The current economic environment has affected all asset classes, including closely-held business interests, marketable securities and personal residences. While low values on balance sheets are disappointing, they can provide excellent estate planning opportunities for these assets if you expect that there is significant appreciation potential from these assets in the future.
Proposed federal legislation would require a ten-year minimum term for a GRAT following the date of enactment, making this a good time to set up a GRAT with a shorter term under current law.
Grantor retained annuity trusts ("GRATs") and qualified personal residence trusts ("QPRTs") are planning vehicles that are designed to take advantage of favorable valuations and shift appreciation to family members free of estate and gift tax. With market values at historic low levels, targeted assets poised for greater than normal appreciation may offer planning opportunities using GRATs and QPRTs as further explained below.
GRATs A GRAT is a potentially powerful and highly effective tax planning tool that can be implemented in a very short time frame. Please note that a pending change to the tax laws would significantly curtail the planning benefits of GRATs. Proposed federal legislation would require a ten-year minimum term for a GRAT following the date of enactment, making this a good time to set up a GRAT with a shorter term under current law along the lines described below.
Essentially, the purpose of a GRAT is to transfer future growth to children without any gift or estate tax charged on that growth. The trust is intended to own assets that are expected to appreciate in value. The trustee of the GRAT pays to the person setting it up (the "grantor") on the last day of each year of the GRAT a designated percentage of the initial fair market value of the trust for the term of the trust, say two years. That percentage is based on the prevailing interest rate for the month that the GRAT is funded. The assets originally transferred to the trust, plus interest, are thus returned to the grantor. Any growth in excess of the annual interest rate is accumulated in the trust and, so long as the grantor is living at the end of the trust term, passes to children (or trusts for their benefit). GRATs offer the potential for transfers to the next generation without tax cost; more importantly, they offer that potential with no significant tax risk because they have been specifically approved by the IRS.
A GRAT generates no gift tax, it transfers no existing wealth, and it moves future appreciation above a current interest rate (for example, 2.8% per year for a GRAT funded in June 2009) down to children.
Thus, a GRAT generates no gift tax, it transfers no existing wealth, and it moves future appreciation above a current interest rate (for example, 2.8% per year for a GRAT funded in June 2009) down to children. For example, a two-year GRAT funded in June 2009 with $1,000,000 would generate "winnings" of about $51,600 passing to children free of estate and gift tax, assuming a 6% annual rate of return on the GRAT assets.
There is no cap or floor on the amount of property that can be contributed to a GRAT. The above example is for illustrative purposes only. Of course, a smaller or larger transfer can be made.
In addition, the settlor can establish a new GRAT each time she receives a payment from a GRAT and contribute that payment to the new GRAT. (The new GRAT would essentially have the same terms as the initial GRAT but would, of course, have a later termination date.) This arrangement is commonly called a "rolling" GRAT plan and takes advantage of the same gift tax principles as the original GRAT.
If the targeted assets are likely to appreciate in a significant way over the next two years and there is a desire to pass that appreciation to children free of transfer tax, a GRAT should be considered at this time.
QPRTs By transferring a primary residence (or vacation home) to a QPRT, the residence can pass downstream to family members at a reduced tax cost. With a QPRT, the grantor retains the right to use (or live in) the home for a fixed number of years (the "QPRT term"). After the QPRT term, the property passes to your designated beneficiaries. The QPRT may be drafted to provide a continuing trust for the non-grantor spouse at the end of the QPRT term. This approach ensures unrestricted use of the residence by the grantor and her spouse at least for the lifetime of the non-grantor spouse. The QPRT may also be drafted so that children own the residence (either outright or in trust) at the end of the QPRT term. Under this approach, the grantor will pay rent to the children, but it is possible when using a continuing trust to structure the rent as nontaxable.
The advantage of a QPRT over an outright gift is that the gift tax is imposed on the value of the remainder interest that passes on the expiration of the QPRT term, which can be substantially less than the full fair market value of the transferred property. By contrast, an outright gift requires that any gift tax be imposed on the property's full value.
The value of the remainder interest is determined by the grantor's age, the QPRT term, the value of the property and the current applicable federal interest rate. A longer QPRT term lowers both the value of the remainder interest and the resulting gift tax liability. However, in order to take advantage of the reduced transfer tax cost, the grantor must survive the full QPRT term. If the grantor does not survive the QPRT term, the property is included in her estate.
For example, if a 60-year old transfers her home valued at $500,000 to a QPRT in June 2009 and retains the right to use the property for 15 years, the total taxable gift would be $233,510 (instead of $500,000). If she survives the 15-year term, the home and all subsequent appreciation in its value will be removed from her estate for tax purposes.
