift tax leaves Connecticut as the only state that charges gift taxes.

The fiscal note for this bill estimated that it will cost the state approximately $15 million per year in revenue. I am sure that the revenue loss for 2012 will be a significantly higher amount due to the window of opportunity for making tax-free gifts at the federal level.

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The Tennessee legislature repealed Tennessee’s inheritance tax, effective as of January 1, 2016. This means that if you can survive until 2016, you will not owe any Tennessee inheritance taxes. If you die before that date, you will owe taxes if your taxable estate exceeds the following exemption levels:

Since the tax still applies until 2016, Wills of married persons should still establish Tennessee QTIP Trusts. This will avoid tax at the first death. As long as the surviving spouse survives at least until 2016, the Tennessee inheritance tax will be permanently eliminated.

There are a lot of existing Tennessee QTIP Trusts (sometimes referred to as Tennessee Gap Trusts) for married individuals who died over the last few years or chose to make a gift to such a trust. These trusts are irrevocable and cannot be modified to add the children as beneficiaries or to change the income payout requirements for the spouse. Depending on the terms of the trust, it may be possible to distribute corpus of the trust to the spouse. Unfortunately, due to the instability of the federal estate tax laws, it would be imprudent to distribute assets from a TN QTIP trust to the spouse. As of January 1, 2013, the federal estate tax exemption is scheduled to be only $1 million. Distributing assets from the Tennessee QTIP Trust might increase federal estate taxes payable by the spouse’s estate.

The elimination of the Tennessee inheritance tax will eventually simplify estate planning for our clients. However, for the next four years, we must pay attention to this tax.

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The potential repeal of Tennessee’s inheritance tax has once again drawn national attention. Last week, the Wall Street Journal published an article and a letter to the editor regarding this matter. This week, the Institute on Taxation and Economic Policy has published a scathing rebuttal of an analysis done by Arthur Laffer and Wayne Winegarden.

In stark contrast to the Laffer article, the ITEP article concludes that repealing the inheritance tax will not significantly increase jobs in Tennessee. I sincerely doubt that Governor Haslam and the legislature believe that repealing the inheritance tax will create 220,000 new jobs. Rather, they perceive the tax to be unfair and realize that some of our wealthiest citizens have left Tennessee to avoid the tax.

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This is the third article of a series designed to provide guidance for those individuals who are considering making a large gift in 2012 to take advantage of the $5.12 million federal gift tax exemption that will expire at the end of the year. For the first two articles in the series, see Part 1: Use It or Lose It and Part 2: Can You Afford to Make a Large Gift?

If you plan to make a gift this year, there are three competing factors you need to evaluate relative to the timing of your gift. First, the sooner you make the gift, the sooner the donee can receive income and appreciation from the gift. Second, Tennessee gift taxes may be repealed. If you make the gift now, you would be sorry if Tennessee gift taxes are repealed for gifts made later this year. Third, we don’t know for sure that the $5.12 million federal gift tax exemption will remain intact for the remainder of the year. Therefore, waiting for a potential change in the Tennessee gift tax laws or for other reasons carries some minor risk that the federal law will be changed before you make the gift. You may remember a rumor last year that caused some of our clients to make their gifts prior to November 23, 2011.

The benefit of making the gift sooner rather than later has been recognized by a couple whom I assisted with an $8 million gift last fall. They have received the 2011 Tennessee gift tax bill from their CPA. It is approximately $737,000. Ouch!

About the time they received their gift tax returns, my clients heard the rumor that Tennessee is considering a repeal of its gift taxes. They were somewhat disappointed that they had not considered delaying their gift, though no one had any idea that Tennessee might repeal its gift taxes during 2012 when my clients made their gifts. However, a closer analysis showed that the family will be considerably better off by having made the gift last fall even if Tennessee repeals its gift taxes. The gift constituted interests in an LLC that primarily owned marketable securities. Due to extraordinary returns in the stock market, the value of the gift has increased from $8 million to $9.2 million, or an increase of $1.2 million. If Tennessee repeals its gift taxes later this year and my clients had waited until that time to make an $8 million gift, the trust for their children would only have $8 million rather than $9.2 million. Especially since the trust is a grantor trust, the extra $1.2 million is likely to increase more between now and the time of death of my clients. If my clients had waited to make the gift, they would have received the $1.2 million of income and appreciation, and they would not have paid the $737,000 of gift taxes. Thus, their personal net worth would be $1,937,000 larger. If you assume a 40% death tax rate on this $1.9 million at the time of the death of the survivor of my client, the children will end up in about the same place. However, this does not take into account the additional earning power of the trust for the children having $9.2 million as compared to having $8 million. This could provide a substantial benefit between now and the time of death of the survivor. Even though my clients’ timing may have been too quick due to Tennessee gift taxes, it was just right from the point of view of appreciation. This was not an accident. My clients suspected that stocks might be poised for a rally when they pulled the trigger on their gift.

The current advice that we are giving is to wait and see if the Tennessee legislature makes a change to its gift tax laws. We expect to know the answer by the middle of May. Meanwhile, there does not appear to be any movement at the federal level to repeal this year’s large federal gift tax exemption. This advice changes for clients who are able to make gifts that do not require the payment of Tennessee gift taxes and for clients who have an asset that may appreciate rapidly in the next few weeks.

When it comes to making a large gift, timing is everything. If you are ready to make a large gift, you should be making preparations but should consider delaying the gift until the Tennessee legislature concludes its legislative session for this year.

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Over the last several years, several of our clients have changed their residences to Florida to avoid certain Tennessee taxes, including our inheritance taxes. Migration to avoid state inheritance taxes has also been occurring in other states.

