Scott Roberts, CPA, CLU
Director of Estate Planning

According to LongTermCare.gov, 68% of all people in the United States will require some type of long-term care (LTC) after the age of 65. Decades ago, older and informed people would not survive long in a state where they required significant aid for their daily living. But medical advances have made is so that such people can now live years in relative comfort, even if they need help to do so. On top of that, health insurance costs, especially in the final years of life, continue to spiral upward out of control.

What is also increasing is the number of years the typical person will require long-term care, also the result of advances in medicine. Years ago, nursing home stays were often brief but the average stay now is 2.3 years and rising (Source: Centers for Disease Control and Prevention, Nursing Home Care FastStats). The result is a significantly negative financial contingency against which it is increasingly prudent to insure.

Of course, among those with significant assets and the ability to comfortably pay for LTC, many choose to self-insure this risk. When considering the fact that substantial LTC premiums could be paid with no claim and, thus, constituting a sunk cost, the self-insured route seems reasonable for the wealthy. And when you also consider the fact that insurance companies reserve the right to increase premiums or decrease benefits on most traditional LTC policies, the argument for self-insuring becomes even stronger.

However, ever the resourceful industry that it is, continually developing products to meet demand, several insurance companies have come out with policies tailored to address these concerns and can be an excellent fit for many wealthy clients. In essence, these policies allow the client to “self-insure” but still leverage the resources of the insurance company into benefits several times the premiums paid, often yielding double-digit IRRs.

Several companies, including Lincoln, Pacific Life and Nationwide, have developed these policies which essentially allow the client to “park” an amount of cash at the company and retain partial or full access to the funds (depending on the company/product) without surrender charges. If the funds are not taken back by the client for other uses, when there is a LTC claim in the future, benefits are paid on a reimbursement or indemnity basis, again depending on the product. Besides the potentially unfettered access to monies deposited in these products, a key feature is if there is never a claim then the client’s heirs receive the monies back plus a small death benefit. As such, it is possible to structure a plan where no money can be lost, whether there is a claim or not (assuming the company does not go out of business – a reason to always use highly-rated companies). In which case, the only “cost” of the coverage is the opportunity cost related to what could be earned elsewhere by the funds on deposit. But when you take into account the fact that most wealthy investors have a portion of their portfolio in liquid money market accounts earning well south of 1%, all that needs to be done is to incorporate the LTC deposit funds as a portion of the highly liquid segment of a diversified portfolio. By doing that, these types of LTC policies become a nearly cost-free hedge against potential future LTC expenses, potentially providing double-digit returns with little or no downside risk.

Each product has subtle but important differences, such as inflation adjustments, reimbursement vs. indemnity benefits, elimination periods, etc., which are beyond the scope of this article. In addition, this material is for general information only and is not intended to provide specific advice or recommendations for any individual. As such, to determine what is appropriate for you, please contact our office to discuss if one of these products may be a fit for you and, if so, which one.

Scott Roberts, CPA, CLU
Director of Estate Planning

With the election of Donald Trump as President, and his previous comments regarding wanting to permanently repeal the estate tax, along with Republican control of both the House of Representatives and Senate, is it possible that the death of the death tax is imminent

Hardly. While permanent repeal is an interesting talking point, and one that can quickly devolve into congressional rules and procedures, permanent repeal of the estate tax is highly unlikely for reasons that fall into three main categories: political, procedural and practical.

Politically, the estate tax is not the “hot button” issue it once was when minimum wage earners were bemoaning the “death tax” due to canny marketing that led to flagrant misunderstanding about whom would be subject to the tax. More importantly, however, most Republican lawmakers feel the estate tax issue was settled, permanently, in 2012 when a huge increase in the exemption (indexed to inflation) meant that less than 1/2 of 1% of the population would be subject to it. With many more juicy tax reforms up in the air (can you say “carried interest”?), not to mention a likely overall reduction in tax rates, most would agree that estate tax repeal will be among the first sacrificed for agenda items that affect more voters.

Procedurally, tax legislation always starts in the House of Representatives but ends up being an exercise in what the Senate will allow. And the Senate can only allow what its rules will allow. As a stand-alone bill, estate tax repeal would only require 51 votes in the Senate to pass (52 Senators are expected to be Republican). However, Senators can extend debate (filibuster) and postpone a vote indefinitely (with some help), effectively blocking the legislation. A filibuster can only be broken with 60 votes, a number the Republicans don’t have without serious defections by Democrats.

