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Transcript of Tax Planning with a $5,000,000 Gift Tax Exemption Presented by: Robert S. Keebler, CPA, MST, AEP...
Tax Planning with a $5,000,000 Gift Tax Exemption
Presented by:Robert S. Keebler, CPA, MST, AEP
Keebler & Associates, LLPPhone: (920) 593-1701
E-mail: [email protected]
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
2
Tax Relief, Unemployment Insurance Reauthorization,
and Job Creation Act of 2010 (“2010 Tax Relief Act”)
Overview
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• Provide an overview of the new law• Discuss the powerful planning strategies that are rapidly
developing• Review the substantial weakness of the portability of the
exemption between spouses• Analyze income shifting opportunities• Explore the spousal access trust• Define the important asset protection strategies being
developed
3
Course Outline
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Summary of New Law and Reversion in 2013
2011 2012 2013
Top Estate Tax Rate 35% 35% 55%
Estate Tax Exemption $5,000,000 $5,000,000 $1,000,000
Gift Tax Exemption $5,000,000 $5,000,000 $1,000,000
GST Exemption $5,000,000 $5,000,000 $1,000,000
4©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Adjusted for inflation
2010 Tax Relief Act(December 17, 2010)
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved. 5
• Summary of certain key provisions (not all-inclusive) Income tax provisions
Extension of lower income tax rates until 2012 Extension of 0%/15% long-term capital gains tax rates until 2012 Extension of favorable tax treatment for qualified dividends until 2012 Extension of other income tax credits
Estate tax provisions Reinstatement of estate and GST tax Higher exemption amounts Lower tax rates Portability of estate tax exemption Election out of 2010 Estate Taxes
6
Prior Estate/Gift Tax Law
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• 2010– No estate tax– No GST tax– $1,000,000 lifetime gift tax exemption amount with a flat 35%
gift tax rate on taxable gifts over the exemption amount• 2011 & Beyond
– $1,000,000 estate tax exemption amount with a maximum estate tax rate of 55%
– $1,000,000 lifetime gift tax exemption amount with a maximum gift tax rate of 55%
Summary of Prior & New Estate/Gift Tax Law
2009 2010 (Prior Law)
2010 (New Law)
2011 (New Law)
Top Estate Tax Rate 45% 0% 35% 35%
Exemption $3,500,000 N/A $5,000,000 $5,000,000
Date-of-Death Basis Increase YES NOYES
(unless estate tax is not elected)
YES
Carryover Basis NO YESNO
(unless estate tax is not elected)
NO
7©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Note: Under the current law, in 2013 the exemption reverts to $1,000,000
• The new estate/gift tax law which passed in Congress allows an estate to elect out of the estate tax for the 2010 tax year– Effective date of law was made retroactive to 1/1/2010– $5,000,000 estate tax exemption
• Indexed for inflation in 2012– 35% marginal estate tax rate– Election out of the estate tax would result in application of the
modified carryover basis rules
8
New Estate/Gift Tax Law
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• The general presumption under the new estate/gift law is that the estate tax applies to all estates in 2010– Thus, one will need to affirmatively elect out of the estate tax
• Reunification of the gift and estate tax exemptions– $5,000,000 gift tax exemption (with a 35% gift tax rate) would
apply to gifts after 12/31/2010– Thus, the gift tax exemption in 2010 would remain $1,000,000
(with a 35% gift tax rate)– The exemption returns to $1,000,000 in 2013– Window of Opportunity
9
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
New Estate/Gift Tax Law
• 2011 & 2012 Gifts• 2011 & 2012 GST Transfers• Spousal access trusts• Income Shifting• “Recapture issue” if exemption returns to
$1,000,000
10
A Powerful Window of Opportunity
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
New Generation-Skipping Transfer (GST) Tax Law
11
• 2010– GST Exemption Amount: $5,000,000– GST Tax Rate: 0%– Available regardless of the estate tax election
• 2011 & 2012– GST Exemption Amount: $5 Million (per person)– GST Tax Rate: 35%
• 2013– GST Exemption Amount: $1 Million (plus inflation since 1998)– GST Tax Rate: 55%
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Unlike a surviving spouse’s ability to utilize a predeceased spouse’s unused unified credit, the new law does not allow a surviving spouse to use the unused GST tax exemption of a predeceased spouse.
