TAX PLANNING FOR MARRIED COUPLES

Tax-Sensitive Estate Planning In 2013 and Beyond: Lots to Think About!

Presented by

Paul P. Morf

[email protected](319)896 4012

mailto:[email protected]

TAX PLANNING FOR MARRIED COUPLES

“Married Couple”

• “Married Couples” now includes Same-Sex Couples for all state and federal purposes if the Couple Resides in Iowa.– Couple must be married in a state that recognizes

same-sex marriage, such as Iowa– Once married, federal marital rights follow the

couple even if they move to a state that doesn’t recognize same-sex marriage.

– See Rev. Rul. 2013-17 and Windsor decision

TAX PLANNING FOR MARRIED COUPLES

NOTABLE DEVELOPMENTS•Portability “permanent”•Higher Exemptions “permanent”•Income Tax and Capital Gains Tax Rates Getting Closer to Estate and Gift Tax Rates•Uncertainty Regarding Federal Status of Same-Sex Marriage

The Estate and Gift Tax in 2013 and Beyond

• No Sunset– Permanent until Congress votes to change it

• Rate Unified at 40% (gift, estate, GST)• Exemptions are Indexed to Inflation

– $5,000,000 in 2011– $5,125,000 in 2012– $5,250,000 in 2013– Increase for 2014 may be about $90,000


• Estate and Gift Tax Exemptions are Portable– GST Exemption is Not Portable– Must File an Estate Tax Return to Elect Portability

• Must be timely, but relief may be available if a deadline is blown.

• Should all decedents with surviving spouses be filing estate taxes?

• Malpractice concerns?


– A great improvement for Doctors and Professors with large qualified plans: Now you can have a Spousal Roll-Over Without Wasting Estate Tax Exemption

• Consider the Physician with a $7,000,000 IRA and no other assets.

• Previously, he had to choose between a spousal roll-over and sound income tax planning vs. a credit shelter trust and good estate tax planning. Now he can name optimize both by naming the Spouse as beneficiary, if she files a federal estate tax return and does a spousal roll-over.

• This is a game-changer for people in that situation.• But GST Tax Exemption is not Portable.


– Allows Most “ordinary folks” to Simplify Their Plans• Beaver Cleaver Family• No Non-Tax Reasons for a Trust• Not Likely to Have Assets Exceeding

$10,000,000 adjusted for inflation• Outright Marital Bequest is Now a Fine Option• Back-stopped by a Disclaimer to a Family

(Bypass) Trust

Estate Tax Freeze, or Second Step-Up in Basis?

– “Disclaimer-Based Contingent-Tax-Planning Will Be Optimal for Many or Most “First Marriage” Clients With Under $10,000,000.

• “I leave everything to my Spouse; What She Disclaims I leave to the Credit-Shelter (Bypass) Trust.”

– Allows Flexibility for Post-Mortem Planning» Disclaim to Fund the Trust and Get an Estate Tax Freeze? Or

Spouse to Receive Assets and Get a Second Step-up?» Either way, no estate tax exemption is wasted.» For families well below the $10,250,000 threshold, the second

step-up in basis will often be optimal» For folks approaching $10,250,000, the estate tax freeze may be

attractive, especially with appreciating assets (farms) that are not likely to be sold by heirs but rather retained as legacy assets.

Disclaimer-Based Plans Allow Post-Death Flexibility:

Disclaim to Fund the Trust and Get an Estate Tax Freeze? Or Spouse to Receive Assets and Get a Second Step-up?»Either way, no estate tax exemption is wasted.»For families well below the $10,250,000 threshold, the second step-up in basis will often be optimal»For folks approaching $10,250,000, the estate tax freeze may be attractive, especially with appreciating assets (farms) that are not likely to be sold by heirs but rather retained as legacy assets.

What if I want a Trust:

• GST Tax Exemption is Not Portable• Protect Children’s Inheritance• Avoid Creditors, Predators, and Future Paramours of

my Spouse and Kids• Ensure Oversight of Financial Decisions if Spouse is

Not Sophisticated

Is a QTIPable Trust allowing a fractional QTIP election the optimal resolution?

Rev. Proc. 2001-38, 2001-24 I.R.B. 1335

• A savings provision• Intended to save taxpayers from unnecessary QTIP

elections made in error• Could possibly be applied to void QTIP elections

made for basis planning purposes rather than to avoid estate taxes at first spouse’s death

• ACTEC and ABA may seek clarification• Until clarification is given, caution should be used in

drafting plans that will utilize QTIP elections to maximize step-up in basis at the second spouse’s death.

Why Use a Credit-Shelter Trust?

• Ensures no Waste of Exemption– No “Election” Need be Filed within 9 months as with Portability: Less

room for user error to result in lost exemption.

– Congress Could Change the Law

• See President Obama’s 2013 Budget, calling for exemptions to fall and rates to rise in 2018.

• A bird in the hand is worth two in the bush

• Obtains an Estate Freeze – (future income and appreciation on trust assets not subject to estate tax)

– A second step-up may be less valuable where assets are not

appreciating or where second spouse has a short life expectancy.

Why Use a Credit-Shelter Trust?

• Second Step-Up is Less of a Concern to Some than Second Spouse.

• There are Many Non-Tax Reasons for Trusts– Protect children’s inheritance from Surviving

Spouse’s second family, creditors, – elder abuse.– A QTIP trust is sometimes an imperfect substitute:

It cannot have a spray power among beneficiaries, and it must require that all income goes to the spouse for life.

My “new favorite” Trust term for married couples

• Grantor and Grantor’s Spouse have discussed the importance of protecting our assets in the event of the remarriage of Grantor’s Spouse following Grantor’s death. If Grantor’s Spouse chooses to remarry following Grantor’s death, then in order for Grantor’s Spouse to continue to be eligible to receive distributions of principal from the Marital Trusts pursuant to this Subsection 7.1.5, Grantor’s Spouse shall execute a valid premarital agreement not less than fifteen (15) days prior to the time of the remarriage that complies with the following terms.


• The premarital agreement must be in writing and signed by Grantor’s Spouse and Grantor’s Spouse’s fiancé with each having been represented by independent legal counsel. Prior to the execution of the agreement, each party must make full and reasonable disclosure of their assets as they exist at that time.


• The premarital agreement must provide that Grantor’s Spouse’s fiancé waives any right to any portion of Grantor‘s Spouse’s share of Grantor’s Spouse’s premarital assets and of Grantor’s Spouse’s share of or interest in any Trust (or Sub-Trust) created hereunder in the event of the dissolution of the marriage, or in the event the new spouse survives Grantor’s Spouse.


• If Grantor’s Spouse fails to obtain a premarital agreement according to the terms set forth in this Subsection, then upon the remarriage of Grantor’s Spouse, Grantor’s Spouse shall no longer be eligible to receive distributions of the principal of the Marital Trusts pursuant to this Subsection 7.1.5.

Conclusion: A/B Plans with Marital Trusts and Family Trusts Will Still be Important Where Trusts are Desired for Non-Tax Reasons

– “Largest Tax-Free Amount to the Family Trust, Rest to the Marital Trust”

• Family Trust can favor spouse but have a spray power, can accumulate income Spouse doesn’t need;

• Protect assets from your surviving spouse’s “second family” and creditors”• Avoids Waste of Exemption and Maximizes Estate Tax Freeze When First

Spouse Dies (future appreciation and income on Family Trust will not be subject to estate tax when second spouse dies)

• But an “Optimal Marital Deduction” Formula may not fully take advantage of the opportunity for a step-up in basis upon the second spouse’s death.

• Some have suggested a Clayton QTIP or Fractional QTIP Trust to solve this problem, but (1) there is a lack of certainty as to whether a QTIP election will be recognized by the service where it is not necessary to avoid estate taxes, and (2) it is potentially problematic having a spouse as trustee making a fractional QTIP election in a Clayton QTIP situation (where the QTIP portion is held on different terms than the non-QTIP portion).

Having Your Cake and Eating it Too With a Credit Shelter Trust?

– Some have giving an independent 3rd party the power to bring Family Trust assets back into the Spouse’s estate to receive a step-up in basis at death if estate taxation will not be a problem:

• Allow them to give the Spouse a general power of appointment over a portion of the trust assets at her death

• Allow an independent trustee to distribute assets to the Spouse from the Family Trust for any purpose, including to facilitate a step-up at death

• These options, of course, undermine at least somewhat the non-tax reasons for using a Family Trust, as they expose the assets to the Spouse’s creditors.