Of course, there is another path – that of budget resolution reconciliation. A budget resolution containing estate tax repeal could be passed and sent to the Senate for reconciliation and vote, a process that limits debate and, therefore, prohibits filibusters. So, clear sailing for a Republican-controlled Senate, right? Nope, sorry. The reconciliation process is subject to the Byrd Rule (named after the late Senator Robert Byrd of West Virginia) which allows any Senator to block legislation that will increase the deficit beyond the term covered by the budget resolution (typically 10 years). Guess how many votes are required to overturn a Byrd Rule objection? Yep, 60. So we are back to square one, right? Not exactly.

It is possible that the estate tax repeal legislation could be crafted so that it “sunsets” (i.e. goes away) after 10 years. That way, it would not be subject to a Byrd Rule objection and would, therefore, only require 51 votes in the reconciliation process. This is exactly what happened in 2001 when George W. Bush was president and Republicans controlled the House and Senate for four years. The best they could do was pass the 2001 EGTRA legislation which, after increasing the estate tax exemption over a period of years, repealed the estate tax for one year (2010) before sunsetting in 2011 and reverting to the 2001 law.

So, as a practical matter, without significant further Republican gains in the Senate, there is no path to permanent estate tax repeal. But let’s go so far as to say that happens during a Trump presidency, allowing filibusters to be busted and “permanent” estate tax repeal to be enacted. Even in that very unlikely scenario, is it really permanent? Many would say no because a future administration could be just as likely to reinstate a tax that has remained remarkably resilient since 1916, and came and went no fewer than four times before that, most famously to help fund the Civil War.

So, to paraphrase a misquoted Mark Twain, the rumors of the death of the death tax have been greatly exaggerated.

This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation. LPL Financial does not provide legal advice or services.

Scott Roberts, CPA, CLU
Director of Estate Planning

On August 2, 2016, the IRS issued the long-anticipated proposed regulations for section 2704 related to valuation discounts for closely-held entities.

The action comes as no surprise to the tax planning community familiar with the long battle our country’s tax collection agency has waged against these discounts which allow savvy taxpayers to leverage exemptions and transfer greater wealth to future generations without taxation. For decades, the IRS has challenged these discounts in court and, barring bad facts on the part of the taxpayer, has repeatedly lost, essentially creating a how-to roadmap along the way.  But, just as it has for multiple other issues, when the IRS can’t win with the rules, it just changes the rules by petitioning congress or, as in this case, simply reinterpreting the rules via new regulations.

First, a word on what this is all about, and then a comment on the Proposed Regulations themselves. In a very simplified nutshell, here is how valuation discounts work: If parents were to gift children 50% of a $10 million asset, logically, the value of the gift would be $5 million. However, if, prior to the gift, the asset is transferred into a Limited Partnership and 50% of the Limited Partnership interest is given to the children, what would be the value of the gift now?  Considering that the parents undoubtedly retained control of the entire partnership by keeping the small General Partner percentage and, further, since the Partnership Agreement likely limits the Limited Partners’ ability to sell, one could conclude that the Fair Market Value of the gift is less than $5 million. Exactly how much less has been the subject of many IRS disputes over the years but the discounts for lack of marketability and lack of control have been repeatedly upheld. Of course, each particular situation is different but, depending on the facts, including language in the agreement and the mix of assets contributed, discounts can range from 15% to 35% or more, resulting in millions of tax dollars saved (or lost, if you’re the IRS).

In a hearing on December 1, the IRS will hear comments on the proposed regulations which, essentially, prohibit the discounts described above on intra-family transfers.  Many feel the IRS has overstepped with a net thrown too widely since the proposed regulations would not only apply to passive entities but also to actual operating companies.  Still, conventional wisdom says that the regulations will become final with very few changes and will affect all transactions beginning 30 days after the date the final regulations are published.  The timing creates a window of opportunity during which many taxpayers will avail themselves of this technique for the last time.

A proven and much-used planning tool is being put out to pasture like an aging, reliable thoroughbred. But there’s still time for one last ride.

This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation.  LPL Financial does not provide legal advice or services.

Scott Roberts, CPA, CLU
Director of Estate Planning

The Estate Tax is a tax on the transfer of assets to heirs upon one’s death, or during life when it is called the Gift Tax.  With a lifetime exemption of $5.45 million, or $10.9 million per married couple, less than 1% of the population will ever pay it.  And yet the tax can still be divisive as some label it the “death tax” and both sides passionately voice their position.  On one side are the wealthy (and those who plan to be wealthy) who claim it is an unfair double taxation on assets accumulated through earnings that have already been taxed.

