Key Private Bank
Philanthropic Advisory Services
Toledo Area Partnership for Philanthropic
Planning Conference, December 5, 2014
Toledo, OH
December 5, 2014
Agenda – Trust Planning Considering IRS, Family and Charities
• Update on Qualified Charitable Distribution (charitable IRA rollover) and
other tax “extenders” after the election, proposed “Kill the Stretch IRA”
bill, new IRS qualified retirement plan after-tax rollover rules
• The charitable planning disconnect between advisors and clients in
planning and how to better engage the client in philanthropic planning
• Building a better trust – options for better ongoing income tax
• Other miscellaneous methods to legitimately shift income tax, above
the line, to charity or kids – QCDs, IC-DISCs, gifts of agricultural goods
• Personal income tax inversions in response to corporate tax inversions
– how we can use CRTs, DDTs and combinations thereof to defer
federal income tax and/or avoid Ohio income tax
Updates on various new income tax developments
• Qualified Charitable Distribution (charitable IRA rollover) still pending
(we’ve heard this story before, right?). Remember the basic rules: over
70 ½ at time of donation, only from IRA, not 401k, 403b, directly to
public charity (not CRT, PF, or even DAF). What’s the harm in making
payment anyway if Congress does not renew? Perhaps none if cash
would otherwise be given, but if LTCG securities would otherwise be
used, there is some opportunity loss. Answer: wait as long as possible
to put off QCD v. LTCG security decision.
• Other tax “extenders” pending as well – many for business owners,
such as S corp rules, 179 expensing increase $25,000 ->$500,000
• “Kill the Stretch IRA” bill – would be a huge boon to using testamentary
CRTs for $14 trillion in retirement plan money!!! If ever passed, only
spouses get IRA rollover, all others 5 years (ex. disabled).
• New IRS qualified retirement plan after-tax rollover rules. E.g. I have
$300,000 in pre-tax 401k, $50,000 in after-tax. Now clear on I can roll
$300,000 to IRA, $50,000 to Roth IRA (if otherwise able).
Charitable Planning: Strategic Objectives & Tools
• There is no shortage of ideas / strategies / giving vehicles to discuss
• Bigger challenge is to connect the right strategies and tools with each
person’s unique circumstances and needs
• Research has shown a huge disconnect between donors’ actual
intentions and their advisors’ interpretation of their intentions
Reasons for Donors’ Reluctance to Give
45%
41%
40%
34%
35%
30%
Advisors’
Responses
25%
22%
20%
15%
10%
5%
0%
Would not have enough money to
leave heirs
Would not be left with enough
money for themselves
Client does not consider
themselves wealthy enough to give
35%
30%
30%
24%
25%
Donors’
Responses
20%
17%
15%
10%
5%
0%
My gift will not be used wisely
Lack of knowledge/connection to
charity
Fear of increased donation requests
from others
* The U.S. Trust Study of the Philanthropic Conversation, 2013
Charitable Planning: Strategic Objectives & Tools
What’s the answer?
Asking the right questions….
Philanthropy Questionnaire
Philanthropy Questionnaire
2. How do you feel about your charitable giving thus far?
Mark with an “x” the statement that most closely reflects your view.
 I am satisfied with my charitable giving in terms of both the causes and the organizations I support.
 My giving into too many directions without a focused annual plan for giving.
 My giving has been determined primarily by personal and/or emotional connections; I would prefer to
be more strategic and objective.
x
Charitable Planning: Strategic Objectives & Tools
Income Tax
Minimization
Strategic
Philanthropy
Charitable Remainder
Trust
Estate Tax
Minimization
Socially Responsible
Investing
Grant-Making
Evaluation
Donor Advised Funds
Retirement Income
Maximization
Asset-Based Giving
Social
Entrepreneurship
Family Legacy
Charitable Lead Trust
Private Foundation
Impact Investing
Pre-Liquidity Event
Planning
Pooled Income Funds
Charitable Gift
Annuities
Mission Statement
Engaging the Next
Generation
Outright Gifts
Strategic Philanthropy
Reactive &
Spontaneous
Proactive &
Intentional
Strategic Philanthropy
(1)
Vision &
Mission
(2)
Values & Goals
(3)
Strategy
(4)
Implementation
• Facilitate family discussions/education
• Develop family gifting philosophy/mission
• Define charitable goals
• Set clear expectations of desired impact
• Seek family consensus and collaboration
• Identify cause(s) that will be supported
• Determine how broad the focus will be
• Define level of involvement (i.e., financial only
or volunteering/ partnering as well)