• Of course, this is less optimal than portability for couples approaching the $10,250,000 limit, as the same property ends up using Estate Tax exemption twice, potentially. But for less wealthy families, it may be a good compromise.

Outright Marital Followed by Inter Vivos Trust Created by Surviving Spouse

• More Potential Leverage Than With Testamentary Trust

• Inter Vivos Trust Could be a Grantor Trust

– Spouse pays tax on kids’ income

– Additional assets could also be loaned/sold to trust

– Potential for Second Step-up if spouse buys assets back

• No Expenses or Taxes Paid from Credit Shelter Trust with After-Tax Dollars

• BUT:

– There’s Many a Slip from Cup to Lip.

– Future of Grantor Trusts Uncertain

– Spouse May Change His/Her Mind.

– Congress may curtail use of Grantor Trusts

– GST Tax exemption is not Portable

In Summary:

• Where there is no non-tax reason for a trust, an outright marital bequest of the residue with a power to disclaim to a Family Trust is optimal for most families who are well under $10,000,000, at least where Generation-Skipping Transfer Tax Planning is not anticipated.

• A fractional QTIP Trust might be optimal in other situations, if Rev. Proc 2001-38 turns out not to be a problem.

• Clayton QTIP elections would be particularly helpful, but an independent trustee should usually make that election in situations where estate or gift taxation could possibly be an issue.

• Leaving the Tax-Free Amount to a Bypass Trust and the excess to a Marital Trust is still a fine plan in many cases, but attorneys should disclose that some opportunity for a stepped-up basis is being left on the table with this option.

• With qualified plans and IRAs, outright bequests to spouse to allow a spousal roll-over is more optimal than ever, as it no longer wastes exemption.

Equalizing Assets Between Spouses a Bad Idea?

• Equalizing assets between spouses for tax planning purposes seems much less important in an era of portability, absent GST-Tax Planning.

• In light of the recent Frye and Myers decisions of the Iowa courts, beware having clients move assets back and forth, or even into revocable trusts, without disclosing to them that they may be impacting their spousal share rights.

• If my spouse signs off on a deed funding my revocable trust, she loses her spousal share in that real estate under new appellate case law (Frye).

• By putting my assets in POD/TOD form, I cut off my spouse’s marital share rights, according to a new Iowa Supreme Court decision (Myers).

The Spousal Share Under Iowa Law

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Iowa Code Section 633.238 – Elective Share of Surviving Spouse

1. The elective share of the surviving spouse shall be limited to all of the following:

a.One-third in value of all the legal or equitable estates in real property possessed by the decedent at any time during the marriage which have not been sold on execution or other judicial sale, and to which the surviving spouse has made no express written relinquishment of right.

THIS IS WHY SPOUSES HAVE TO SIGN OFF ON REAL ESTATE DEEDS EVEN WHEN THEY HAVE NO OWNERSHIP

THIS IS “DOWER” and “CURTESY”

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Iowa Code Section 633.238 – Elective Share of Surviving Spouse – Continued


b. All personal property that, at the time of death, was in the hands of the decedent as the head of a family, exempt from execution.

What about IRAs?

District Court case (Rich) says yes, exempt from execution.

Myers may mean that IRAs are not “personal property,” at least if the beneficiary is not a revocable trust or will.

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c. One-third of all personal property of the decedent that is not necessary for the payment of debts and charges.

Is there any kind of property other than real property and personal property?

Is personal property that passes by beneficiary designation personal property “of the decedent?

Sieh (no longer good law)

Myers (holding Sieh was abrogated by statute)

What about property that passes by beneficiary designation to a revocable trust or to an estate?

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d. One-third in value of the property held in trust not necessary for the payment of debts and charges over which the decedent was a grantor and retained at the time of death the power to alter, amend, or revoke the trust, or over which the decedent waived or rescinded any such power within one year of the date of death, and to which the surviving spouse has not made any express written relinquishment.

-What about deeds used to fund revocable trusts?

-What if the deed includes language waiving dower and curtesy?

See Frye.

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2. The elective share described in this section shall be in lieu of any property the spouse would otherwise receive under the last will and testament of the decedent, through intestacy, or under the terms of a revocable trust.

-doesn’t mention beneficiary property

-doesn’t mention joint tenancy property

What about property that passes by beneficiary designation to a revocable trust or to an estate?

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Cases Preceding Estate of Myers

Sieh v. Sieh:

•Facts - In Sieh, Edward Sieh became deceased and left considerable assets at his death in a revocable inter vivos trust. On May 19, 1992, Edward had created a revocable inter vivos trust, which he funded with all of his personal effects, furniture, appliances, vehicles, tools, and shop equipment. At the time the trust was created, Edward was unmarried. The beneficiaries of the trust were Edward’s son and daughter. On December 23, 1992, Edward transferred a substantial amount of Grundy County farmland, which was owned by him, to the trust. On June 21, 1998, Edward married Mary Jane, and they remained married until his death on September 25, 2003. Edward’s Will was admitted to probate without present administration and a Notice to Creditors was published in the local newspaper, with a copy of the Notice being mailed to Mary Jane, the surviving spouse of Edward.

•Mary Jane filed a Spousal Election against the Will. Mary Jane then sought a Declaratory Decree in probate establishing the assets of the revocable trust should be included in her statutory share.

•The District Court ultimately entered summary judgment against Mary Jane, and she appealed.

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Cases Preceding Estate of Myers - Continued

Sieh v. Sieh, 713 N.W.2d 194, 198 (Iowa 2006) abrogated by statute as recognized in In re Estate of Myers, 825 N.W.2d 1 (Iowa 2012).

•Change to Elective Share - Interestingly, in 2005, while the appeal was pending with the Iowa Supreme Court, the Iowa Legislature amended the Spousal Elective Share under Iowa Code section 633.238 to add subsection (1)(d) to apply to trusts.

•On March 17, 2006, the Iowa Supreme Court filed its opinion and reversed the Iowa District Court’s summary judgment ruling against the surviving spouse.

•Holding: “In the present case, the decedent had complete control over the trust assets at all times prior to his death. Under the position adopted by the American Law Institute in the Restatements to which we have referred, that fact would allow the assets in the revocable trust to be included in the statutory share of Edward's spouse electing against the will. We adopt the view of the American Law Institute on this issue. Although Edward very likely did not intend for Mary Jane to share in any of the trust assets, we are satisfied that this is her right by reason of section 633.238.”

– Spouse should be treated no worse than a general creditor

– Personal Property of the Decedent means property Owned or Owned in Substance by the Decedent on the eve of death. (citing Restatement)

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Other Cases:•In Rich v. Rich (Case No. EQCV 141699), the surviving spouse and decedent had married on August 11, 1971, and at the time of their marriage, each party had children of a prior marriage. No children were born of the marriage between the surviving spouse and decedent. In 1971, the parties executed Wills naming each other as executors and beneficiaries of their respective Wills. In 1992, unbeknownst to the surviving spouse, the Decedent executed a Revocable Trust and a new Will, which contained pour-over provisions to the Trust, but the Decedent failed to fund the Trust during his lifetime. Upon the decedent’s death, the surviving spouse discovered her husband’s new estate plan and ultimately elected against the Will. At issue was whether the elective share should include exempt personal property which included an IRA with beneficiary designation to the Trust and POD accounts payable to children. The Woodbury County District Court held that the surviving spouse was entitled to include such assets in the elective share calculation. Since the IRA was exempt, the Court held that her share of the IRA was 100%.


• In Re Estate of Albers ((Pottawattamie County). District Court held that the surviving spouse’s elective share does not include POD or TOD accounts.

• In re Estate of Dunn (Johnson County) District Court held that the surviving spouse’s elective share does not include POD or TOD accounts (appeal mooted by Myers decision and dismissed prior to briefing).

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Estate of Myers, 825 N.W. 2d 1 (Iowa 2012)

Facts of Case:

•Decedent died on November 2, 2009, and was survived by her husband, Howard.

•At the time of Decedent’s death, she owned a number of assets, either jointly or individually, which were valued at approximately $479,989.29.