New Generation-Skipping Transfer (GST) Tax Law
12©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
13
The greatest wealth transfer in American history will occur
over the next two years.
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
14
Immediate Tax Planning Opportunities in 2011 & 2012
“A Two Year Window of Opportunity”
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
•Taxable gifts in 2011– $5,000,000 lifetime gift tax exemption (with a
35% tax rate on taxable gifts over $5,000,000)– Utilize the additional $4,000,000 of gift tax
exemption to shelter future growth from estate tax
15
Tax Planning Opportunities in 2011 & 2012
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• $5,000,000 gifts in trust• Spousal access trusts• Life insurance trusts• Dynasty trusts• Income shifting family trusts• Asset protection trusts
16©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Tax Planning Opportunities in 2011 & 2012
Spousal Access Trust
Reciprocal Trust Doctrine
17©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
ConceptOne spouse transfers up to $5,000,000, in trust, to their spouse, children and future generations.
18©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Spousal Access Trust
Benefits•Asset protection•Estate tax•Direct decedent protection•Income shifting
Risks•Reciprocal trust doctrine•Grantor trust rules
Reciprocal Trust Doctrine
• Reciprocal trusts are trusts created by grantors whereby, upon transfer the grantors are in the same economic position as if they had created the trusts for themselves.
• Example:
• Mr. and Mrs. Smith create two separate trusts and fund each trust with assets of similar value, wherein, Mr. Smith’s trust provides that upon his death, his wife is a beneficiary of his trust, and Mrs. Smith’s trust provides benefits to Mr. Smith. In this example, the IRS would likely find that the Smiths have reciprocal trusts.
• Where this is the case, the Internal Revenue Service and/or courts will uncross the trusts and include the value of trust in each of the grantor’s gross estate.
19©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Reciprocal Trust Doctrine
• U.S. v. Estate of Grace, 395 US 316 (1969) • Husband and wife each created a trust, at separate times, that
contained identical provisions. The Supreme Court developed a two part test to determine whether a reciprocal trust situation existed: • trusts must be interrelated• transaction must leave the grantors of the trusts in the
same economic position as they would have been in if they had created the trusts naming themselves as life beneficiaries.
• Court uncrossed the transfers and included the property in the wife’s trust into the husband’s gross estate.
20©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Gifts to anIrrevocable Life Insurance
Trust (ILIT)
21©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• Estate tax-free• Income tax-free• Utilize the $5,000,000 exemption and the GST
exemption amounts• Determine need based on 2011 rates or 2013
rates?
Irrevocable Life Insurance Trusts (ILIT)
22©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• A type of trust which holds a life insurance policy on the grantor’s life so as to benefit the grantor’s children without the imposition of future estate, gift and/or GST tax.
• To the extent that the grantor’s estate has insufficient liquid assets to cover the estate tax liability, trust assets can be lent
to the estate or used to purchase assets from the estate.
• To the extent that the grantor does not hold any “incidents of ownership”, none of the trust assets will be included in his/her taxable estate.
Irrevocable Life Insurance Trust (ILIT)Liquidity Strategies
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
23
Grantors(Insured)
ILIT(Beneficiary)
Annual gifts to cover life insurance
premiums Life Insurance Company
Payment of premiums
Discretionary distributions of income and principal during the
lifetime of the trust’s beneficiaries
Assets outside of the taxable estates of beneficiaries
Payment of death benefit proceeds at
death of insured
Children & Future Generations
Liquidity StrategiesIrrevocable Life Insurance Trust (ILIT)
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
24
• A type of trust which benefits multiple generations where none of the assets held by the trust are included in either the grantor’s taxable estate or any of the beneficiaries’ taxable estates.
- However, under the tax law, whenever a transfer is made by the grantor to a “skip person” (e.g., grandchild, great-grandchild, etc.) or a trust for their benefit (e.g., dynasty trust), a second level of tax is imposed on the transfer (in addition to gift tax).
- Notwithstanding, a grantor is allowed a lifetime GST exemption on the first $5,000,000 of taxable transfers to “skip persons”.
• Thus, if the grantor allocates all or a portion of his/her GST exemption to the entire transfer, none of the transfer will be subject to GST tax either in the current year or future years.
Dynasty TrustSummary of Technique
25©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Dynasty Trust
Discretionary Distributionsto Children for Life
Discretionary Distributionsto Grandchildren for Life
Discretionary Distributionsto Great-Grandchildren
for Life
Future Generations
No transfer tax paid.