• Evaluate potential recipients of grants
• Management of investments & grant-making requests
• Maximize tax benefits through appropriate charitable
gifting vehicles
Philanthropy Questionnaire
3. What best represents your family’s views about philanthropy?
Mark with an “x” the answer that best describes your view.
 Model: We want to model philanthropic giving, and support younger generations as they, in turn, get
involved with their own causes and interests.
 Mentor: We want to mentor younger generations by having them be part of our family foundation
and/or charitable causes and interests.
 Mobilize: We want to mobilize all of the generations, channeling the family’s resources of time,
knowledge, and money into one area of passion.
x
Philanthropy Questionnaire
4. Based on what you know about your family, do you think it is possible to
arrive at consensus around gifting?
Check the statement that most closely reflects your view.






x
No, and I would prefer to not involved the family in philanthropy at this time.
No, but resources should still be made available for each individual member to give as he/she wishes.
Yes, and we would like to find a way to be more collaborative in our approach to charitable giving.
Yes, and we are already collaborating on a number of social causes that we collectively support.
Not sure, but would like to evaluate and discuss further.
Not sure, but would prefer to not involved the family in philanthropy at this time.
Charitable Planning: Strategic Objectives & Tools
Income Tax
Minimization
Strategic
Philanthropy
Charitable Remainder
Trust
Estate Tax
Minimization
Socially Responsible
Investing
Grant-Making
Evaluation
Donor Advised Funds
Retirement Income
Maximization
Asset-Based Giving
Social
Entrepreneurship
Family Legacy
Charitable Lead Trust
Private Foundation
Impact Investing
Pre-Liquidity Event
Planning
Pooled Income Funds
Charitable Gift
Annuities
Mission Statement
Engaging the Next
Generation
Outright Gifts
NonProfit Evaluation
1)
Organization History – Provide a brief history of the organization, its mission, and activities. Why is it
the logical organization to carry out this project?
2)
Beneficiary Demographics – Provide demographic information to describe the population served by
this program.
3)
Intent – Why is the purpose of this project or request? What significant will this project have to
recipients and the community?
4)
Timeline – How will this project be implemented? Where will it take place? Who is responsible for its
implementation? What is the timetable for completing it?
5)
Budget – What is the proposed budget of this project?
6)
Sources of Support – What organizations or corporations have committed funding for this project, and
in what amounts? What additional organizations or corporations will be approached for funding of
project?
7)
Sustainability – How will this project be sustained once support is completed?
8)
Management – What review and evaluation procedures will determine the success of this project?
Philanthropy Questionnaire
5. Some families establish private foundations in order to engage in philanthropy.
Check the statement and any applicable subcategory that most closely reflects your
view.
 I am attracted to the idea of a private family foundation.
 I am interested in a foundation, but would prefer a less complicated alternative.
 I have already established a private foundation and,
 so far, have been disappointed.
 have been satisfied, but feel there is room for improvement.
 have found the process compelling and rewarding.
 I am not interested in establishing a private family foundation.
x
Charitable Planning: Strategic Objectives & Tools
Income Tax
Minimization
Strategic
Philanthropy
Charitable Remainder
Trust
Estate Tax
Minimization
Socially Responsible
Investing
Grant-Making
Evaluation
Donor Advised Funds
Retirement Income
Maximization
Asset-Based Giving
Social
Entrepreneurship
Family Legacy
Charitable Lead Trust
Private Foundation
Impact Investing
Pre-Liquidity Event
Planning
Pooled Income Funds
Charitable Gift
Annuities
Mission Statement
Engaging the Next
Generation
Outright Gifts
Private Foundation
Advantages:
1) Flexibility in giving
2) Control of process
3) Timing of gifting
4) Family involvement
Private Foundation
Disadvantages:
1) Expenses, excise taxes
2) Detailed administration
3) Income tax deductibility limitations, including basis v. FMV
4) Prohibited transaction/self dealing rules
5) Disclaimer-funding rules
Philanthropy Questionnaire
10. How would you like your giving to be recognized?
Check any statement(s) that reflect your view.
x
I would like the ability to gift anonymously.