•Of Decedents’ various assets, Howard became the sole owner of the jointly owned real estate through his rights of survivorship. Decedent left no other property in her Will to her husband, other than some household furnishings, and bequeathed the rest of her property to her daughters and stepson.

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Estate of Myers, 825 N.W. 2d 1 (Iowa 2012) - Continued

Facts of Case:

•Three assets were at issue in the case, a checking account, a certificate of deposit, and an annuity, all of which were accompanied by beneficiary designations payable on death to Decedent’s daughters.

•A probate was opened for Decedent’s estate, Decedent’s brother was appointed Executor, and Howard filed a Spousal Election.

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District Court Decision:

•The Court was asked to determine whether the checking account, certificate of deposit, and annuity should be included in Howard’s elective share calculation given each had a POD designation.

•The District Court relied on the Sieh (713 N.W.2d 194) decision and concluded “‘the decedent had complete control over the trust assets at all times prior to his death’ . . . Karen retained control over the POD assets before her death and thus, . . . these assets, like the assets of a revocable trust, should be included in Howard’s elective share.”

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Supreme Court Decision– Noting Legislative Abrogation of Sieh:

•In discussing the Sieh decision, the Court determined that that case held that section 633.238 “could be read more expansively”; however, the Court also addressed the general assembly’s amendments to 633.238 in 2009 wherein the words “limited to” were added to the statute.

•The Supreme Court noted that the post-amendment version of 633.238 states that the “elective share of the surviving spouse shall be limited to all of the following” and “[i]is clear that the legislature, by this language, intended to limit the property that would be included in the surviving spouse's elective share to the four categories of property specifically identified in the statute.”

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Supreme Court Decision– Noting Legislative Abrogation of Sieh:

•The Supreme Court further stated that the surviving spouse’s “interpretation is consistent with the general assembly's explanation accompanying the House version of the bill” which stated “[t]he bill limits the elective share of the surviving spouse who elects to take against a decedent's will to the elective share portions contained in Code section 633.238 and does not include nonprobate or nontrust assets.”

•Based upon the legislature’s 2009 amendment, the Supreme Court opined that Sieh was abrogated in part and that “the elective share is limited to those assets specifically enumerated in section 633.238(1) and cannot be judicially expanded.”

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Supreme Court Findings – POD Assets under 633.238:

•The surviving spouse’s assignees claimed that the POD assets fell within 633.238(1)(c) (personal property of the decedent), but the Supreme Court opined that “POD assets are not included in the surviving spouse's elective share under section 633.238(1)(c).”

•The Court stated: “POD accounts, such as the checking and certificate of deposit accounts here, and annuities are nonprobate assets. Nonprobate assets are interests in property that pass outside of the decedent's probate estate to a designated beneficiary upon the decedent's death. Although these assets are the personal property of the grantor before death, they become the personal property of the designated beneficiaries upon the grantor's death pursuant to a contract between the grantor and the administrator of the account….”

– By Judicial Gloss, Then, “Personal Property of the Decedent” is limited to “Personal Property passing under will or under revocable trust.

• What if the beneficiary is the revocable trust?

• What if the beneficiary is the Family Trust created under the Revocable Trust?

• What if the beneficiary is the revocable trust, but the trustee disclaims?

– Breach of fiduciary duty of impartiality?

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Ramifications of Estate of Myers:

•While the Myers decision only addressed POD assets in the Decedent’s estate, the ramifications of the statute are much broader.

•The Supreme Court adamantly stated that the Spousal Elective Share applies to probate assets and is inapplicable to non-probate assets and thus allowing Executors in all sorts of various non-probate asset situations to preclude the surviving spouse’s elective share claim against non-probate assets.

•Leads to Strange Results.

Example 1: Consider a deceased spouse with a $1,000,000 IRA and a $200,000 in probate property

–1. If spouse gets $1,000,000 IRA, she can still claim 1/3rd of probate estate of $200,000.

–2. If the IRA is designated to children, spouse may only receive 1/3rd of the probate property

–3. Surviving spouse can be entirely disinherited if the property is put in POD form.

Example 2: Consider deceased spouse with $2,000,000 in Iowa real estate

1. No ability to avoid spousal share on this property, without spousal waiver.

2. Funding revocable trust or LLC could be an “unwitting” spousal waiver.

Moral of the Story of Myers

• If you are a gold-digger, marry someone with land, not with a big IRA

• While You Can’t do a Consensual Post-Marital Agreement in Iowa, You Can Secretly and Slyly Disinherit Your Spouse by using POD/TOD and Jt. Property Arrangements in Iowa, at least with respect to Personal Property.

• If you fear your spouse may disinherit you (or that your spouse’s POA or Trustee may try to do so when your spouse is old and frail) be careful what you sign to allow funding of LLCs and Revocable Trusts

• Attorneys should consider conflicts of interests and CYA letter practices anew when representing married couples.

• Iowa Needs Legislation in this area (the Court in Myers all but called for it).

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Estate of Frye, 2012 Iowa App. LEXIS 950

Facts of Case:

•This case involves the language contained in a Warranty Deed, a revocable trust, and a spouse’s waiver of her elective share rights.

•In 1974, the Decedent married Maria (his 2nd marriage and her 1st marriage). At the time of the marriage, Decedent had children from his first marriage.

•On June 22, 2007, Decedent created a revocable inter vivos trust with his children as beneficiaries.

•On June 26, 2007, Decedent and his wife executed a Warranty Deed transferring 5 parcels of real property into the Trust.

•Four of the parcels had been in Decedent’s name alone, and one parcel was held in joint tenancy with the spouse with right of survivorship.

•The Warranty Deed contained the following provision: “Each of the undersigned hereby relinquishes all rights of dower, homestead, and distribute share in and to the real estate.” It should be noted that this language is pre-printed on the Iowa Docs form Warranty Deeds.

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Estate of Frye, 2012 Iowa App. LEXIS 950 - Continued

Facts of Case:

•In November 2008, Decedent died and his Will was admitted to probate.

•Lincoln Savings Bank, as wife’s guardian and conservator, filed a Spousal Election.

•The Executors filed a Petition for Declaratory Judgment alleging that the surviving spouse was not entitled to take an election against the real property based upon the deed language relinquishing her rights in the property.

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District Court Findings:

•The District Court concluded that “[s]aid deed does not relinquish any rights to the elective share pursuant to 633.238, and she is therefore entitled to one-third in value of all the legal or equitable estates in real estate possessed by Decedent at any time during the marriage including that real estate contained in the Decedent’s living trust dated June 22, 2007.”

•On appeal, the Iowa Supreme Court disagreed and reversed.

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Iowa Supreme Court Findings:

•On appeal, the sole issue was whether the warranty deed language (“all rights of dower, homestead and distribute share in and to the real estate”) qualifies as an “express written relinquishment” under Iowa Code section 633.238(1).

•Under Iowa Code section 633.238(1)(a), the elective share is limited to one-third (1/3) in value of “all the legal or equitable estates in real property possessed by the decedent at any time during the marriage which have not been sold on execution or other judicial sale, and to which the surviving spouse has made no express written relinquishment of right.”

•Furthermore, section 633.238(1)(d) provides that the elective share is limited to one-third (1/3) in value “of the property held in trust not necessary for the payment of debts and charges over which the decedent was a grantor and retained at the time of death the power to alter, amend, or revoke the trust, or over which the decedent waived or rescinded any such power within one year of the date of death, and to which the surviving spouse has not made any express written relinquishment.”

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•The Court noted that the statutory language: “reveals subtle, but significant differences in how the legislature expressed the waiver requirement in paragraph (a) and the new paragraph (d). Paragraph (a), specifically addressing real property, requires an ‘express written relinquishment of right.’ Standard warranty deeds, such as the one used in this case, provide an express written relinquishment of ‘all rights of dower, homestead and distributive share in and to the real estate.’ In contrast, paragraph (d) only requires a spouse to make "any express written relinquishment" of the property held in the revocable trust. The legislature could have used the identical language in paragraph (d) it used in paragraph (a) or it used in Iowa Code section 633.211 defining the spousal elective share for surviving spouses of intestate decedents. Instead, the legislature chose not to require a relinquishment of right concerning the surviving spouse's dower rights, but merely to require a surviving spouse to make any express written relinquishment of the property.”

