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ADVICE AND COUNSEL

The purpose of presenting this newsletter is to help clients and friends learn of new legislation, court decisions, planning techniques and concepts which may impact individual estate plans and the administration of trusts and estates. This newsletter will not present vendor ghost written articles. Some of the newsletter content will be new to the client and some content will be technical, however, it is better to be familiar with this knowledge than not. Also, the newsletter will offer context and perspective on issues raised in the articles. The newsletter will be available on the firm's website. If there are any matters which are unclear, I hope that you will drop me a note with your comments. If you find this newsletter to be beneficial, please feel free to pass it along to a friend. -DCR-

Recently, the New York Times ran an advertisement which suggested that if the federal estate tax was repealed, then you would pay for the lost tax revenue and that charitable giving by estates would be diminished. What nonsense. Why should the IRS be a beneficiary of your hard work and disciplined financial responsibility just because you died?

The fact is that the real benefit to making large charitable gifts is through lifetime charitable giving since not only does the gift reduce the potential estate of the donor, but it produces a present income tax deduction which if not used in the year of the gift, can be carried forward for 5 years. Generally, a charitable gift in an estate setting merely produces a deduction to the gross estate. Consider George Soros who was one of the signatories of the ad. He is purported to have made lifetime charitable gifts in excess of $600 million. That avoids a lot of present income tax. Who makes up that present lost tax revenue? Not George.

For the tax year 1999, Americans gave over $193 billion to charity. In 1999 gifts to charity by estates amounted to $14.5 billion and this represented an average of 7.4% of the gross estate for those estates which made any charitable gifts. In 1985 charitable gifts in estates amounted to $4.5 billion and averaged 7.2% of the gross estate for estates which made any charitable gift. Compare 7.2 % to 7.4 %. Not much difference over the past years.

For 1998 the gross tax revenue received by IRS from the estate tax amounted to $24 billion or 1.4% of budget revenues or .36% of GDP. Only Japan, France and Belgium have higher estate taxes (estate, gift and inheritance tax) than does the United States as a percentage of GDP.

Historically, the federal estate tax has been implemented to help finance war efforts, beginning in 1797 with stamp taxes on certain documents. It was repealed in 1802. The stamp tax reappeared between 1862 to 1870 during and shortly after the Civil War. The estate tax next appeared in 1898 to 1902 to help with the Spanish American War. In 1916 (another war) the estate and gift tax became law with the rates of 1% to 10% ( the latter for estates in excess of $5 million- real money in 1916). In 1926, the maximum bracket was 20% on estates over $10 million. In 1934 the top rate was 60% and in 1935 the top rate was 70% on estates in excess of $50 million. In 1941 the top rate was increased to 77% on transfers in excess of $50 million. As recently as 1977 the top federal estate tax bracket was 70% on estates in excess of $5 million and thereafter that top bracket declined to 55% on estates in excess of $3 million. Although the rate came down, the tax base was broadened to catch more estates. No meaningful tax relief came until the Reagan tax cut in 1981 which put the taxpayer in the position he/she should have been in after taking into account inflation- the hidden tax.

As noted by the Joint Committee on Taxation, " Critics of the federal transfer taxes document that these taxes create incentives to engage in tax avoidance activities…involve complex legal structures and can be expensive to create…(these costs) are socially wasteful because of time, effort and financial resources are spent that lead to no increase in national wealth."

Keep the estate tax? Nonsense!

With the shift of retirement funds into 401K plans, 403b. IRAs and similar plans, a greater portion of the client's wealth is housed within investment vehicles that have not been subject to income tax. These plans are of significant benefit due to tax free compounding of the retirement accounts. In addition, the client may have tax deferred salary, commissions or Buy/Sell agreements which agreements are drafted to cause income to be paid out over a number of years. Buy and Sell agreements intentionally allocate this deferred income (consultation or non-compete provisions) to the deal because such payments are deductible as paid by the Buyer. The Seller may not be as concerned that such payments are not capital gain, since it is similar to a salary continuation, something that the Seller is accustomed to receiving. Sometimes this income/gain is contained in a mortgage or secured note which will be paid over time and may not be paid in full at death of the Seller.

However, in an estate setting, these income payments can cause a significant income tax problem to the estate or trust which receives these payments. These payments can become trapped in the estate or the trust and be subject to very high income tax rates at different and lower brackets from those which we as taxpayers experience during our lifetimes. For example, if income is trapped in an estate or trust, the maximum federal rate of 39.6% is applicable to all income retained over $8,600. Between the estate tax and the income tax on the benefit, the total tax bite can exceed 70% of the asset. This is why the beneficiary designations of an IRA, SIP etc. and the estate's liquidity are so important. If you make a mistake, the primary beneficiary will be the IRS. (See the manual "IRA and Qualified Plans at the Website- dcreid.com)

Under the Cannons of Ethics, a lawyer's obligation to his/her client is one of undivided loyalty and all communications are privileged and confidential. The client is always aware that any information given to a lawyer is not to be communicated without the client's prior knowledge or express consent, FTC regulations notwithstanding.