The recent downturn in property values may make this is good time to "freeze" the asset value of your home for transfer tax purposes through the use of a QPRT, but the percentage reduction in the gift value of the property (as compared to its fair market value) is even greater when interest rates are higher. You should carefully weigh these competing interests before transferring property to a QPRT.
IRAS: MINIMUM DISTRIBUTION REQUIREMENTS WAIVED FOR 2009
Required minimum distributions from Individual Retirement Accounts (IRAs) and defined contribution retirement plans are suspended for 2009. The suspension applies to IRAs, 401(k) plans, 403(b) plans, and various other defined contribution retirement plans. Typically, those who are over age 70½ and who hold an IRA or 401(k) plan in their own name are required to withdraw a minimum amount from their retirement plan annually. After the owner of an IRA dies, the individuals who inherit that IRA are also subject to annual required minimum distributions--with certain exceptions for the spouse of the original retirement plan owner. The required distributions from an inherited IRA are also waived for 2009, regardless of whether the beneficiary of the inherited IRA is withdrawing funds over the beneficiary's life expectancy, the life expectancy of the deceased owner, or over a five-year period that sometimes applies, especially for 401(k) plans.
The suspension applies to IRAs, 401(k) plans, 403(b) plans, and various other defined contribution retirement plans.
Although the annual required minimum distribution is waived for 2009, individual owners and beneficiaries of an inherited IRA may continue to withdraw money from these accounts in 2009 if they wish. Withdrawals made in 2009 are treated for income tax purposes as they would be if the required minimum distribution had not been waived. The waiver provides flexibility for IRA owners and beneficiaries to allow the assets to potentially regain some of the value lost by the account in 2008; however, this waiver applies regardless of whether the account actually lost value in 2009. Thus, in 2009 you need not make any withdrawal from your retirement account, although you may still withdraw any amount you wish.
Under current laws, required minimum distributions will resume in 2010. For account owners, the standard rules will apply. For beneficiaries who have inherited an IRA or other defined contribution plan and who must receive the entire account over a five-year period, it will be as if 2009 did not "count" and the five years will become six years.
New Massachusetts Probate Code
The following summary covers the enactment of a new probate code in Massachusetts, which affects both Massachusetts residents and non-residents who own Massachusetts property. We plan to highlight state-specific planning items in each issue of our newsletter focusing on topics from Connecticut, New York, New Jersey and Massachusetts.
Nearly 40 years after the National Conference of Commissioners on Uniform State Laws approved and recommended the Uniform Probate Code (UPC) for enactment in all states, Massachusetts has joined the numerous other states that have adopted variations of the UPC. The Massachusetts Uniform Probate Code (MUPC) will simplify and streamline the administrative process for routine trust and estate matters, modernize the laws governing Massachusetts trusts and probate matters, and align Massachusetts trust and estate laws more closely with those of other jurisdictions.
Importantly, the MUPC expands protections afforded to individuals requiring guardianship or conservatorship. Changes include more precise definitions of incapacity and disability, increased accounting and reporting requirements, and heightened court oversight of guardianships and conservatorships. New requirements include that a guardian must report in writing to the court within 60 days of appointment, and provide broad information about the incapacitated person, his living arrangements, required services, the guardian's visits, plans for future care, opinions as to current care and more. A conservator must file an inventory within 90 days. Provisions relating to guardians, conservators and related proceedings, personal representative bonds, and durable powers of attorney go into effect on July 1, 2009.
The MUPC provides new "rules of construction" that will apply to pre-existing wills and trusts, but it does not apply to governing instruments that are irrevocable prior to the date the MUPC becomes effective. We are still studying whether or not the MUPC will require updating of existing wills and trusts, but our initial view is that there will be no need for clients to revise documents on account of the MUPC. The provisions of the MUPC affecting wills and trusts go into effect on July 1, 2011.
SIX MONTH WINDOW FOR DISCLOSURE OF FOREIGN FINANCIAL ACCOUNTS UNDER IRS VOLUNTARY COMPLIANCE INITIATIVE
Accounts maintained by US persons in foreign countries have received great attention from the government and the press in the past year due to the high publicity scandals of UBS and LGT Bank of Liechtenstein. We expect further scrutiny in the coming months. On September 30, 2008, the US Treasury released a newer, more comprehensive version of Form TD F 90-22.1. The Bank Secrecy Act requires this Form to be filed by every US person who has a financial interest in or signature or other authority over a foreign financial account. The form is due by June 30, 2009, for 2008. Thus, it is filed with the federal income tax return. Information on the Form is used by the US to combat money laundering, terrorism and tax evasion.
