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

If you are a beneficiary of a trust that requires income to be distributed to you, you may be able to increase your trust distributions by taking advantage of a new Tennessee law that will become effective on July 1, 2010. Section 21 of Public Chapter No. 725 of the Tennessee Public Acts of 2010 authorizes a trustee of a trust that requires mandatory distributions of net income to convert the trust to a total return unitrust.

The effect of a conversion is to change the trust distributions from “income” to a fixed percentage of the value of the trust. Assume that your trust has $1 million of assets and generates net income of $25,000 per year. If the trust is converted to a 4% unitrust, your distributions will increase to $40,000.

The fixed percentage must be between three percent (3%) and five percent (5%). Ideally, the income and remainder beneficiaries of the trust will agree to the percentage in advance. If the beneficiaries fail to agree in advance, the trustee will either not make the conversion or will choose the percentage on its own.

The conversion can be made without a court proceding if certain procedures are followed. If the Trustee is not “disinterested,” the Trustee must appoint a disinterested person to determine the unitrust percentage, the method to be used in determining the fair market value of the trust, and which assets are to be excluded in determining the unitrust amount. The trustee must send written notice of the proposed conversion to all qualified beneficiaries of the trust and not receive an objection within thirty (30) days. If a beneficiary objects, the Trustee can petition the Court to approve the conversion.

The main benefit of making a conversion is to eliminate an inherent conflict of interest between the income and remainder beneficiaries. With an all income trust, the income beneficiaries generally want the trustee to purchase investments that generate a lot of income and remainder beneficiaries want the Trustee to purchase assets that will appreciate in value. As a general rule, high income investments do not appreciate as much in value. When payments to the income beneficiary are dependent on the value of the trust rather than income received, the income beneficiary prefers for the trustee to maintain an investment policy that results in growth of the value of the trust over time. Growth will increase distributions to the income beneficiary and will also benefit the remainder beneficiaries of the trust.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

For the last four years, IRA owners who are over age 70.5 have been able to make charitable gifts from their IRA of up to $100,000 per year. This law has been extended before and Congress is currently working on another extension for 2010. Congress’ willingness to continue extending this law is attributable to the popularity of this technique.

Even if Congress extends the law, there may be a better way to make a gift to charity. Here’s how it works: Step 1: Determine how much you want to give to charity from your IRA. Step 2: Make the gift to charity from your non-IRA assets. For example, you could give highly appreciated securities or real estate. Step 3: Convert the same amount of your IRA to a Roth IRA.

The income from the Roth conversion will be offset by the charitable income tax deduction so that the net effect on your income taxes is neutral. Income tax neutrality is consistent with a direct gift to charity from your IRA. However, the synthetic gift has the additional effect of converting appreciated securities from your taxable portfolio into a Roth IRA where you will never pay taxes on the appreciation or the earnings of the securities.

There are 3 other benefits of the synthetic gift technique. You are not limited to a charitable gift of $100,000 per year. You can make a gift to your private foundation or donor advised fund. This is not possible with a direct gift from the IRA.  Finally, if you have not yet attained age 70.5, you are not eligible to make a direct gift from your IRA.  The synthetic gift technique has no age limit.

There is a potential pitfall with this technique. There are complicated income tax rules that affect the timing and amount of your charitable income tax deductions. Make sure your CPA examines the consequences before you make a synthetic charitable IRA gift™.
 

A synthetic charitable IRA gift™ may be a better choice for you than a charitable IRA rollover because it provides money to charity and allows you to convert a portion of your taxable portfolio to a Roth IRA. 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

When someone dies, their estate becomes a separate taxpayer for income tax purposes. Estates are allowed to choose their tax year. We generally recommend that estates elect the longest fiscal year available, which is the end of the month preceding the one-year anniversary of the decedent’s death. For example, the latest fiscal year that can be elected for a decedent who dies in April of 2010 is March of 2011. The reason that we generally elect a fiscal year is to postpone the time when income taxes will be paid on income earned by the estate.

Revocable trusts are also allowed to make the same fiscal year election, though they are required to make a separate election (referred to as a Section 645 election) with the IRS.

Federal income taxes will be increasing for tax years beginning after December 31, 2010. The maximum rate for dividends will increase from 15% to 39.6%. The maximum rate for capital gains will increase from 15% to 20%. The maximum rate for rents and interest income will increase from 35% to 39.6%.

As a general rule, the estate or revocable trust pays taxes on capital gains and taxes on other income is paid by the beneficiaries to the extent the income is distributed, or paid by the estate or revocable trust if the income is retained.

If the estate retains the income, the estate will benefit from making a fiscal year election. If the estate or revocable trust intends to make distributions to the beneficiaries, and the beneficiaries are in a high income tax bracket, the estate or revocable trust may want to avoid a fiscal year election for decedents who die in 2010.  The fiscal year election would cause the beneficiaries to pay higher taxes because the income will be taxed on their 2011 federal income tax returns.