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•“Having a different relinquishment requirement was both purposeful and necessary. Had the legislature used identical language in both paragraph (a) and (d), the new paragraph would not have provided an effective way for spouses to use revocable trusts in estate planning. Trustors and their revocable trusts are often considered the functional equivalent of each other. Any property placed in a revocable trust would still be ‘owned in substance’ by the trustor. When spouses attempt to waive their dower interest in property placed in a trust, such interest would automatically reattach to the asset because the revocable trust was the alter ego of the trustor. The legislature, in paragraph (d), made a policy choice to define a spouse's elective share in revocable trust assets so that dower rights would not reattach after the transfer of the property into a trust if the spouse made an express written relinquishment of the property. The legislature did not require any ‘magic formula’ for relinquishment; any express written relinquishment of the property is sufficient.”

•The Iowa Supreme Court opined that “the language in the warranty deed executed by the Fryes satisfies the express written relinquishment requirement of section 633.238(1)(d). The property conveyed to the trust by the warranty deed is not subject to the surviving spouse's elective share.”

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PROPOSED LEGISLATIVE RESPONSE TO FRYE

• The following legislative change to section 633.238(1)(d) is being studied by the leadership of the Iowa Academy of Trust and Estate Counsel. It has not yet been taken to the legislature:

•

• 1. The elective share of the surviving spouse shall be limited to all of the following:

• d. One-third in value of the property held in trust not necessary for the payment of debts and charges over which the decedent was a grantor and retained at the time of death the power to alter, amend, or revoke the trust, or over which the decedent waived or rescinded any such power within one year of the date of death, and to which the surviving spouse has not made any express written relinquishment. A deed signed by the surviving spouse for the purpose of conveying real property to a trust shall be an express written relinquishment of the real property under subparagraph (a) above but shall not be deemed a relinquishment of the value of the real property in the trust unless the surviving spouse specifically states an intent to relinquish the value in the deed.

•

Effective Date: This proposed change should be made retroactive.

COMMENTS to IATEC DRAFT PROPOSAL TO ABROGATE FRYE RETROACTIVELY:

• Paragraph 1(d) was added to this code section in 2005 to clarify that assets held in a revocable trust were to be taken into account when calculating a surviving spouse’s elective share. At the time this legislation was discussed by the ISBA Probate Section, there was discussion on whether a spouse who joined in a deed transferring property into a Revocable Trust would be treated as having made an express written relinquishment under paragraph (d). It was the consensus of the Probate Section that when the spouse joined in a deed transferring property into a Revocable Trust, the spouse was relinquishing his/her right to claim a 1/3 share in the actual piece of real estate under paragraph 1(a), but was not relinquishing his/her right to claim a 1/3 share of the value of the real estate owned by the Trust under paragraph 1(d).

•

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COMMENTS TO IATEC DRAFT PROPOSAL TO ABROGATE FRYE RETROACTIVELY:

• For the past 7+ years, practitioners have asked spouses to join in deeds transferring property to Revocable Trusts without advising the spouse that they might be waiving their right to claim the value of the real estate as part of their 1/3 spousal elective share in the future. The decision by the Iowa Court of Appeals is problematic for the following reasons:

– It conflicts with the purpose for adding subparagraph (d) to the Code;

– It conflicts with other rulings of the Court which prohibit spouses from entering into post-nuptial agreements;

– It conflicts with practitioners’ interpretation of the Code and exposes practitioners to potential malpractice liability.

• The proposed change to subparagraph (d) has been made in an effort to reverse the decision in the Frye case.

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Estate Tax Planning Strategies for the Top 1%

10 Powerful Estate Tax Strategies for Families Who Face Estate Taxes (singles above $5,250,000; couples above

$10,500,000).

1. Defer any taxes until the second spouse dies2. Accelerate gifts of exemption amounts to obtain freezes:

Keep Future Income and Appreciation Out of Your Estate3. Put Life Insurance in Irrevocable Life Insurance Trust (or

LLC, or Children’s names) to Avoid Subjecting Death Benefit to Estate Tax.

4. Use Grantor Trusts: Pay Taxes on Income That Benefits Your Children and Grandchildren So They Don’t Have To

5. Take Full Advantage of Valuation Discounts

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10 Powerful Estate Tax Strategies for Families Who Face Estate Taxes (singles above $5,250,000; couples above

$10,500,000).

6. Use Interest Rate Arbitrage & Cherry-Picking Assets to Beat IRS Assumptions on Trust Total Return

7. Lock in Low Interest Rate Assumptions for 9 Years or Longer

8. Consider Multi-Generational Trusts: Use GST Exemption to Avoid Taxes When Your Children and Grandchildren Die As Well

9. Consider a Wandry Clause to Reduce Valuation Risk.

10.Keep Plan and Trusts Flexible in case the law changes.

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Tools for Families with more than $10,000,000 in assets

• Same tools are still available, at least for now– Corporations, FLPs and LLCs with valid business purposes are eligible

for significant valuation discounts if “what passes” is a non-controlling interest.

– Grantor Trusts provide significant opportunity for arbitrage and for Grantor to pay income taxes on income that belongs to his children or grandchildren

• Gifts• Loans• Sales on Installment Contracts• Can also hold life insurance policies if structured carefully

– GST exemption allows assets in trust to avoid transfer taxes at multiple generations.

– Zeroed-out GRATs, CLTs, and QPRTs are all still great strategies, especially with low interest rates and where GST planning is not paramount.

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What is a Wandry Clause?

• Defined Value Clauses– They help mitigate risk of tax in the event your valuation is

not accepted by the IRS and is adjusted on audit.– Traditional Approach: First $1,000,000 stays in the Family

Trust; “The Remainder to my Favorite Charity”– Wandry Clause as an Alternative to “Excess to a Charity”:

• Define the amount transferred by value rather than by the number of shares or units in the Farm Corporation or LLC.

• Wording is extremely important, and it is not entirely certain that these clauses will be respected.

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What Could the Future Hold?

• GRATs could have a minimum term

• Grantor Trusts Could be Curtailed (prospectively, probably)

• Valuation Discounts on Closely-Held Companies Could be Limited (regulations forthcoming?)

• Crummey Trust Could be Eliminated

• Exemptions Could fall to $3,500,000 in 2018 per President’s budget;

• Rates Could Conceivably go Up

• GST Trusts Could be Given Maximum Term

• IRA accumulations could be taxed (President’s Budget)

SELECTED 2013INCOME TAX ISSUES

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Impact of American Taxpayer Relief Act of 2012 – Income Tax

• Income Tax Rates. • For most Americans the income tax rate

remains the same with tax rates of 10%, 15%, 25%, 28%, 33% and 35%.

• For individuals with income of $400K (single), $425K (head of household), $450K (joint filers and qualifying widowers) and $225K (married filing separately) there is a new tax rate of 39.6%.

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Federal Individual Filer Rates (2013):

– $0 to $8,925 = 10% rate – $8,926 to $36,250 = 15% – $36,251 to $87,850 = 25% – $87,851 to $183,250 = 28% – $183,251 to $398,350 = 33% – $398,351 to $400,000 = 35% (weird)– $400,001 and above = 39.6%

Federal Married Filing Jointly Rates (2013):

– $0 to $17,850 = 10% – $17,851 to $72,500 = 15% – $72,501 to $146,400 = 25% – $146,401 to $223,050 = 28% – $223,051 to $398,350 = 33% – $398,351 to $450,000 = 35% – $450,001 and over = 39.6%

Iowa State Married Filing Jointly Rates (2013):

– $0+ 0.36%

– $1,439+ 0.72%

– $2,878+ 2.43%

– $5,756+ 4.50%

– $12,951+ 6.12%

– $21,585+ 6.48%

– $28,780+ 6.80%

– $43,170+ 7.92%

– $64,755+ 8.98%

Impact of American Taxpayer Relief Act of 2012 – Income Tax

• Personal Exemption Phase-out. Personal exemptions will be phased out for adjusted gross income over $250K (single), $275K (head of household), and $300K (joint filers).

• Taxpayers with income falling within the 33% tax rate bracket or higher may see an increase in their income tax liability due to personal exemption phase-out and the Pease limitation on itemized deductions.