 I would like to receive public recognition for larger gifts.
 I would like to make gifts through typical channels – make donees aware of gift but without special
recognition.
Charitable Planning: Strategic Objectives & Tools
Income Tax
Minimization
Strategic
Philanthropy
Charitable Remainder
Trust
Estate Tax
Minimization
Socially Responsible
Investing
Grant-Making
Evaluation
Donor Advised
Funds
Retirement Income
Maximization
Asset-Based Giving
Social
Entrepreneurship
Family Legacy
Charitable Lead Trust
Private Foundation
Impact Investing
Pre-Liquidity Event
Planning
Pooled Income Funds
Charitable Gift
Annuities
Mission Statement
Engaging the Next
Generation
Outright Gifts
Donor Advised Funds
Donor A
Donor-Advised Fund (DAF)
Opens an account with
the DAF and makes
irrevocable contribution
of assets.
DAF creates a separate account to hold assets contributed by Donor A.
The DAF owns the assets and has ultimate control over distributions.
Contributions are
generally tax deductible
by the donor in year
they are paid to DAF.
Offers DAF nonbinding
advice about how
grants to Charities
should be made.
Assets
Donor
A’s
Account
Advice
Donor
X’s
Account
Donor
Y’s
Account
Donor
Z’s
Account
While the DAF will generally follow a donor's recommendations, it is
not bound by them. The DAF has control over which charities receive
contributions and when contributions are made.
Recipient
Charity
One
Recipient
Charity
Two
Recipient
Charity
Three
Donor Advised Funds
5 Questions to Ask:
1)
What types of grants recommended by donors will the Donor Advised Fund
(DAF) sponsoring organization approve?
2)
What types of assets can the DAF accept besides personal checks?
3)
Can the assets in a DAF account be transferred to another DAF sponsor?
4)
Are there restrictions on the amount that can be granted from a DAF?
5)
What are the specific account details for this DAF?
Philanthropy Questionnaire
7. A variety of charitable purposes could benefit from your contributions.
Choose up to 3 that are of greatest interest to you.












x
x
Poverty
Microfinance / Small Business Development
Water & Sanitation
Education
Health and Wellness
Disaster Response
Arts, Culture and Humanities
Environment and Wildlife
Affordable Housing & Community Development
Religion or Spiritual Endeavors
Advocacy & Human Rights
Other (please specify): __________________________________________________
Charitable Planning: Strategic Objectives & Tools
Income Tax
Minimization
Strategic
Philanthropy
Charitable Remainder
Trust
Estate Tax
Minimization
Socially Responsible
Investing
Grant-Making
Evaluation
Donor Advised Funds
Retirement Income
Maximization
Asset-Based Giving
Social
Entrepreneurship
Family Legacy
Charitable Lead Trust
Private Foundation
Impact Investing
Pre-Liquidity Event
Planning
Pooled Income Funds
Charitable Gift
Annuities
Mission Statement
Engaging the Next
Generation
Outright Gifts
Socially Responsible & Impact Investing
Philanthropy Questionnaire
12. Have you established a mission statement and/or strategic goal for your
philanthropy?
Check the answer that most closely reflects your view.
 No, and I am not interested in it.
No, but I would like help in developing that.
 Yes, and I feel that it is sufficient.