No transfer tax paid.
No transfer tax paid.
No transfer tax paid.
GrantorGift*
Advantages• Creditor protection• Divorce protection• Estate tax protection• Direct decedent protection• Spendthrift protection• Consolidation of capital
* Gift should take advantage of any remaining lifetime gift exclusion and lifetime GST exclusion
Dynasty TrustOverview of Technique
26©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Wealth of Parents 1,000,000$ 1,000,000$ 1,000,000$ Estate Tax Rate 35% 35% 35%Estate Tax 350,000$ 350,000$ 350,000$
Wealth of Children 650,000$ -$ -$ Estate Tax Rate 35% 35% 35%Estate Tax 227,500$ -$ -$
Wealth of Grandchildren 422,500$ 650,000$ -$ Estate Tax Rate 35% 35% 35%Estate Tax 147,875$ 227,500$ -$
Wealth of Great-Grandchildren 274,625$ 422,500$ 650,000$
% of Original Wealth Passing to Great-Grandchildren 27.4625% 42.2500% 65.0000%
Dynasty TrustExample – Erosion of Estate at Each Generation Level
27©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
5% Growth 7% Growth 9% GrowthValue of Trust in 20 years 13,266,489$ 19,348,422$ 28,022,054$ Estate Tax Savings @ 45% 5,969,920$ 8,706,790$ 12,609,924$
Value of Trust in 40 years 35,199,944$ 74,872,289$ 74,872,289$ Estate Tax Savings @ 45% 15,839,975$ 33,692,530$ 33,692,530$
Value of Trust in 60 years 93,395,929$ 289,732,134$ 880,156,460$ Estate Tax Savings @ 45% 42,028,168$ 130,379,460$ 396,070,407$
Value of Trust in 80 years 247,807,205$ 1,121,171,938$ 4,932,758,341$ Estate Tax Savings @ 45% 111,513,242$ 504,527,372$ 2,219,741,253$
28©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Dynasty TrustExample – Summary of Estate Tax Savings
Initial investment of $5,000,000
Concept Shift income to younger family members to reduce income taxes
Considerations•Asset protection•Kiddie tax•Potential $10,000,000 gift•Children use income to invest or purchase insurance
29©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Income Shifting
Action PlanHusband and wife gift $10,000,000 of non-voting S-Corporation stock to their four children (15% each)
• $10,000,000 gift will utilize husband’s and wife’s $5,000,000 lifetime gift tax exemption Thus, no gift tax will be incurred on the gift
• Income generated by S-Corporation will pass through to each child (i.e. income shifting)
30©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Income ShiftingExample
Assumptions•Parents’ filing status = Married jointly•Parents’ exemptions = 2•Parents’ itemized deductions = $80,000•Children’s filing status (each child) = Single•Children’s exemptions (each child) = 1•Children’s standard deduction (each child) = $5,800•S-Corporation income = $2,000,000
31©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Income ShiftingExample (cont.)
32©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Income ShiftingExample (cont.)
OPTION 1 OPTION 2 OPTION 1 OPTION 2 OPTION 1 OPTION 2Gross Income 2,000,000$ 800,000$ 25,000$ 325,000$ 25,000$ 325,000$ Itemized Deductions/Standard Deduction (80,000) (80,000) (5,800) (5,800) (5,800) (5,800) Personal Exemptions (7,400) (7,400) (3,700) (3,700) (3,700) (3,700) Net Taxable Income 1,912,600$ 712,600$ 15,500$ 315,500$ 15,500$ 315,500$
Income Tax 639,282$ 219,282$ 1,900$ 89,012$ 1,900$ 89,012$
PARENT CHILD #1 CHILD #2
Scenarios•Option 1 – No Planning•Option 2 – Transfer 15% interest to each child
33©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Income ShiftingExample (cont.)