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The Pease Limitation on Itemized Deductions Has Been Re-Implemented

• The Itemized Deduction Phase-Out (“Pease Limitation”) Reduces Marginally the Tax Benefits of Charitable Giving for Some Itemizers

• The phase-out of itemized deductions returns to the tax code in 2013 after a several-year absence and the American Taxpayer Relief Act of 2012 increased the threshold amounts in cases in which it becomes applicable.

• If your AGI is more than a “threshold amount ($300,000 in 2013 for married filers filing jointly and $250,000 for single taxpayers, indexed to inflation for future years), then your itemized deductions will be reduced by 3% of the excess. So if a married couple’s AGI is $500,000 in 2013, then their itemized deductions for 2013 will be reduced by 3% of $200,000, or by $6,000. This includes their mortgage deduction and your charitable deductions. (It does not include medical expenses, investment interest, casualty and theft losses, and permitted wagering losses, oddly).

• The disallowance under this provision, however, is limited to 80 percent of a taxpayer’s total itemized deductions. All taxpayers, regardless of the level of their adjusted gross income, are permitted to keep at least 20 percent of their itemized deductions.

The Pease Limitation and its Impact

• Studies show the Pease limitation will reduce the economic benefits of giving to charity only in unusual cases

– Many high-income donors will have itemized deductions beyond the Pease limitation in any event (due to mortgage interest, for example), and in such cases there will be no impact on the tax benefits of charitable giving

– Since income tax rates are higher in 2013, the benefits of charitable giving are higher in 2013, and this should offset slippage caused by the Pease limitation in most cases.

Capital Gains Rates

• Capital Gain and Qualified Dividend Tax Rates. Tax rate on long-term capital gains and qualified dividends is 0% for individuals with income below the 25% rate, 15% for individuals at or above the 25%, but below the 39.6% rate, and 20% for individuals with income at the 39.6% rate.

• 3.8% Surtax on “Net Investment Income” Increases the Real Capital Gains and Dividend Rates. The application of the 3.8% surtax increases the effective top rate for long-term capital gains and qualified dividends to 23.8%. For lower income levels, the tax will be 0% or 15%, or 18.8%.

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New Medicare Tax to Fund Obamacare

• New Tax on “Net Investment Income”– “Medicare Tax”– 3.8%– Applies to passive income including dividends, capital gains, and to

K-1 distributions, attributable to passive investors.– Will probably apply to all cash rent arrangements, but talk to your tax

advisor if you have a hybrid arrangement or if you believe you materially participate. (Should not apply if you are subject to self-employment tax under your rental arrangement---most if not all rental arrangements will now be subject either to self-employment tax or to this 3.8% Medicare tax)

– Does not apply to distributions from IRAs/Qualified Plans– Only impacts for folks whose income is relatively high ($200,000 for

individuals; $250,000 for joint filers)– No Charitable Deduction against this tax

Obama Care Surtax• Common Items considered investment income:

– Passive Rental Income– Interest Income– Dividends– Capital Gains (long and short)– Annuity Withdrawals (but not while in tax deferral)– Royalty Income

• Common Items not considered investment income:– Wages and Self-Employment Income– Active Business Income– Distributions from IRAs, Roths– Municipal Bond Interest– Life Insurance Proceeds– Social Security & Veteran’s Benefits

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Charitable Planning

What’s New in Charitable Planning?

• Direct Charitable IRA Roll-Over Renewed Through December 31, 2013

• Endow Iowa Credits Were Used up for 2012----Legislation is Still Pending that would retroactively increase the ceiling for 2012 and raise it for 2013. Will folks amend their returns to take advantage of this if it passes?

What’s New in Charitable Planning?

• Pease limitation on itemized deductions which came back on January 1, 2013

• New Medicare Tax (3.8%) Enacted; No Charitable Deduction Against This Tax.

• New 39.6% Federal Rate Bracket; New 20% Capital Gains Bracket.

10 Great Charitable Planning Ideas

1. Make gifts during life to capture income tax deductions

2. Fund gifts with appreciated property

3. Give to public charities whenever possible

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A Lifetime Gift Funded in Kind With Appreciated Assets such as Stock or Land is more Powerful than Ever

• If I paid $100/acre for my farm in 1960 and my basis has not been adjusted since that purchase, and if it would sell at market today for $10,000, upon sale I would owe capital gains tax on $9,900 per acre.

• For all but the highest earners, federal capital gains tax rates are 15%, but a new 20% rate now exists

• Iowa has no separate capital gains rate, so assume another 8% of Iowa tax.


• Capital gains rates for high earners (those in the 39.6% bracket, i.e., single filers with over $400,000 in taxable income and joint filers with over $450,000 in taxable income) are now 20% federal (up from 15%), plus an additional 3.8% tax that is intended to fund Medicare (for joint earners with MAGI over $250,000 and single filers with MAGI over $200,000). That means long-term rates for high income earners have jumped from 15% to 23.8%, plus another 8% in Iowa tax, for a total rate of 31.8% for high-income Iowans. Capital gains taxes per acre upon sale might be as high as $3148.20/acre for these folks.

• All of this 31.8% capital gains tax should be avoided if the charity makes the sale. It is important that there be no contract or prearranged binding agreement prior to the donation.


• If, after selling my 100 acre farm for $1,000,000 on January 1, 2013, and paying capital gains taxes of $314,820, I then donated my net proceeds to a public charity, the charity would receive $685,100.

• I would get a deduction of my marginal tax rate (lets assume I have a very high AGI, and then conservatively assume 40% state and federal)

• 40% x $685,100 = a tax benefit to me of $274,040.• To summarize, if I sell and then gift the proceeds, my

$1,000,000 ends up as follows:– Charity gets: $685,100– Donor gets: $274,040– IRS gets: about $40,860


• That’s not bad, but if instead, I gift the farm and the charity sells it:– The non-profit gets the full $1,000,000 of value, – I avoid the capital gains tax of $314,820, and – my tax benefit from the charitable deduction is increased by

$125,960, to $400,000. My $1,000,000 is now a parable of loaves and fishes:

a. The Charity gets $1,000,000 of valueb. I get $400,000 in reduced income tax liability.c. My $1,000,000 has become $1,400,000.

Loaves and fishes! • That’s roughly $440,000 of added benefit from gifting property rather

than proceeds of sale.


4. Qualifying gifts to endowed funds at Iowa-based community foundations (including gifts of land or appreciated stock) create 25% Iowa income tax credits plus federal deductions.

5. Qualifying gifts of land or easements for permanent conservation generate 50% Iowa income tax credits plus federal deductions.

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Endowment Gifts to Iowa-Based Community FoundationsOffer Maximum Tax Benefits for Lifetime Gifts

• The Iowa Legislature created “Endow Iowa” state income tax credits to create an incentive for Iowans to establish endowments for Iowa-based charities.

• Such endowments have to be created at Community Foundations, but can be dedicated to a particular Iowa-based non-profit institution, or can be donor-advised funds.

• For example, Orville Bloethe set up an “Endow Iowa” fund at the Greater Cedar Rapids Community Foundation for the benefit of the HLV District.

• Each year, in perpetuity, the HLV District will receive a distribution from this endowed fund, not to exceed 5%.


• Gifts to Endow Iowa Funds qualify for a 25% Iowa state income tax credit. This is available to itemizers and non-itemizers alike.

• This is in lieu of any state income tax deduction on the same gift, but in addition to the federal deduction. For a federal taxpayer in a 39.6% bracket, the total tax benefit could approach 65%.

• For example, if I give $10,000 to a fund at an Iowa-based Community Foundation for the benefit of St. Ambrose College, I will receive a credit of $2,500. This means I will pay $2,500 less in state income taxes. Any excess beyond what I can use is carried over to future years. And I get this even if I don’t itemize.


• Tax credits of 25% of the gifted amount are limited to $227,590 in tax credits per individual (25% of a maximum gift of $910,362) or $455,181 in tax credits per couple (25% of a maximum gift of $1,820,724) if both are Iowa taxpayers.

• There is a maximum of credits available each year (about $4,500,000 in 2012), but if the state runs out, you get the credit in a future year. In 2012, the credits did run out, but the cap was retroactively raised in 2013.