Last week, the Wall Street Journal published an article about various states, including Tennessee, that are considering a repeal of their death taxes. The article states that “the main obstacle to reform in Nashville is GOP Governor Bill Haslam…”

Governor Haslam responded to the Wall Street Journal by writing a letter to the editor. In his letter, the governor points out that he has recommended repealing the taxes in the next three years and that he has worked with House Finance Committee Chairman Charles Sargent to completely repeal the taxes in four years. Indeed, the House Finance Subcommittee has recommended an amendment to House Bill No. 3760 that would increase the inheritance tax exemption to $1,250,000 in the year 2013, $2 million in the year 2014, $5 million in the year 2015, and would totally repeal Tennessee inheritance taxes beginning in the year 2016. I find it interesting that our state legislature has taken some lessons from recent federal tax cuts. If we can’t afford a tax cut now, phase it in so that the impact will be postponed to future years when revenue collections will hopefully be better. The danger with a phase-in approach is that it is easier for future legislatures to “change their mind.”

Normally, I would be skeptical that a bill with a large tax cut would survive the final budget cut. However, the governor’s unusual public support for the cut gives me reason to hope that this change will be made.

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Tax Foundation has published a map showing the top income tax rates in all 50 states. There are seven states that have no income taxes at all: Alaska, Washington, Nevada, Wyoming, South Dakota, Texas, and Florida. Tennessee and New Hampshire only tax dividends and interest. Except for Iowa, the high tax states are on the coasts.

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This is the second article of a series designed to provide guidance for those individuals who are considering making a large gift in 2012 to take advantage of the $5.12 million federal gift tax exemption that will expire at the end of the year. For the first article in the series, see Part 1: Use It or Lose It.

Prior to 2011, clients seldom made gifts of several million dollars unless they were very wealthy.  Due to the temporary expanded gift tax exemption, clients who are not so wealthy are considering gifts worth several million dollars. If you have $100 million, you might not miss the income that you will lose if you make a gift of $5 million. However, what if you have $20 million, or $8 million? The income you lose from a gift of $5 million might easily impact your lifestyle choices. Everyone has their breaking point.

Several of our clients who really cannot afford to lose the income from a gift have nevertheless made large gifts to take advantage of the temporary higher gift tax exemptions. In order for the gift to be prudent, our clients have taken several different approaches. One approach is to create more cash flow from another source prior to making a gift. Assume that you are 85 years old and you would like to have guaranteed cash flow of $200,000 per year. Also assume that your children, or a trust that you previously established for their benefit, are financially secure. You could transfer $1,157,000 of cash to your children or the trust in exchange for their obligation to pay you $200,000 per year for the remainder of your life. This transaction will not be considered a gift because the present value of the annuity payments that you are receiving equals the amount of property you are transferring to your children. After implementing the private annuity, you are then free to make a gift of other assets without worrying about losing the income from the assets that you gift.

Many of our clients have given away nonvoting interests in entities such as limited liability companies, limited partnerships, and corporations. By retaining voting control of these companies, our clients have the ability to pay themselves reasonable salaries for the services that they provide to the companies.

A very popular approach that our clients are using is to make a gift to a spousal access trust. There are two general types of spousal access trusts. One is a trust which includes your spouse and descendants as discretionary beneficiaries of the trust. Often the spouse serves as the trustee of the trust. Since your spouse has the ability to access income from the trust, you should be more comfortable about making gifts.

The other type of spousal access trust is a marital trust, which does not include your descendants as beneficiaries. As will be discussed in a later article, this trust can also be used to avoid the payment of Tennessee gift taxes on the trust.

The “flaw” with gifts to spousal access trusts is the danger that your spouse could predecease you. In that case, income from the trust will not be available for your benefit. Some of our clients have been willing to take the gamble that their spouse would not predecease them by a long period of time. Perhaps the donee spouse is younger and/or in better health than the donor spouse. Another factor to keep in mind is that your expenses will go down when one spouse dies because there is only one mouth to feed.

Another option when the donee spouse is young enough and healthy enough is to purchase life insurance on the life of the donee spouse. If the donee spouse dies too soon, the life insurance could provide a source of funds for the donor spouse.

Another hedging technique is to have each spouse make a gift to a spousal access trust for the other spouse. There is a tax concept known as the reciprocal trust doctrine, which requires careful planning if both spouses intend to establish spousal access trusts.

Another aspect of increasing your cash flow is to decrease your expenses. A lot of our clients have established grantor trusts that allow them to pay income taxes on income earned by the trust. This basically allows them to make tax-free gifts to their children. Generally, these grantor trusts have been designed to allow the grantor to discontinue paying income taxes in the future. When you have the opportunity to “turn off” a grantor trust, you need to factor this into your cash flow planning.

Another factor that affects your expenses is whether you will pay Tennessee gift taxes. Future articles will discuss various ways to make gifts without paying Tennessee gift taxes. When there is pressure on your cash flow, it might be preferable to make gifts in a manner that does not require you to pay Tennessee gift taxes. The Tennessee gift taxes “saved” can be used to shore up the income lost from the assets that you give away.

Before making a large gift, you need to be totally comfortable with your future access to cash flow.

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A group known as Tennesseans Against Death Taxes is lobbying the Tennessee government to repeal Tennessee gift and inheritance taxes. Tennessee is one of only two states that charge gift taxes. Our state gift tax roadblocks a lot of good estate planning that could otherwise be done, with the result that families pay significantly more federal estate taxes. A number of our clients have moved to Florida to avoid these taxes and the Tennessee Hall income tax.

If you would like the Tennessee gift and inheritance taxes to be repealed, you should consider contacting your representatives in the near future. Enclosed are a sample letter in Word and PDF, a list of Senate and House contacts, and an economic study prepared by Art Laffer, a former economic advisor to President Reagan.

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