ESTATES AND TRUSTS

July 2000

INCOME TAX AND ESTATE PLANNING UPDATE

By Laurence Keiser, JD, CPA, Stern Keiser Panken & Wohl, LLP

With the effective repeal of all estate and gift taxes by New York State as of February 1, 2000, estate tax planning opportunities will involve only consideration of planning opportunities to avoid federal transfer taxes. The same planning can be used for all "pick-up" states.

We recently advised a number of clients on the sale (as opposed to gifting) of business interests to their children in consideration of a long-term promissory note funded with salaries and bonuses that otherwise would have gone to the parents. In other words, one or more children would receive the earnings that otherwise would have been paid to the parents, which in turn they pay to the parents for the S corporation or C corporation stock pursuant to an installment sale agreement with treatment at the lower capital gains rates. This puts the parents in basically the same cash flow position that they had while working, perhaps even better, because of the lower tax rate. In some cases, the parents have relocated to Florida and changed their domicile before the sale documents are executed, thereby avoiding New York State income tax on the payments. This is not possible if the clients relocate after the documents are signed because such a move out of state will accelerate the capital gains tax to New York (unless a bond is posted, which is rarely done).

With older clients, a sale of stock or real estate may involve a private annuity, a self-canceling installment note (SCIN), or a sale to a defective grantor trust. These tax planning techniques may be combined with others, including--

* family limited partnerships
* qualified personal residence trusts
* charitable remainder/lead trusts
* grantor retained annuity trusts.

Taxpayers and their advisors should determine which technique is best suited to the particular financial and family situation. The point to remember is that estate taxes are to a certain extent voluntary--those who fail to plan have no opportunity to avoid what can be an extremely heavy burden on the family. It should be noted that the President's tax proposals call for the prospective (not retroactive) repeal of the personal residence trust gifting technique, which is all the more reason for prompt action.

Discounts in Valuations

A great deal of emphasis today is being placed on the use of discounts in valuing partnership and closely held business interests for such things as lack of marketability, minority interest, lack of liquidity, a bundling of assets, and built-in gain. These discounts amounted to an amazing 76% of net asset value, when supported by a careful appraisal, in Estate of Helen I. Smith v. Comm'r [T.C. Memo 1999-368 (11/5/99)]. This fragmenting of interests producing valuation discounts applies even to a division of stock ownership, such as between a surviving spouse and a qualifying terminable interest property trust (QTIP) created for her benefit with an independent trustee [see Estate of Mellinger v. Comm'r, 112 T.C. 26 (1999), acq.-1999-35 I.R.B. 314]. This is another reason to create a QTIP, besides concerns about remarriage by the surviving spouse.

Furthermore, the need to regularly review how a taxpayer owns her assets has become a crucial part of the estate planning process. Some advisors are comfortable that a taxpayer with a well-drafted "tax planning" will--one with a credit shelter trust and the balance going outright to, or in trust for, the spouse--is well positioned. Upon review, however, it may be discovered that most of the taxpayer's assets will not be disposed of under the will. In fact, a major portion of the assets owned by many individuals are now held in the form of IRAs or qualified plans, which pass outside of the will by beneficiary designation (usually to the surviving spouse), thus defeating the estate tax planning set forth in the taxpayer's will.

This problem can be addressed by creating a trust to receive distributions from the taxpayer's IRAs or qualified plans, either through the taxpayer's will or through setting up a trust during the taxpayer's lifetime. The use of post-mortem disclaimers can give taxpayers flexibility in deciding upon the funding of such trusts during the estate administration process. Those in this situation should change beneficiary designations and create trusts in order to preserve the tax benefit of the credit shelter amount while providing for the surviving spouse. *

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