• Example: John Brown, with an AGI of $500,000 donates a 40 acre farm with basis of $1000/acre and a Fair Market Value of $10,000 per acre to the Greater Des Moines Community Foundation, to be added to a designated fund for the United Way.

• This gift is worth $400,000, but it will take him 3 years to absorb the federal income tax deductions, since 30% of his AGI is $150,000.


• Assuming a 35% federal marginal rate, this $400,000 gift may generate a federal tax benefit as high as $140,000. In addition to that benefit, the donor will receives a $100,000 state income tax benefit over time, assuming he has sufficient state income tax to absorb it over 5 years.

• The potential combined tax benefit if $240,000, or 60%, in this example, aside from the capital gains tax savings.

• If you assume $360,000 in avoided capital gains, at even 27%, you can add another $97,200 of tax savings, bringing the total to $337,200, or roughly 84% of the fair market value of the gift.


• The Moral of the Story for Iowa-based non-profits is:

– Partner with a Community Foundation

– Establish an Endow Iowa Fund benefitting your institution

– Communicate to Your Donors About the Opportunities to Leverage Their Endowed Giving With Endow Iowa Credits.


6. Fund Charitable Gifts at death with tax-deferred retirement assets.

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Fund Gifts at Death First With IRD

• IRD = Income In Respect of a Decedent.• IRD is subject to income tax after death, in addition

(potentially) to federal estate tax and Iowa inheritance tax.

• Examples of IRD assets are traditional IRAs and qualified plans, as well as some tax-deferred government bonds.


• If my beneficiary designation leaves my traditional IRA, worth $100,000, to my son, and my $100,000 life insurance policy to the Red Cross, I have missed an opportunity to save income taxes on the tax-deferred IRA. My son’s withdrawals from the IRA over time will all be taxed to him at is marginal income tax rates (state + federal).

• If I instead leave the IRA to the charity and the insurance to my son, the income taxes are avoided, and each gets $100,000.

• This benefit exists even for small estates that will not be subject to estate tax.


• For people with taxable estates, the gross tax burden on IRAs and Qualified Plans is even more severe.

• Federal Estate Tax Rates in 2013 are 40% (but only on estates over $5,250,000).

• This means that an IRA worth $100,000 could be taxed first at the estate level at a 40% rate. If the IRA has to be cashed to pay that $55,000 tax, it will also trigger income taxes in the estate, which could be as high as an additional 47% state and federal. The beneficiary’s share of the IRA after taxes could be $35,000 or less.


• At these tax rates (65% or higher combined), some wealthy individuals easily decide to designate a charity as beneficiary.

• Alternatively, they can name a child first, and (perhaps the United Way) as contingent beneficiary. That way, the child can disclaim the IRA, if desired, in which case it passes to (the United Way) income-tax and estate-tax free.


7. Folks over age 70.5 should consider a direct IRA rollover in 2013.

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Charitable IRA Roll-Over

• It is generally not possible to give away IRAs and qualified plans during life. Donors must withdraw funds and then make a donation.

• A direct charitable IRA rollover is again allowed for 2013, for folks over age 70.5, up to $100,000.

• Not all charities qualify: No private foundations; some supporting organizations may not qualify; donor-advised funds will not qualify. Make sure you qualify before you agree to accept such a gift----unless you are recognized as a publicly-supported 509(a)(1) or 509(a)(2) public charity, it may be safer to work through a designated fund for your institution at a Community Foundation.

• This is a great opportunity for folks who don’t itemize, in particular. And it avoids triggering the Pease limitation. This opportunity sunsets at the end of 2013 unless extended.

• Donors planning to give their IRAs to charity should not do Roth Conversions.• It appears one can make a direct IRA rollover to an Endow Iowa fund, as long as

it is not a donor-advised Endow Iowa fund.

Caution About IRAs

• Caution: IRAs and Qualified Plans should not pass through a pecuniary formula under will or revocable trust. If not designated directly to a charity, they should be specifically bequeathed to a charity by will or by revocable trust, to avoid triggering the income in the estate or trust, and thus the tax. Often wills contain clauses that specifically direct all charitable bequests should be funded first with IRD assets such as IRAs.


8. As interest rates rise, gifts of appreciated land to Charitable Remainder Trusts will start to look attractive again.9. Gifts of appreciated land or stock to a charity in exchange for a charitable gift annuity can be beneficial.10. Consider a “zero estate tax” plan with the tax-free amount to kids and the rest to a charity or a charitable lead trust.

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The Zero Estate Tax Plan


• With estate tax rates at 40%, donors could consider a “zero tax” estate plan funded with an outright charitable bequest or a testamentary charitable lead trust.


• “I leave the Mount Vernon School Foundation $100,000 as a minimum charitable legacy. Thereafter, I leave the largest amount that can pass free of federal estate taxes to my only child, whom I love, if she survives me, and if not to her children per stirpes. I leave any residue beyond this tax-free amount to the School Foundation, to ensure that I pay no federal estate taxes by reason of my death. I never liked taxes, and this way I will die happy.”

The Zero Estate Tax Plan:Consider using a Zeroed-Out Charitable Lead Trust

• The residue can alternatively go to a zeroed-out Charitable Lead Annuity Trust, which pays a fixed annuity (x% of the FMV of the residue on the date of death) to (the charitable beneficiary) for a period of years (25 years, perhaps), and then leaves any residue to the testator’s children. If the annuity is calibrated to equal the value of the residue, there is no taxable gift. If the residue’s total return outperforms applicable IRS assumptions about interest rates (currently very low assumptions), then something passes tax-free to children at the end of the term.

Charitable Lead Annuity Trusts

• Very powerful for families with charitable intent who face estate taxes

• Uses an annual payment to a charity of family’s choice to reduce the actuarial value of a remainder interest that passes to children at expiration of annuity term

• Trust can be calibrated so that taxable value of remainder is zero.

• Can be done during life or at death.

• The “annuity” is a % of the FMV of the trust assets on the date of funding.

Charitable Lead Trusts (“CLT”)

• Trust is established to pay an annuity to a designated charity or charities for a term of years.

• At the end of the “annuity term,” the assets remaining in the Trust pass to the remainder beneficiary, usually the Grantor/Donor’s children.

• Charitable Lead Trusts are used by people of significant wealth to pass property to their children with a reduced estate and gift tax liability. They work extremely well in a low-interest rate environment.

• Lifetime CLTs work particularly well if the Grantor is making annual gifts to Charity anyway, as this technique simply allows the Grantor to use those annual gifts to pass some money down to the next generation tax-free.

Bonus Idea:Provision in Will Allowing

Advancement of Charitable Gifts During Life

• If the will directs $100,000 to Mercy Hospital, it should also indicate that this will be reduced by any lifetime gift earmarked as an “advance”.

• The power-of-attorney designation must then authorize charitable gifts made as advances. (Or the revocable trust instrument).

• During a period of dementia, charitable gifts could be advanced by a surrogate to capture the income tax deductions that would otherwise be lost.

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Thank you for your attention!

Paul P. MorfSimmons Perrine Moyer Bergman PLC

115 Third Street SE, Suite 1200Cedar Rapids, Iowa 52401

(319) 366-7641(319) 896-4012 direct line

[email protected]/p_morf.htm


http://www.simmonsperrine.com/p_morf.htm

BONUS MATERIALS:EXAMPLES OF PLANNING STRATEGIES

FOR FARMERS AND FARM OWNERS

Paul P. Morf

[email protected](319)896 4012


PART IIIEXAMPLES OF PLANS

FOR FARMERS AND FARM OWNERS

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EXAMPLES OF FARM PLANS

• Facts have been modified to protect the confidentiality of our clients

• Each client is unique• I believe it is better if possible to keep it

simple and avoid shared inheritances• For tax and non-tax reasons, this is

sometimes difficult or at least clients sometimes select other options, especially where there is an on-farm heir or dividing the farm is complicated.

Example 1 – Equal Distribution of Separate Farmland Parcels

No Farmer in the Family• Facts: Client has four children, none of whom farm. Client has 160 acres of farmland (a quarter section (valued at $1,600,000) and

about $1,000,000 of other assets.

• Client’s Intent: Client wants his children to receive their inheritance outright and does not want to use trusts. Client wants his children to inherit a roughly equal share of his farmland and a roughly equal share of his other assets and does not want to force his children to be in business with one another.