Plus, it is anathema to our American values since it acts as a disincentive to entrepreneurship.  On the other side are those who point out that the tax is needed to prevent an unfair advantage to the wealthy who can pass on assets with built-in gains that are never taxed because of the step-up in tax basis at death.  Plus, they argue, some reallocation of wealth is needed to prevent an ever-increasing wealth divide, and friction, between the haves and have-nots.

Without delving into the philosophical and macroeconomic arguments for and against wealth redistribution, there are some truths to be highlighted.  It is true that the estate tax, in many situations, does represent a double taxation on assets that have already been taxed as income when earned.  Of course, it is also true that built-in gains, some very large, are never taxed due to the step-up in basis at death.  But if there were a way to address the main arguments of each side on this issue, doesn’t it make sense to explore?

Often, the simplest solution is the best and we need look no farther than to our neighbors up north who have already addressed this very situation.  Canada’s estate tax is quite simple: when you die, the transfer of your assets to your heirs (except a spouse) is treated as a deemed sale and any accrued gains are taxed at that time.  This approach represents the very epitome of simplicity, effectively dealing with the main arguments of both sides.  By taking away the step-up in tax basis and treating the transfer like a sale, the wealthy aren’t able to avoid taxation on built-in gains. And if only the built-in gains are taxed, then there is no double taxation on the wealthy.  It begs the question: how have we not done this already?

Part of the answer to that question is that other factors need to be considered also.  For example, should there be an exemption for very small estates with built-in gains?  Should the rate be the same as the long-term capital gain tax rate, or should it be higher (or lower)?  Would such a change have a net negative effect on government revenues?  All good questions, among others, that can be addressed in another article.  But, at the end of the day, why do we keep tinkering with something anachronistic and broken?  Can’t we just answer the implementation questions and formulate a better way, incorporating the simplicity of a deemed sale?  I believe we can.

This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation.  LPL Financial does not provide legal advice or services.

Scott Roberts, CPA, CLU
Director of Estate Planning

Planning for the succession of your business when your partner is not a family member can be fraught with financial and relationship peril.  That clichéd, dramatic and rhetorical question “how would you like suddenly to be in business with your business partner’s spouse?” is apt because it is a common result for those who don’t plan.  But, as you will see, there is planning and then there is planning.  In this case, the former is merely having a buy-sell agreement and the latter is consciously choosing the optimal type of agreement.

Most business owners with a partner know they should have a buy-sell agreement which allows a surviving partner to purchase the deceased partner’s business interest at a contracted price, either mutually agreed from time to time or based on a formula related to the business’ financial information.  Such an agreement ensures a ready market for the deceased shareholder’s stock, while simultaneously allowing the surviving shareholder to retain control of the company, rather than suddenly be in business with any heirs who would have inherited the stock.  While the concept of a buy-sell agreement is simple, the type of agreement implemented can have a profound effect on the tax situation of the surviving shareholder.

A redemption agreement provides for the business entity to purchase the deceased shareholder’s shares, and is often funded by life insurance owned by the company.  This is the simplest structure and may be the best when multiple partners are involved.  However, the surviving shareholder will receive only a partial step-up in basis, at best, from the purchase and may, as a result, pay more in capital gains tax in the future if the business is sold.

A cross-purchase agreement provides for the surviving shareholder to personally purchase the shares of the deceased shareholder, and is often funded by life insurance owned by the shareholder (i.e. they each own a policy on the other).  While slightly more complicated to implement and fund, the surviving shareholder will receive a full step-up in basis from the purchase and can save capital gains taxes if the business is sold in the future.

To illustrate the difference between the two structures, consider a $10 million company owned 50/50 by two partners, each with a $1 million basis.  If the surviving shareholder under a redemption agreement later sold the business (assuming no appreciation and disregarding the Net Investment Income Tax), there would be approximately $1,800,000 of capital gains taxes due ($10,000,000 – $1,000,000 = $9,000,000 * 20% = $1,800,000).  However, that same surviving shareholder, had a cross-purchase agreement been implemented, would only have approximately $800,000 due in capital gains taxes ($10,000,000 – $6,000,000 = $4,000,000 * 20% = $800,000), a $1 million savings!

Several variables, including basis, purchase price and a future sale, have to line up for tax savings to be realized through a cross-purchase agreement.  But those savings can be so significant that taking the time to explore the best type of buy-sell agreement can be a $1 million exercise.

This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation.  LPL Financial does not provide legal advice or services.

