By Lawrence M. Lipoff, CPA, CEBS, Rogoff & Company, P.C.
In recent Treasury regulations (IRB
1999-5) addressing the complicated area of "flip unitrusts," the IRS provided, as an aside, practical guidance that can be of benefit to many practitioners preparing income tax returns for net income make-up charitable remainder unitrusts (NIMCRUTs). The IRS's advice can eliminate a complicated calculation that tax preparers previously had to perform.
Basically, a charitable remainder unitrust (CRUT) is designed to pay a settlor a distribution stream for a period of years or for life, with the remainder to be donated to charity. The distribution stream is based upon the fair market value of the trust's assets, measured at a consistent time annually. The fair market value is multiplied by a pre-established percentage. If income (current and undistributed) is insufficient, then capital gain, non-taxable income, and trust corpus (in that order) must be distributed until the required amount is met.
In addition to providing a future benefit to charity while being entitled to a current, actuarially determined income tax deduction, highly appreciated assets can become currently useful to the donor without incurring a capital gains tax. However, as time passes and distributions are received by the donor, the immediate tax deduction is "recaptured" to the extent of the trust's taxable income.
The NIMCRUT distribution amount in a given year is, at first glance, the unitrust amount. However, if the trust's fiduciary accounting income is less than this amount, then the distribution for the year is the fiduciary accounting income. In a year that fiduciary accounting income exceeds the unitrust amount, the distribution is increased until the held-back (net income make-up) amount is distributed.
The fair market value used in the calculation of the following year's unitrust payments has been the value of the assets less any payment not made by the valuation date. As an example, assume the value of the trust's assets was $100,000 and the unitrust rate is ten percent (10%). If the $2,500 quarterly unitrust payment has not been made, the calculation [($100,000$2,500) x 10%/4] yields $2,437.50 instead.
Effective December 10, 1998, there is no longer a need to reduce the fair market value by the unpaid unitrust amount. Under this simplified unitrust calculation, the payment to the unitrust beneficiary will increase, and the amount available for charities will decrease. However, this does not apply to previously established NIMCRUTs because the calculation to satisfy IRS requirements must have been set forth in previously drafted documents. Clearly, provision should be made in all newly drafted NIMCRUT documents to permit this calculation.
The above-referenced Treasury regulation refers only to NIMCRUTs. It is noteworthy that CRUTs were not addressed, although logically the rule should also apply to them. It will be interesting to see if new documents will apply this change to CRUTs. *
By Alan D. Kahn
As an estate and retirement planner, I often find that one of the most overlooked areas of planning is succession planning. It amazes me to see how many individuals build family businesses and fortunes over their lifetimes, only to lose it all because they were too busy creating their dynasty to preserve it.
It is estimated that over half of all family-owned businesses never make it to the second generation. Why? Because of the unexpected: the sudden death of the business owner and the corresponding confiscatory estate tax bill, the disability of an owner, the retirement of a partner, or unresolved family conflicts.
Business succession planning will not only help to ensure the continuity of the family business for future generations, but it will also assist the current owners in reaching their goals. As current owners pass the torch to younger generations, they must also obtain the financial security to support their own future needs and retirement dreams. For some, financial needs are greater during retirement because of an increased desire to finally enjoy the fruits of their labor.
Here are some tips to help your family business continue for future generations.
Buy-Sell Agreements. Ascertain that a properly funded buy-sell agreement has been drafted. The agreement should be continually updated to reflect the changing needs of the owners and values of the business. In the event of a partner's death, the agreement will ensure that the heirs will receive a fair price for their interest. It will also provide immediate liquidity for their business interest.
A disability buy-sell agreement can also protect against a shareholder's permanent disability. The disabled partner's interest easily can be bought out from the business, thereby relieving the burden of supporting an unproductive partner.
Estate Planning. Partners should evaluate their estate tax exposure in conjunction with their business succession planning. Business valuations should be updated along with the proper valuations of other assets such as real estate and investments. For some, the best estate plan may be to spend everything: Go on vacations, buy gifts for the children and grandchildren, pay for their college education, or just give it all away. Then again, how many people are willing to surrender control of their assets during their lifetime to protect their children's inheritance? Frankly, not many.
Life Insurance. There are those individuals who dislike life insurance because they have difficulty paying for something expensive that they will never see. However, life insurance, if properly utilized in an estate or succession plan, can enable individuals to maintain control and protection of their assets, effectively reducing their state tax rate to possibly 10 or 15%. This is accomplished either by the use of an irrevocable trust or by having the heirs own the policy directly.
Irrevocable Life Insurance Trust. By placing property in an irrevocable trust, the grantor is giving the property (in this case, life insurance) away permanently. Since the grantor no longer owns the insurance, the proceeds do not become part of the estate and are not subject to estate tax.
The same is true if the heirs own the insurance. If used in this manner, the insurance provides the liquidity necessary to pay the estate taxes, so the bulk of the estate (including the family-owned business) passes to the heirs.
In effect, the insurance company is being utilized to pay the estate taxes for just the cost of the insurance premiums, which in many cases is only 10 or 15 % of the death benefit. What appeared to be expensive at first is actually very reasonable and extremely useful.
Review Current Tax Laws. Estate planning must take into account the most current tax law changes regarding the family-owned business deduction from the IRS Restructuring and Reform Act of 1998.
For those who wish to keep the business in the family, the benefits of these new rules may be helpful. Qualified family-owned business interests are now deducted from the gross estate to the extent that such interests exceed the applicable exclusion amount up to a maximum of $1.3 million.
The 1998 tax act revised the rules to relate the increase in unified credit with a decrease in the family-owned business deduction, so that as increases in the unified credit are phased in, there is neither an increase or decrease in the total estate tax on family-owned businesses. These rules are complicated and should be carefully reviewed.
Team Approach. Every succession plan needs to be built and customized by a team of advisors so that it fits the specific needs and goals of the individual shareholders. Usually the team is composed of a financial planner, insurance specialist, attorney, and accountant. Because each succession plan is an evolving process, it is of utmost importance that it be periodically reviewed so that it continues to reflect and protect shareholder needs and goals, which will change over a lifetime. *
Alan D. Kahn, CLU, CHFC, CPA, is president of the AJK Financial Group. This column is adapted from an article that first appeared in the Long Island Business News.
Lawrence M. Lipoff, CPA
Rogoff & Company, P.C.
Alan D. Kahn, CPA
The AJK Financial Group
Barry C. Picker, CPA
Richard H. Sonet, JD, CPA
Marks Shron & Company LLP
Peter Brizard, CPA
Ellen G. Gordon, CPA
Lopez Edwards Frank & Company LLP
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