• Resolution/Estate Plan Implemented: • A. Client’s will leaves a separate 40 acres to each of his four children, and he directs which parcel goes to which child,

provided that any two children can swap if they so desire; or• B. Client’s will directs that the Executor shall divide the land such that each child receives 40 acres, more or less, with the

Executor having them draw lots to see who gets which 40; or• C. Client’s will directs that a separate 40 acres to each of his four children, and he directs which parcel goes to which child,

but also directs that each 40 acres be separately appraised, and any difference in value be “equalized” with cash or other assets, such that the total value of each child’s inheritance is equal.

• D. Client names all 5 children as co-executors, and tells them they can divide the estate into 4 equal shares in whatever manner they unanimously agree is fair, and if they fail to agree, then the farm is sold at auction.

• E. Client could additionally require each child to sign, as a condition of receiving this bequest of land, an agreement that will be recorded, granting each sibling an first right of refusal in the property at issue, for a period of 20 years. Such a right that purported to extend beyond 20 years could be considered, but presents more enforcement issues.

• F. Another option would be to allow the children, if they unanimously agreed, to instead put the entire 160 acres into an LLC and continue owning it together. (They would have this ability in any event, but this reminder may cause them to consider it more carefully).

It is Usually Best to Avoid Imposing Shared Inheritances on Future Generations Where Possible

• “You never really know someone until you have shared an inheritance.”

• Simpler is better• Less dead-hand control is often preferable to kids.

If they want to work together, they can always join forces

• Shared ownership is most difficult where at least one child farms, or where siblings (or their spouses) have personal baggage, or where children have significantly different financial situations such that some will need or want liquidity more than others.

When is shared ownership a good idea?

• Where dividing an asset is simply not acceptable for personal or family reasons.

– Corporations are hard to divide, especially C corporations– Where you want your son or daughter to farm the whole thing, and cashing the other

child out is just to expensive to be practical, at least in the short run– Where the asset is a family retreat or otherwise not easily or happily divided, or where

division will cause diminution in value• Where the children have been consulted and are happy to share the

inheritance;• Where everyone has a clear exit option that is reasonably fair, and there is

no immediate reason to think the arrangement won’t work;– Right to sell (at pro rata share of net asset value, or some discounted value)

• Where for tax reasons a shared inheritance may generate valuation discounts that save significant estate planning benefits

– Special Use Valuation– Valuation discounts for lack of control/marketability

Example 2 – Shared Inheritance of a Farm via an LLC Agreement

No Farmer in the Family• Facts: Married clients have four children, none of whom farm. Client owns a whole section of farmland, 640 acres, worth $7,000,000, as well as 500

acres of woods and pasture with a trout stream in Clayton County that is much more interesting as a single parcel than it might be divided up. It may be worth $2,000,000 if you could subdivided it, but Client doesn’t want to see that done, and thinks if it were protected by a conservation easement, it would only be worth $1,000,000. Client wants the family to keep the trout stream and 500 acres, but has no liquid assets, and fears that it will require significant income to support. Client is very proud to have put together an entire section of Iowa land, and doesn’t want to see it sold or divided.

• Client’s Intent: Client wants his children to receive equal value, but doesn’t want the farm or the recreational ground divided up. He wants the recreational ground maintained by his family as a special place for family and for wildlife.

• Resolution/Estate Plan Implemented: • A. Client creates an LLC and puts all of his ground in it. His estate plan provides that each child will receive an equal interest

in the LLC.• B. Clients donate conservation easements on the Clayton County land over a period of years, reducing the estate tax value

by $1,000,000, generating $500,000 in Iowa state income tax credits, as well as significant federal income tax deductions. They then put the Clayton County land, subject to the conservation easement, into the LLC as well.

• C. The LLC requires that all expenses on all real estate be paid annually.• D. The LLC forbids sale of any land without unanimous approval of the members.• E. The LLC requires each owner to offer his units to the LLC and to the other owners at a 30% discount from • net asset value before offering them to a third party for sale. The LLC has to buy the offered units, but can do so on a note

payable over 9 years. LLC may opt, by unanimous vote of non-offering members, to dissolve.• F. The LLC requires that all Income not required for expenses or to service repurchase obligations or debt is distributed annually to

the owners, pro rata.• G. Owners are allowed to make estate planning transfers of their units to descendants and trusts of descendants, and to

provide income interests in favor of their spouses in trusts that are otherwise for the benefits of descendants.• H. Clients’ estate plans take advantage of the valuation discounts to reduce the tax value of the farm by 30% or more.

Shared ownership may work here because:

• No on-farm/off-farm division• Funds will be available from farming operation to

cover carrying costs of family recreational land• Each family member has an exit option that

appears fair to them, while hopefully not unduly burdensome to the company.

• LLC operating agreement guarantees that owners will receive some economic return from ownership

• Family appears to get along• Discounts will help avoid estate taxes

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But tensions could still arise, for example if:

• Personalities of children, grandchildren, or spouses become an issue;

• Disputes arise as to use of the recreational land or how much to invest in that property, or toys or improvements related to that property;

• The farm falls upon hard times and cash flow diminishes, after folks have come to rely upon it.

• Estate taxes at children’s deaths create estate tax issues (putting children’s inheritances in a GST-exempt trust could help avoid this issue)

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What if one of my Children Stayed Home to Run the Farm?

Options for Balancing On-Farm and Off-Farm Heirs• John has $6,000,000 in farmland and $2,000,000 in other assets ($8,000,000 total). Two children, son who farms and daughter who doesn’t.

• Options to consider:– 1. Treat them identically?

• How? • Give different dirt to different children? Put daughter’s land in trust and require her to rent it to her brother for a

fair rate until he retires? • Direct executor to borrow against farms, Give Farms to Son Subject to $2,000,000 (or lesser amount) of debt,

and give borrowed funds to daughter to equalize?• Buy $2,000,000 in life insurance to equalize?• Use an LLC or Corporation? Voting and Non-Voting Stock? Give Son Control? Create Deadlock possibility?

Will my Children End Up Hating One Another? What is the Exit Plan?

– 2. Give farming son the right/option to purchase farms from estate or sister?• FMV• Discount off of FMV?• For How Long

– 3. Hold all land in Trust, require rental to son at fair market rental rates (county average per ISU extension, or appraised rental value, or 50/50 crop-share), and distribute rent equally to siblings?

• Give son right to purchase farms from trust?• GST exempt trust, to avoid taxation at children’s deaths?• Fund during life to obtain freeze; use entity to capture valuation discounts?• Do you give the children some power to unwind this situation?

– 4. Sell farms to Son (or grantor trust for son) on an installment contract during life?• Avoids a fight after you die• Loses step-up in basis opportunity• Obtains a freeze for your son, and you can sell at a discount if desired, but that would entail a taxable gift

equal to the difference between appraised value and purchase price.

Example 3 – Unequal Distribution of Separate Farmland Parcels

One Farmer in the Family

• Facts: Client has three children, one of whom farms. Client has 400 acres of farmland (valued at $4,000,000) and about $1,000,000 of other assets.

• Client’s Intent: Client wants his children to receive their inheritance outright and does not want to use trusts. Client wants his children to inherit an equal share of his other assets, but wants his farming child to receive more farmland than his non-farming children. The Client does not want to force his children to be in business with one another.

• Resolution/Estate Plan Implemented: Upon the Client’s death, each of the four children will receive separate parcels of farmland, with the client’s farming child receiving 200 acres and each of the Client’s non-farming children receiving 100 acres, such parcels to be selected by the executor/trustee in a manner that effectuates Client’s intent (or alternatively, the parcels going to each child could be legally described in the will). The Client’s other assets will be distributed equally among the three children. This is seen as rough justice.

• Alternative Resolution/Estate Plan Implemented: Each child could be required to grant rights of first refusal to his or her siblings in the inherited parcels.

Example 4 – Distribution of Farm Assets to Farming Children and Other Assets to Non-Farming Children

• Facts: Client has three children, two of whom farm and one of whom does not farm. Client has 1,500 acres of farmland (valued at $15,000,000) and about $1,000,000 of other assets.