OPTION 1 OPTION 2 OPTION 1 OPTION 2 OPTION 1 OPTION 2Gross Income 25,000$ 325,000$ 25,000$ 325,000$ 2,100,000$ 2,100,000$ Itemized Deductions/Standard Deduction (5,800) (5,800) (5,800) (5,800) (103,200) (103,200) Personal Exemptions (3,700) (3,700) (3,700) (3,700) (22,200) (22,200) Net Taxable Income 15,500$ 315,500$ 15,500$ 315,500$ 1,974,600$ 1,974,600$
Income Tax 1,900$ 89,012$ 1,900$ 89,012$ 646,882$ 575,330$
ANNUAL INCOME TAX SAVINGS 71,552$
TOTALCHILD #3 CHILD #4
Scenarios•Option 1 – No Planning•Option 2 – Transfer 15% interest to each child
Long-Term Tax Planning Opportunities
• Lifetime gifting• Grantor Retained Annuity Trust (GRAT)• Installment sales to an IDGT• Life insurance trusts• “Tax-burn” strategies• Spousal access trust(s)
34©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• Gift tax imposed on the donor is calculated based on the value of the gift passing to the donee (after the imposition of gift tax).
• Estate tax, on the other hand, is calculated based on the total value of the taxable estate, regardless of the net amount passing to the beneficiaries of the
estate.
Lifetime GiftingTax Exclusive Nature of Gifts
35©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Estate Tax Gift TaxTotal Taxable Estate / Gift 10,000,000$ 10,000,000$ Effective Tax Rate* 35.00% 25.93%Total Tax (3,500,000)$ (2,592,593)$
Savings -$ 907,407$
* Effective Gift Tax Rate = 35%/135%
Lifetime GiftingTax Exclusive Nature of Gifts
36©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• A type of trust that benefits the grantor’s future generations (i.e. children) without the imposition of estate or gift tax.• To the extent that the actual rate of return on the trust’s assets exceeds the IRS’s rate (a.k.a. IRC §7520 rate), the “excess” is transferred to the trust’s beneficiaries free of any estate and/or gift tax.• All income earned by the trust is taxed to grantor because the trust is “defective” for income tax purposes, thus allowing for a “tax-free” gift to the trust’s beneficiaries.
NOTE: The IRC §7520 rate for January 2011 is 2.4%
Grantor Retained Annuity Trust (GRAT)Summary of Technique
37
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Grantor(Lead Beneficiary)
Transfer of assets
Annuity payments over a fixed term
GRAT
Payment of gift tax on present value of remainder interest transferred to children (should be at or near $0)
Children* (Remainder Beneficiaries)
IRS
At end of term, any residual assets remaining in the trust pass to the children free of any gift tax
* Instead of naming the children as outright remainder beneficiaries of the GRAT, a grantor trust could be used (thus producing a greater estate tax benefit)
Grantor Retained Annuity Trust (GRAT)Overview of Technique
38©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
ASSUMPTIONSFMV of Assets Contributed to GRAT 10,000,000$ IRC §7520 Rate 1.80%Term of Trust (Years) 5Increase in Annual Payment 0.00%Payment Period AnnuallyTiming of Payments End of Period
GRAT Payout Rate 21.09304%Taxable Gift -$
Income10.00%
1 10,000,000$ 1,000,000$ (2,109,304)$ 8,890,696$ 2 8,890,696$ 889,070$ (2,109,304)$ 7,670,462$ 3 7,670,462$ 767,046$ (2,109,304)$ 6,328,204$ 4 6,328,204$ 632,820$ (2,109,304)$ 4,851,720$ 5 4,851,720$ 485,172$ (2,109,304)$ 3,227,588$
Year Beginning Balance
GRAT Payment
Ending Balance
Amount passing to beneficiaries free of estate and gift tax
Grantor Retained Annuity Trust (GRAT)Example
39©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
An IDGT is a type of dynasty trust where all income earned by the trust is taxed to the grantor because the trust is “defective” for income tax purposes, thus allowing for a “tax-free” gift to the trust’s beneficiaries.
Intentionally Defective Grantor Trust (IDGT)Summary of Technique
40©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• A type of transaction whereby a grantor sells a highly-appreciating asset to an IDGT in exchange for an installment note. Note, however, that the grantor should make an initial gift (at least 10% of the
total transfer value) to the trust so that it has sufficient capital to make its payments to the grantor.
• To the extent that the growth rate on the assets sold to the IDGT is greater than the interest rate on the installment note taken back by the
grantor, the “excess” is passed on to the trust beneficiaries free of any gift, estate and/or GST tax.
• No capital gains tax is due on the installment sale to the trust because the trust is “defective” for income tax purposes.
• Interest income on installment note is not taxable to the grantor because the trust is “defective” for income tax purposes.