Scott Roberts, CPA, CLU
Director of Estate Planning

Aside from the basic structure of a buy-sell agreement, other factors are equally important.  For example, if the purchase upon death is mandatory, which is recommended, then adequate funding should be ensured.  This is typically done with life insurance to avoid a situation where a surviving shareholder is left with a large liability and no way to easily pay.  Careful consideration should also be given to whether a purchase upon disability is mandatory or not.  Since buy-sell disability insurance can be difficult to obtain in large amounts, a mandatory provision might leave the non-disabled shareholder similarly financially hampered.

Buy-sell agreements also create a valuation conundrum for many business owners.  On one hand, they want to set the purchase price high enough so they can ensure their heirs receive full value for their business interest.  On the other hand, they would prefer to set the value of their business interest low for estate tax purposes.  What many don’t know is that it is possible to peg the value of a business at a low, substantiated amount for estate tax purposes while also ensuring your family members receive a higher amount.

The brilliance of the technique to accomplish this “dual valuation” is its simplicity.  It all comes down to the simple ownership structure of the insurance policies funding the agreement.  But, first things first, the matter of valuation must be addressed.

As the conundrum referred to above reveals, a true valuation of a privately-owned company can be elusive.  It is common knowledge that a company’s value is often best expressed as a range, sometimes even a large range, due to various circumstances and uncertainties.  For example, one qualified appraiser may value a company at $20 million and another qualified appraiser may value the same company at only $12 million.  For a 50% shareholder, that is a difference of $4 million.

This inexactness of valuation provides a planning opportunity if, for example, the shareholder wanted his family to benefit from the higher valuation, but wanted to mitigate taxes at the same time.  In such case, the buy-sell agreement, an arm’s length agreement between business partners, could reasonably use the lower valuation substantiated by a qualified appraiser’s valuation report and a $6 million insurance policy could be obtained, which would be part of the taxable estate.  Meanwhile, another $4 million insurance policy, separate from the buy-sell agreement, could be obtained and owned in a life insurance trust.  In this way, the shareholder could ensure that $10 million would benefit the family while only $6 million would become a part of the taxable estate.  Assuming a 40% estate tax rate, the potential tax savings of this simple tweak to the structure is $1.6 million.

While not every situation lends itself to this method of funding a buy-sell agreement, a careful examination of all the opportunities with a qualified advisor is recommended.  And, in any case, careful consideration of mandatory buy-out provisions should always be part of the planning process.

This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation.  LPL Financial does not provide legal advice or services.

Scott Roberts, CPA, CLU
Director of Estate Planning

If I had to pick the most common area that is ripe for improvement in many of my clients’ estate plans, it would be the terms by which assets are left to children and other heirs. More often than not, documents direct assets to be left to heirs in trust only until they reach a certain age, frequently staggering the distribution over a period of years such as one third at age 25, one third at age 30 and the balance at age 35. For most people, such a distribution schedule is perfectly adequate because the amount of assets is not substantial. However, when the amounts to be divided and distributed among heirs are hundreds of thousands, millions, tens of millions or more, a different approach is recommended, the benefits of which include increased asset protection and potentially significant future estate tax savings.

Specifically, instead of directing the assets to be distributed outright at certain ages, consideration should be given to leaving the assets in trust for the entire lifetime of the beneficiary, and beyond. Then, at the ages when assets would otherwise be distributed outright, the beneficiary can be given some measure of control. For example, they can become co-trustee at a certain age and even sole trustee of their trust.

When directing that a beneficiary can become trustee of their own trust, it is important to limit the discretionary distributions to the “ascertainable standard” which allows for distributions for “health, education, maintenance and support.”  Following that language, and allocating the appropriate amount of the decedent’s generation-skipping transfer tax (GST) exemption, should prevent some or all of the corpus of the trust from being taxable in the beneficiary’s estate, potentially saving up to millions of dollars of estate taxes. Fortunately, the ascertainable standard is sufficiently broad to allow beneficiary/trustees the type of control and beneficial access that clients typically wish to give – funds to start a business, help with bills or buy a house, but not the ability to gamble it away in Las Vegas.

Lifetime trusts also provide asset protection for beneficiaries in the event of a lawsuit or divorce because, technically, the beneficiary does not “own” the assets, the trust does. This protection is arguably stronger if the beneficiary is not a co-trustee or sole trustee, although the Florida state statute concerning “spendthrift provisions” in trusts does protect a beneficiary’s interest.  In any case, it is safe to assume that assets in trust are better protected than those left outright to beneficiaries, and it decreases the chances that assets earned and accumulated are not lost to lawsuit or divorce by the beneficiary.

Given the significant potential benefits of asset protection and estate tax savings, the use of lifetime trusts for beneficiaries should be considered in all cases where the amounts bequeathed are more than nominal.

This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation.  LPL Financial does not provide legal advice or services.