• Client’s Intent: Client wants his two farming children to receive an equal share of the farmland and wants his non-farming child to receive other assets. Client believes farmland prices are inflated, so Client is fine that the value of the other assets passing to non-farming child is something less than the shares passing to the farming children. Client does not want his two farming children to have to be in business with each other.

• Resolution/Estate Plan Implemented: Client places half of his farmland into one LLC and the other half of his farmland into a second LLC. During Client’s life, Client established an irrevocable life insurance trust (“ILIT”) holding a $5,000,000 policy on Client’s life. Client’s non-farming child is named as the sole beneficiary of this ILIT. Upon the Client’s death, LLC #1 goes to one farming child, LLC #2 goes to the other farming child, and the life insurance proceeds pass to the non-farming child. All other assets of Client’s estate pass in equal shares to Client’s children.

– If clients are a married couple, they can divide ownership of the LLCs so that each dies with a minority interest, triggering valuation discounts. They can also make gifts during life and capture minority discounts, leveraging their $10,250,000 in estate and gift tax exemption even further, and placing future income and appreciation beyond the estate tax at their deaths. If these lifetime gifts are made to grantor trusts, they can keep paying the income tax on income that inures to the benefit of their children, which further leverages their estate tax exemption. It may be possible to avoid estate tax entirely even on this $16,000,000 estate, by taking some or all of these steps.

• Alternative Resolution/Estate Plan Implemented: If the Client is not insurable and is unable to obtain adequate life insurance, the Client could instead provide in his estate planning documents that the farming children will issue the non-farming child a note equal to some set amount or equal to some percentage of the value of the farm assets passing to the farming children. This note could be payable over a term of years at a specified interest rate.

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Example 5 – Equal Distribution by Valueof Separate Farmland Parcels

One Farmer in the Family Allowed to Get All the Land

• Facts: Client has three children, one of whom farms. Client has 400 acres of farmland (valued at $4,000,000) and about $2,000,000 of other assets.

• Client’s Intent: Client wants his children to receive their inheritance outright and does not want to use trusts. Client wants his children to inherit an equal share of his estate by value, but wants the on-farm child to own all of the farm if he so desires. The Client does not want to force his children to be in business with one another.

• Resolution/Estate Plan Implemented: Upon the Client’s death, each of the four children will receive $2,000,000 in value. The executor will encumber the farm with $2,000,000 in debt, and distribute $2,000,000 in cash to the non-farming children, and all of the farmland ($4,000,000 worth, less the $2,000,000 in debt) to the farming son. The values are equal, but the son who farms owns all the land.

– Variation 1: Rather than going to a 3rd party lender to borrow against the land, the son receives the farms subject to a binding obligation to pay each sibling $1,000,000 over the next 15 years, and this obligation is secured by a mortgage in the farm.

– Variation 2: Son who farms receives $2,000,000 in farm land and each sibling receives $1,000,000 in farm land and $1,000,000 in other assets. Son is given the right to purchase the farm from each of his siblings for fair market value, paid either in cash, or on an installment contract.

Example 6 – Equal Distribution; Shared Inheritance with Certain Rights Given to the Farming Child

• Facts: Client has four children, one of which farms and three of which do not farm. Client has 400 acres of farmland (valued at $4,000,000) and about $1,000,000 of other assets. Client’s home acreage is essential to the ongoing operation of the farm.

• Client’s Intent: Client wants his farming child to receive the home acreage, and then wants his children to inherit an equal share of his other farmland and an equal share of his other assets. However, Client does want to ensure his farming child has the right to continue farming the farmland on favorable terms and the right to purchase the farmland if Client’s other children want to sell.

• Resolution/Estate Plan Implemented: Client places all of his farmland into a LLC except the 80 acres with the home site. Grantor’s will provides that the farming child has a right to buy the homestead with the grain set-up and machine sheds for fair market value upon Grantor’s death, payable in cash at closing. If farming child elects to exercise this option, the home acreage will be separated off from the rest of the home farm. The farming child will receive the home acreage and the rest of the home farm will be placed into the LLC with the other farmland. Trusts benefiting each of the Client’s four children will then receive an equal share of the LLC units and an equal share of Client’s other assets (including cash from the sale of the home farm by the farming child if the child exercises his option).

• The LLC operating agreement will provide the following terms: (1) the farming child will have the nonassignable option to farm the farmland held by the LLC at the ISU extension average rental rate for the county in question until his retirement from active farming; (2) the farming child the first option (with the other owners having the second option and the LLC having the third option) to purchase the LLC units of any owner transferring his/her units (whether voluntarily or involuntarily) at an undiscounted value with cash at closing; and (3) any owner shall have the right to “put” (force the purchase of) his/her units at an undiscounted value, with the farming child having the first option to purchase, the other owners having the second option to purchase, and the LLC have the obligation to purchase.

• The Trusts provide that the Trustee is not to change the operating agreement to reduce the farming child’s rights, and that the farming child is a beneficiary of each trust to the extent necessary to eliminate any fiduciary duty that would otherwise require the trustee to do so.

• The Trusts can terminate when the farming child retires from farming, at which point the LLC could be liquidated.• Alternative Resolution/Estate Plan Implemented: Alternatively, GST tax exemption could be allocated to each

trust, and the LLC and trust could continue down to the generation of the grandchildren without being taxed in the estate of any of Grantor’s children. Options could be given to any grandchild interested in farming to rent the farms on the same terms that had been made available to Grantor’s farming child. 114

Example 7 – Equal Distribution in GST-Tax-Exempt “Dynasty” Trust with Certain Rights Given to Farming Child

• Facts: Married clients have four children, one of which farms and three of which do not farm. Client has 1,500 acres of farmland (valued at $15,000,000) and about $5,000,000 of other assets.

• Client’s Intent: Clients want their children to receive their inheritance in trust to take advantage of Clients’ generation-skipping transfer (GST) tax exemption to the extent possible. Clients want their children to inherit an equal share of their farmland and an equal share of his other assets. However, Clients want to ensure his farming child has the right to continue farming the farmland on favorable terms and the right to purchase the farmland on a discounted basis in the future.

• Resolution/Estate Plan Implemented: Clients place all of his farmland into an LLC, except those acres already in a C Corporation. Clients order their affairs so that each has a minority non-controlling interest at death. Upon Clients’ death, a Sub-Trust is established for the benefit of each child and each such Sub-Trust receives an equal number of units in the LLC and an equal share of Client’s other assets. Each generation is given the power to have the trust terminate and pass out to their descendants at death, or to allow the trust to continue outside the federal estate and gift tax system. (This Trust could be created and partially funded during life, if desired, which could have additional tax benefits).

• The LLC operating agreement will provide the following terms: (1) the farming child will have an option (and possibly farming grandchildren will have second option) to farm the farmland held by the LLC at the ISU extension average for the county in question (or on a crop-share basis); (2) the farming child’s separate Sub-Trust will have the right to at any time purchase some or all of the units in the LLC held by the Sub-Trusts created for the other children (perhaps at Fair Market Value calculated on a fully discounted minority non-controlling interest value payable with a promissory note bearing reasonable interest). The voting units of the other children can only be purchased if the farming child’s Sub-Trust purchases all of the units in the LLC.

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There are Many Other and More Complicated Formulations

• Large farming operations involving multiple entities and thousands of acres, with multiple family members involved, combine numerous estate and income tax issues with family business succession planning issues

• Fair is not always equal• Sometimes it is not possible or feasible to divide the farming operation

immediately upon the first generation’s death, even with life insurance and other liquidity-creating strategies.

• Often, situations like this call for some lifetime gifting with flexibility to change things down the road as situations change.

• These types of plans are fact-specific and beyond the scope of this outline.• There are many tools available to reduce or avoid estate taxes, but there

are always trade-offs. Make sure your advisors know your objectives and discuss with you the pros and cons of available techniques.

• Make sure your advisors understand and give attention to both your tax and non-tax objectives, and that the tax planning tail doesn’t wag the dog.

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Thank you for your attention!

Paul P. MorfSimmons Perrine Moyer Bergman PLC

115 Third Street SE, Suite 1200Cedar Rapids, Iowa 52401

(319) 366-7641(319) 896-4012 direct line

[email protected]/p_morf.htm


http://www.simmonsperrine.com/p_morf.htm

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TAX PLANNING FOR MARRIED COUPLES