As an aside, the economics and ethics of the market place recently have caused some accountants to sell financial products and services, due to "modification" in their prior ethical code. They want to avoid hourly billing and receive compensation as a portion of the investment broker's annual and recurring management fees. Some lawyers sell title insurance and retain a portion of the premium to supplement their marginal fee quote to the Buyer of real estate. In both cases, the ethical requirement for professional independent judgment is compromised under the guise of disclosure to the client. Who protects the client from the disclosure? If the investment portfolio sustains losses, will the CPA write a check? What side agreements are not disclosed to the client? Shouldn't they be?

Recently, a new client (age 70+) came to office and asked me to examine a proposal presented by her stock broker to establish a charitable remainder trust with low basis stock. The trust would terminate at her death and the assets remaining would pass to charity. She would receive an 8% payout from the trust each year. The client would set up a new life insurance trust so that the proceeds of the policy at her death would pass to the client's three children free of income and estate tax. The charitable trust would reduce her estate for estate tax purposes. It sounded proper until you ran the numbers.

The proposed annual life insurance premium was $29,000, which allowed only $1,000 of the annual gift tax exclusion in the future to be split among her children. The trust would generate $36,000 of income to the client per year. After income taxes, all of the trust payout, and perhaps more, would be used to pay insurance premiums! Would the broker be compensated with any of those premium dollars? Didn't know. The client's future income stream (Adjusted gross income-AGI) was insufficient to use up the charitable deduction. About $72,000 of this deduction would be wasted even when carried forward. Was she told that? No. Did she need the additional income? No. Did she want to diversify out of the investment? No. What was the fee structure by the broker for the new trust investment account? Unknown. The client was referred to the broker's attorney and did not involve her attorney of 40 years. Were any of these issues discussed with her by the broker's attorney? No. Drafts were prepared. The broker had assured the client that the proposal did not have a single problem. That is what can and does happen to clients in the ethics of the market place.

If the client was worried about her estate tax and after considering the change in the estate tax law which will commence in 2002, the solution for her was to have her children purchase either a term or whole life policy for the amount of the estate tax exposure. The annual premiums would be significantly lower and the policy could be kept or cancelled as events unfolded.

When you abandon your independent judgment, you start down the slope of personal financial accommodation and the client's interests receive lip service.

This question will answered over the next several issues of this newsletter.

First, do not assume that the future increases in the exemption and scheduled repeal of the estate tax will in fact occur. Congress is on a spending spree as excess revenues come into the Treasury. Moreover, Congress continues to take money out of the Social Security/ Medicare trust fund, spends it and gives an IOU to the trust fund. But there are no present assets to back up the repayment. To make good on the resulting mountain of IOUs, Congress will have to get additional revenue in the future or cut benefits, or both. Also, 2010 will coincide with the retirement of the Baby-Boomers and I would guess that the surplus numbers will have dwindled to a trickle….There will be "The Sky is falling" Congressional lament and that will be translated into the need for increased revenue. So, don't count your estate tax repeal chickens just yet!

Next, for husbands and wives who have wills or trusts which use and set apart the unified credit/ exemption in a credit shelter trust, that exemption becomes $1 million dollars as of January 1 2002 and stays at that level through 2003. The increase is only $325,000 from what it is today. The numbers in your plan should be examined in 2001 and you should be prepared to examine your plan every year to make sure that your plan makes sense.

If you have disclaimer trust provisions, whereby the surviving spouse can disclaim property at the death of the first spouse and that property will pass to a disclaimer trust of which the surviving spouse is the beneficiary, you (actually your spouse) can disclaim that amount of property needed to fund the credit shelter trust depending on the assets passing to the surviving spouse and the amount of the unified credit available at the first spouse's death. It might be decided that nothing will be disclaimed because the surviving spouse's own unified credit will shelter all assets. Then again, you may want the certainty of protecting assets from creditors, children, etc. by the use of a credit shelter trust during the surviving spouse's lifetime.

Those clients who have credit shelter provisions should discuss their plans now and those who have disclaimer provisions can wait until the new year.

During the interim, those clients with IRAs/401Ks, etc should check your beneficiary designations (get a written copy). We want make sure that the benefit is going to give the designated beneficiary the best options for payment and investment. If you are presently taking minimum distributions, the January Temporary Regulations, which you have to opt into this year (but apply to everyone next year with a limited exception), can reduce the amount you are required to take out in 2001. (See Website for details)

If there are issues or questions which you have on estate planning, estate and trust administration, charitable giving or related issues, please drop me a note. You can also E-mail me at davidreid@dcreid.com. I will call or write to you since I distrust cyberspace. See Privacy Notice

The information you obtain at this site is not, nor is it intended to be, legal advice. You should consult an attorney for individual advice regarding your own situation.

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