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

This is the first article in an eight part series on Roth IRA conversions. For other articles, please see:

Part 2 – The Recharacterization Option
Part 3 – The Impact of Income Tax Rates
Part 4 – How Long Can You Stretch?
Part 5 – The Impact of Investment Returns During the First 21 Months
Part 6 – The Impact of Estate Taxes
Part 7 – Ramifications of Charitable Giving
Part 8 - Putting It All Together

A lot of my clients are planning to take advantage of a new opportunity that will be available for the first time in January of 2010. They will be able to convert their traditional IRA account to a Roth IRA account. The conversion opportunity has been available for several years, but only to individuals with less than $100,000 of adjusted gross income.

Roth IRAs offer several benefits. Like Traditional IRAs, Roth IRAs do not have to pay taxes on their earnings. However, unlike traditional IRAs, qualified distributions from Roth IRAs are not subject to income taxes.

Another advantage is that Roth IRAs do not require you to take minimum annual distributions after you attain age 70½. If you designate a child or grandchild as the beneficiary after the deaths of you and your spouse, the child or grandchild will be required to take distributions over his or her remaining life expectancy. The potential for allowing funds to grow in a tax-free environment and be withdrawn over a long period of time makes a Roth IRA a fantastic asset to pass on to children and grandchildren.

If you convert to a Roth IRA, you are betting that the present value of the incremental after-tax distributions to you and your beneficiaries in the future is greater than the taxes you will have to pay at the time of the conversion. Whether paying tax now is a good bet depends on a number of factors including tax rates, and the ability of you and your heirs to keep the Roth IRA intact for a long time.

The analysis is complex. I plan to write several additional blogs regarding this topic in order to help you make this decision.

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When my clients want to make a charitable gift that will be given to charity in future years, there are two primary vehicles for managing the funds. One choice is a donor advised fund, which can be established at the Community Foundation of Middle Tennessee, the Jewish Federation of Nashville, or various other organizations. The advantages of a donor advised fund are summarized at the bottom of the attached link to the website of the Community Foundation of Middle Tennessee.

The potential benefits of a private foundation are discussed in the attached paper from the Foundation Source.

I have worked with numerous donor advised funds and private foundations and they both serve a useful purpose. Whether a private foundation or donor advised fund is right for you depends upon a number of factors. As a general rule, I encourage clients who are setting aside less than $1 million to use a donor advised fund.
 

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Tennessee imposes Franchise and Excise Tax on limited partnerships and limited liability companies unless they qualify for an exemption. Due to a law change enacted earlier this year, numerous entities converted from the family owned non-corporate entity (“FONCE”) exemption to the obligated member entity (“OME”) exemption.

The OME exemption requires the entity’s owners to assume personal responsibility for liabilities of the entity. Most entities that switched to the OME exemption own commercial real estate.

In order to qualify for the OME exemption for 2009, appropriate documentation had to be filed with the Tennessee Secretary of State by October 1, 2009. On November 10, 2009, the Department of Revenue imposed an additional requirement to qualify for the OME exemption for 2009.

Each entity that switched to the OME exemption must file a new Application for Exemption with the Department of Revenue on or before November 30, 2009. If the entity does not file an Application for Exemption by November 30, 2009, it will not be exempt for 2009.

The Department of Revenue has discretion to allow a late filing of the application. However, if they permit the late filing, they must charge a $1,000 penalty.

If the entity failed to convert to an OME prior to October 1, 2009, it has the option of converting to an OME prior to December 31, 2009 if the entity wants to be exempt from franchise and excise taxes for 2010 and future years.

If you are an owner of an OME and are concerned about your potential exposure to liabilities of the entity, you should consider transferring a portion of your assets to an asset protection trust.
 

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Over the course of my career, I have worked with several clients who knew they had but a few months to live due to inoperable cancer. As a general rule, these clients have been mentally sharp when I have worked with them.

The knowledge that death will occur in the near future causes the client to be keenly focused on making sure their estate planning affairs are in order. It is basic to make sure that the client has incapacity documents such as a living will, health care power of attorney, and a financial power of attorney.

There are numerous financial matters to be considered. Perhaps ownership of assets can be changed to avoid probate or to provide tax benefits. Should gifts be made to children and grandchildren? Should a revocable trust be utilized in order to avoid probate? Beneficiary designations on assets such as retirement accounts and life insurance policies should be verified.

One married client changed the ownership of the house into his name and changed the beneficiary of his life insurance policy to his estate. These steps will provide his estate with enough assets to fund a credit shelter trust. The credit shelter trust will save substantial estate and inheritance taxes upon the subsequent death of his wife.

The estate planning steps outlined above would be equally effective for any client nearing the end of his or her life. Unfortunately, a lot of terminal illnesses incapacitate the client to the point that he or she is not able to accomplish them. The only “good” thing about terminal cancer is that it generally gives the client adequate time to get their affairs in order and to say their good-byes.
 

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Federal and state lawmakers continue to pass laws that provide tax and non-tax benefits to trusts. I have often wondered why legislators love trusts so much.

Richard Johnson and I did a presentation to the Nashville Estate Planning Council titled “60 Trusts in 60 minutes.” We came up with 65 different types of trusts. Let me know if we forgot any.
 

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The estates of a lot of Tennessee decedents pay Tennessee inheritance taxes but do not pay federal estate taxes. The federal estate tax exemption is currently $3.5 million. As of the date of this article, various members of Congress favor extending this exemption amount indefinitely into the future. The Tennessee inheritance tax exemption is currently $1 million. There does not appear to be much likelihood that Tennessee will increase its exemption to match the federal exemption.

The difference between the federal and Tennessee exemptions means that unmarried decedents who die with a taxable estate with a value between $1 million and $3.5 million will pay Tennessee inheritance taxes but not federal estate taxes. There are several things that can be done to reduce the value of assets for Tennessee inheritance tax purposes.

Some of these steps can be taken shortly before death. As an example, a parent might make a deathbed gift of a fractional interest in real property to a child with the goal of capturing a fractional interest discount for the remaining portion of the property when the parent dies. There are also various post-mortem decisions that can affect the value of the assets owned by the estate.

Even though the estate is not subject to federal estate taxes, the date of death value of the assets becomes the basis of the assets for federal income tax purposes. Basis will be relevant when the estate or the beneficiaries later sell the assets. Federal capital gains taxes are 15% and are scheduled to increase to 20% in the year 2011. If the beneficiaries live in a state outside of Tennessee that imposes a capital gains tax, this will make the capital gains tax rate even higher. The maximum Tennessee inheritance tax rate is 9.5%.

Since capital gains tax rates are higher than the maximum Tennessee inheritance tax rate, it is generally not advisable to take steps that reduce the value of the decedent’s assets for Tennessee inheritance tax purposes, unless it is known that the beneficiaries will continue to own the assets in the estate for several years. The reduction in the value of the estate will increase capital gains taxes by more than the Tennessee inheritance taxes that are saved.

Making tax-free annual exclusion gifts is still a good idea. It is better to give cash as opposed to an appreciated asset that will receive a free basis increase upon death. A cash gift reduces Tennessee inheritance taxes without increasing capital gains taxes.
 

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