Installment Sales to an IDGTSummary of Technique
41©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Grantor
Gift & sale of highly-appreciating assets
Installment note(s) IDGT
Children, Grandchildren,
Great-Grandchildren & Future Generations
Discretionary distributions of income and principal during the
lifetime of the trust’s beneficiaries
Assets outside of the taxable estates of beneficiaries
Installment Sales to an IDGTOverview of Technique
42©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Short-Term AFR (3 years or less) .43%
Mid-Term AFR (over 3 years, up to 9 Years) 1.95%
Long-Term AFR (over 9 years) 3.88%
Installment Sale to an IDGTCurrent Interest Rates – January 2011
43©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
ASSUMPTIONSFMV of Assets Sold to IDGT 10,000,000$ Interest Rate (Long-Term AFR) 3.53%Term (Years) 10Payment Structure Interest-Only w/Balloon PaymentPayment Period AnnuallyTiming of Payments End of Period
YearBeginning Balance Income
Installment Payment
Ending Balance
10.00%1 10,000,000$ 1,000,000$ (353,000)$ 10,647,000$ 2 10,647,000$ 1,064,700$ (353,000)$ 11,358,700$ 3 11,358,700$ 1,135,870$ (353,000)$ 12,141,570$ 4 12,141,570$ 1,214,157$ (353,000)$ 13,002,727$ 5 13,002,727$ 1,300,273$ (353,000)$ 13,950,000$ 6 13,950,000$ 1,395,000$ (353,000)$ 14,992,000$ 7 14,992,000$ 1,499,200$ (353,000)$ 16,138,200$ 8 16,138,200$ 1,613,820$ (353,000)$ 17,399,020$ 9 17,399,020$ 1,739,902$ (353,000)$ 18,785,922$
10 18,785,922$ 1,878,592$ (10,353,000)$ 10,311,514$
Amount passing to beneficiaries free of estate and gift tax
Installment Sale to an IDGTExample
44©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
“Tax-burn” Strategy
• “Bet to live” strategy• Utilize “grantor” trusts• Grantor pays the income taxes• Additional tax-free wealth transfer• Hedge with life insurance• Long life creates greatest “burn”
45©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Example
ASSUMPTIONSFMV of closely-held family business: $10,000,000Pre-tax rate of return on closely-held family business: 10%
FMV of “other” assets: $10,000,000Pre-tax rate of return on “other” assets: 10%
Sale price of closely-held family business: $6,500,000 ($10M sale less 35% discount)
Installment note interest rate: 4.5%
Income tax rate: 40%
Estate tax rate: 45%Estate tax exemption: $3,500,000
46©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Example
No planning ▪ Sale▪
47©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Example
48©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Example
49©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Example
50©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Example
51©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
TAX BURN SCINSM
Mathematics of Gifting & Inter Vivos Sales
52©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• SCIN is used in combination with IDGT• IDGT is a “Bet to Live” Strategy• SCIN is a “Bet to Die” Strategy
Tax Burn SCINSM
Mathematics of Gifting & Inter Vivos Sales
Grantor(Child) IDGT
Sale
53©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
SCIN
• Income tax liability of trust is paid by deemed grantor of the IDGT due to the grantor nature of the trust
Tax Burn SCINSM
Mathematics of Gifting & Inter Vivos Sales
IDGTGrantor(Parent)
Investment(i.e. closely-held stock, marketable securities, etc.)
Cash flow
Taxable income
IRS
Payment of income tax on IDGT’s taxable income
54©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• The Key is to “balance” the “Bet to Die” Strategy with the “Bet to Live” Strategy
• On the “Bet to Live” side If the Seller Lives to Life Expectancy the Principal and Interest Payments from the Note are used to pay the Income Tax Liability on the Grantor Trust
• Over Time the Value of the Note is Eliminated along with the Estate Tax on the Note
• On the “Bet to Die” side - If the Seller Dies Early the Note is “Cancelled” and the Estate Tax is Eliminated
Tax Burn SCINSM
Mathematics of Gifting & Inter Vivos Sales
55
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
56
• To the extent that the income tax liability on IDGT’s income is greater than installment payments received back from the trust, the excess income tax liability will reduce the grantor’s taxable estate (i.e. “tax burn”).