There is a corollary problem for estates that already have fiscal years. If the estate is terminated in 2011 or later, the income will flow out to the beneficiaries in 2011, when it is likely to be taxed at a higher rate. Conversely, if the estate is terminated by December 31, 2010, the income will be taxed to the beneficiaries based on the lower 2010 rates. It is not always possible to accelerate the closing of an estate. However, if there are just a few minor details, it may be possible for the beneficiaries to assume responsibility for the final details in order to allow the estate to close.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The past decade has seen a vast improvement in Tennessee's trust laws, making it one of the leading states for establishing a trust. Major laws that have been enacted include the Uniform Principal and Income Act (2000), the Tennessee Uniform Prudent Investor Act of 2002, the Tennessee Uniform Trust Code (2004), the Tennessee Investment Services Act of 2007, and the Tennessee Community Property Trust Act of 2010.

On April 9, 2010, the Governor signed another law that makes numerous improvements to the trust laws. The new law includes provisions providing enhanced creditor protection for various trusts, including special needs trusts and inter vivos marital trusts, and contains a provision allowing a Trustee to convert a mandatory income trust to a “unitrust” with an annual payment of between three percent (3%) and five percent (5%). I will be writing additional articles to provide more details about these changes.
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

I came across an interesting article which concludes that federal estate and gift taxes account for the elimination of numerous small businesses, thereby promoting the concentration of wealth in larger firms. I can attest to the accuracy of this conclusion based upon several family businesses that I have worked with over the years.

All businesses have market risks, including competitors and obsolescence of their products. Family businesses have two significant additional risks, succession and estate and gift taxes.

The succession risks are two-fold. First, is there a manager or management team that can continue to operate the business in a profitable manner after current management retires or dies? For example, one of my clients is ready to retire, but has no one in his family or company who would be able to run the business if he retires or dies. He is entertaining offers from larger competitors and venture capital funds.

The second succession issue relates to financial and emotional family issues. Is there a way to treat everyone fairly and keep everyone happy after the patriarch or matriarch dies? As businesses move down generations, family issues often place a heavy burden on the business.

Estate and gift taxes present a major obstacle to successfully passing down the family business. I am currently working with the owners of a third generation family business that has been very successful for approximately 70 years. The management and family succession are aligned in a manner that will allow this business to pass smoothly to the fourth generation. However, finding a way to deal with estate and gift taxes is an enormous problem.

My clients are aggressively attacking the estate and gift tax issue on several fronts. First, they purchased $5 million of life insurance while they were insurable. Second, they have established various trusts to which they have been making gifts over several years. This effort has taken away part of their time that could have been spent in growing the business. More importantly, they have spent significant legal, accounting, appraisal and insurance costs. Despite taking all of these steps, they are still looking at an estate tax bill of $12 million. The estate taxes will drain the house and cash and will force the family to borrow money from the government to pay the remaining estate tax.  If the family finances a portion of its estate tax liabilities, profits from the business will be dedicated to paying this liability for several years, leaving the family with insufficient funds to pay for anticipated living expenses.  Because of these estate tax issues, the family is evaluating offers from some of its publicly traded competitors. 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

A prior article pointed out that higher tax rates in the future would increase the chance that converting your IRA to a Roth IRA would provide a benefit to you and your family. We now know that income tax rates for high-income individuals will increase beginning in 2013, due to the 2010 Healthcare Act.

High-income taxpayers, defined as single people earning more than $200,000 and married couples earning more than $250,000, will be hit with a a tax increase on wages and a new levy on investments. Under the provisions of the new law, which take effect in 2013, high-income taxpayers will be taxed at an additional 0.9% on wages exceeding $200,000 for single people or $250,000 for married couples.

Beginning in 2013, a new 3.8% tax will be imposed on net investment income of high-income taxpayers. Net investment income includes interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and net gain from disposition of property (other than property held in a trade or business). Net investment income is reduced by properly allocable deductions to such income. However, the new tax will not apply to income in tax-deferred retirement accounts such as IRAs and 401(k) plans. Also, the new tax will apply only to income in excess of the $200,000/$250,000 thresholds.

These new taxes enhance the benefits of a Roth IRA conversion in two respects. First, if you do not make the conversion, the required distribution from your regular IRA will increase the chance that you are a high-income individual. Even though the new investment tax will not apply to the amount distributed from a regular IRA, the income from the IRA may force more of your other income to bear a 3.8% tax. If you had converted to a Roth IRA, you would not be required to take a required minimum distribution. Even if you take a distribution, it would not be considered income.

If you make a Roth IRA conversion, it is advisable to pay the income taxes from separate assets. If you do not make a conversion, the income from those separate assets would be hit with this 3.8% investment tax. Stately differently, the after-tax income that you would have received from the money used to pay the conversion tax will be decreased due to the new 3.8% investment tax.

The increased taxes for high-income taxpayers may only be getting started. The new taxes in the Healthcare Act help to pay for the benefits provided by the Act. Many have predicted that the cost of the new Act will substantially exceed the government’s estimates. If this is true, someone will have to pay for the additional costs.

Regardless of whether the new taxes fully pay for the Healthcare Act, someone needs to pay for the burgeoning federal deficit. High-income taxpayers will be a likely target. Any additional taxes imposed in the future will further enhance the benefit of having made a Roth IRA conversion in 2010.
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link