Just to be clear: a US citizen or resident is permitted to own assets and maintain bank and securities accounts abroad. However, all such accounts are subject to US income, gift and estate tax in the same way as US assets. In addition, the US person must check the appropriate box on Schedule B of Form 1040 and must file Form TD F 90-22.1 disclosing the offshore accounts (since the income they produce is not always automatically reported to the IRS, as is the case with US accounts). Failure to comply with all filing requirements may result in significant penalties, even if all taxes have been paid.
On March 26, 2009, the IRS announced a voluntary disclosure procedure, targeted towards US persons with unreported foreign accounts and entities. The procedure is effective March 23, 2009, and in effect for only the next 6 months. Generally, a taxpayer who takes advantage of the voluntary disclosure must make all delinquent filings, including Form TD F 90-22.1 and information returns, pay "back-taxes" and interest for the past 6 years, and either an accuracy-related or delinquency penalty for those years. In addition, but in lieu of all other penalties, the taxpayer is required to pay a 20% penalty of the highest asset value in any unreported bank account at any time during the 6-year period.
When and by whom? Form TD F 90-22.1 must be filed on or before June 30th by each US person who has a financial interest in or signature or other authority over any foreign financial account(s) including bank, securities, or other types of financial accounts in a foreign country if the aggregate value of those financial accounts exceeds $10,000 at any time during the calendar year. To have a filing requirement, each part of the above needs to be met.
US person A US person means both a citizen of the United States, regardless of residence, and a resident of the United States, regardless of citizenship. Also included is "a person in and doing business in the United States". This category appears for the first time in the new version of the form. However, on June 5, 2009, the IRS announced that with respect to forms due by June 30, 2009, US taxpayers may rely on the older definition of US Person (found in the pre-2008 version of the form) for purposes of determining whether they have an obligation to file.
There are limited exceptions which include (i) an officer or employee of a bank that is subject to Federal Bank supervision, provided the officer or employee has no personal interest in the account, and (ii) an officer or an employee of a domestic corporation which meets specified qualifications, again provided he has no personal financial interest in the account.
Financial Account This covers any bank, securities, securities derivatives or other financial instruments account. A financial account includes an account where assets are held in a commingled fund, which may include mutual funds, if the account owner holds an equity interest in the commingled fund. Financial account includes savings, demand, checking, deposit or any other account (including debit card and pre-paid credit card accounts) maintained with a financial institution or person engaged in the business of a financial institution. Individual bonds, notes and stock certificates are not a financial account.
Foreign To satisfy the foreign requirement, the account must be located outside the United States. It does not matter if the account is held at an affiliate of a US bank or other financial institution. An account in a foreign country in an institution known as a "United States military banking facility" is not reportable even though in a foreign country.
Financial interest A US person has a financial interest in an account if he is the owner of record or has legal title over the account and whether or not the US person has a beneficial interest in the account (thus a US person has a financial interest in a foreign account of which he is the holder of record for the benefit of a non-US person); a US person has a financial interest in an account which is in the name of a person acting as agent, nominee or other capacity for the US person; a US person has a financial interest in an account in the name of a corporation, 50% of which is owned or 50% controlled by the US person; a US person has a financial interest in an account in the name of a partnership in which the US person owns an interest in more than 50% of the profits or more than 50% of the capital; a US person has a financial interest in an account in the name of a trust in which the US person has a present beneficial interest directly or indirectly in more than 50% of the assets of the trust or from which the US person receives more than 50% of the current income.
Also, and appearing for the first time in the new version of the form, a US person has a financial interest in an account in the name of a trust, or in the name of a person acting on behalf of the trust, if the trust was established by that US person and the trust has a trust protector appointed. A trust protector is a person defined as responsible for monitoring the activities of the trustee with the authority to influence the decisions of the trustee or to replace or recommend the replacement of the trustee.
Signature or other authority A US person has signature or other authority over an account if the person can control the disposition of the money or other property in the account by delivery of a document with his or her signature (alone or with others) to the place where the account is maintained. A US person has "other authority" over an account if the US person can exercise the comparable power to control the disposition of the property in the account by directly or indirectly (through an agent, nominee or the like) communicating with the place where the account is held. The IRS has taken the position that a person whose sole power is to direct investments in an account but who may not make deposits to or disbursements from the account does not have a reporting requirement.
Format The revised Form TD F 90-22.1 has five Parts to it. Part 1: Filer Information; Part II: Information on Financial Account Owned Separately; Part III: Information on Financial Account Owned Jointly; Part IV: Information on Financial Account Where Filer has Signature or Other Authority, but No Financial Interest in the Account; Part 5: Information on Financial Account Where Corporate Filer is Filing a Consolidated Report.
Penalties Civil penalties can range up to the greater of $100,000, or 50% of the amount in the account at the time of the violation. Criminal penalties can be up to $500,000 or 10 years in prison or both.