Tax Burn SCINSM
Mathematics of Gifting & Inter Vivos Sales
YearIncome Tax on IGDT Income*
Installment Payment
Received From IDGT** "Tax Burn"
Cumulative "Tax Burn"
1 (400,000)$ 378,000$ (22,000)$ (22,000)$ 2 (440,000)$ 378,000$ (62,000)$ (84,000)$ 3 (484,000)$ 378,000$ (106,000)$ (190,000)$ 4 (532,400)$ 378,000$ (154,400)$ (344,400)$ 5 (585,640)$ 378,000$ (207,640)$ (552,040)$
* $10,000,000 FMV of assets held in IGDT x 10% return x 40% tax rate (compounded by 10% per year)** $6,300,000 SCIN principal (discounted) x 6% interest rate (AFR + mortality risk premium)
EXAMPLE
56©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• If grantor dies during term of SCIN, the note and assets sold to the IDGT are out of the grantor’s estate
• If the grantor survives the term of the SCIN, then the “Tax Burn” will have eroded the grantor’s estate to the point where the repayment of the note will not increase the grantor’s taxable estate
Tax Burn SCINSM
Mathematics of Gifting & Inter Vivos Sales
YearIncome Tax on IGDT Income*
Installment Payment
Received From IGDT** "Tax Burn"
Cumulative "Tax Burn" SCIN Balance
Assets Included in Grantor's Estate
1 (400,000)$ 378,000$ (22,000)$ (22,000)$ 6,300,000$ -$ 5 (585,640)$ 378,000$ (207,640)$ (552,040)$ 6,300,000$ -$ 10 (943,179)$ 378,000$ (565,179)$ (2,594,970)$ 6,300,000$ -$ 15 (1,518,999)$ 378,000$ (1,140,999)$ (7,038,993)$ 6,300,000$ -$
-$ * $10,000,000 FMV of assets held in IGDT x 10% return x 40% tax rate (compounded by 10% per year)
** $6,300,000 SCIN principal (discounted) x 6% interest rate (AFR + mortality risk premium)
EXAMPLE
Asset not included in grantor's estate during note termCumulative effect of "tax burn"
eliminates value of SCIN coming back into grantor's estate upon repayment
57©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
• Initial Burn Point (a.k.a “Tax Burn”) – The point at which the income tax liability paid by the grantor becomes greater than the installment payments received from the trust.
• Full Burn Point – The point at which any cumulative reinvested “positive transfers” (i.e. installment payment received > tax liability) by the grantor and the SCIN are eliminated by the cumulative effect of the “tax burn.”
Tax Burn SCINSM
Mathematics of Gifting & Inter Vivos Sales
YearIncome Tax on IGDT Income*
Installment Payment
Received From IGDT** "Tax Burn"
Cumulative "Tax Burn" SCIN Balance
Assets Included in Grantor's Estate
1 (400,000)$ 378,000$ (22,000)$ (22,000)$ 6,300,000$ -$ 5 (585,640)$ 378,000$ (207,640)$ (552,040)$ 6,300,000$ -$ 10 (943,179)$ 378,000$ (565,179)$ (2,594,970)$ 6,300,000$ -$ 15 (1,518,999)$ 378,000$ (1,140,999)$ (7,038,993)$ 6,300,000$ -$
-$ * $10,000,000 FMV of assets held in IGDT x 10% return x 40% tax rate (compounded by 10% per year)** $6,300,000 SCIN principal (discounted) x 6% interest rate (AFR + mortality risk premium)
EXAMPLE
Initial Burn Point
Full Burn Point
58©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
59
Tax Burn SCINSM
EXAMPLE
Net Taxable Estate
$-$1,000,000$2,000,000$3,000,000$4,000,000$5,000,000$6,000,000$7,000,000$8,000,000$9,000,000
$10,000,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Year
SCIN Note Outside Assets
Natural "tax burn"
Mathematics of Gifting & Inter Vivos Sales
59©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.
Estate Tax is Eliminated in Year One
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©2010 Keebler & Associates, LLPRobert S. Keebler, CPA, MST, AEPAll Rights Reserved.
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Circular 230 Disclosure
Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.
For discussion purposes only. This work is intended to provide general information about the tax and other laws applicable to retirement benefits. The author, his firm or anyone forwarding or reproducing this work shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to be caused, directly or indirectly by the information contained in this work. This work does not represent tax, accounting, or legal advice. The individual taxpayer is advised to and should rely on their own advisors.
©2010 Robert S. Keebler, CPA, MST, AEPAll Rights Reserved.