 Yes, but I would like to revisit what is in place currently to see if it can be improved or updated.
x
Charitable Planning: Strategic Objectives & Tools
Income Tax
Minimization
Strategic
Philanthropy
Charitable Remainder
Trust
Estate Tax
Minimization
Socially Responsible
Investing
Grant-Making
Evaluation
Donor Advised Funds
Retirement Income
Maximization
Asset-Based Giving
Social
Entrepreneurship
Family Legacy
Charitable Lead Trust
Private Foundation
Impact Investing
Pre-Liquidity Event
Planning
Pooled Income Funds
Charitable Gift
Annuities
Mission Statement
Engaging the Next
Generation
Outright Gifts
Family Mission Statement
The Optimal Basis Increase
Trust – Better Income Tax
Results for Trusts
Presented by:
Edwin P Morrow III, JD, LL.M., CFP®
Senior Wealth Specialist, Key Private Bank
edwin_p_morrow@keybank.com
12/5/2014
edwin.morrow3@gmail.com
Toledo Area Partnership for Philanthropic Planning
White paper at http://ssrn.com/abstract=2436964
Information provided is not intended to be individual tax advice.
Copyright 2013-2014 Edwin Morrow, KeyBank, NA
Agenda
•
•
•
•
•
Tax law changes and the lure of portability
Adapting disclaimer-based plans
Reducing ONGOING income tax of higher rates
Shifting tax to lower brackets through trusts
Exploiting the 642(c) charitable deduction
31
What’s New in Estate Tax Planning?
• “Permanent” $5 million estate/gift/GST,
adjusted for inflation ($250,000 added in just
two years with LOW inflation, up to $5.34
million in 2014), with spousal “portability”
• Ohio estate tax eliminated
• 2014 “Greenbook” proposals propose again to
make $3.5 million estate/gst excl., $1 million
gift excl, 45% top rate – unlikely to pass, but
Congress may pass “loophole closers”
(GRATs, IGTs, entity valuation).
32
What’s New in Income Tax Planning?
• For 2013, new tax law (ATRA and ACA):
• New ordinary income rate of 39.6% and 20% LTCG/QD
on taxable income (not AGI) over:
$400,000 (single) (in 2014, $406,750)
$450,000 (married) (in 2014, $457,600)
$11,950 (trusts/estates) (in 2014, $12,150)
Medicare Surtax of 3.8% (net investment income) or 0.9% (wages)
• Hits taxpayers with AGI over $200k/$250k
• Trusts/estates AGI over only $11,950 ($12,150 in 2014)
• Together, investments top at 43.4%/23.8%
(w/ Pease limitations effect (not trust), 44.6%/25%)
(if Ohio income tax counted, add another 5.41%*!)
33
The Challenge for Sub $10.68 Million Estates
• The popular financial press, even
sophisticated CFPs, CPAs, and yes, even
attorneys are questioning bypass trusts or
even the need for trusts at all for the “99%”
• The most common “solutions” cited are to
ditch the trust altogether, use disclaimer
funding, or use an “all marital” approach – all
of these have significant flaws and issues.
34
Why not ditch the trust?
•
Traditional Asset Protection/Family Bloodline
•
Management/ Avoid Probate
•
Quirks of Portability, DSUE, simultaneous
death, remarriage
Income Tax Benefit? - state, spray, etc
•
See page 4-8 of longer CLE outline
35
Three Key Income Tax Problems Post-ATRA
1. Lack of second basis “step up” (or “step
down”) that a simple “I love you will” or even
intestacy would probably provide the family
2. Potentially higher trust income tax rates
3. Unique assets may get worse tax treatment
Goal – eliminate concerns and even turn these
income tax negatives of trusts into POSITIVES!
See infographic p. 132
Understanding Powers of Appointment
•
Powers of Appointment (POA) have TREMENDOUS
income tax planning potential for both stepping up
basis (at death) and spraying income (lifetime).
•
GPOA (general power of appointment) – power to
appoint to yourself, your estate, or creditors of either –
can be lifetime, or testamentary (only effective at
death) – triggers gift tax/estate inclusion
•
LPOA (limited powers of appointment) – power to
appoint that excludes power to appoint to self, estate,
or creditors or either – usually does NOT trigger gift
tax or estate inclusion, except special circumstance
37
Busting Spousal Disclaimer Myths
•
You have all been taught that spouses using any
disclaimer funding have to disclaim any powers of
appointment in trusts receiving disclaimed assets.
•
This is wrong, or at least, overbroad
•
A POA that can only trigger estate/gift tax, or that
is limited by ascertainable standard, CAN BE
retained. OBIT clauses meet this requirement
See page 52-54 of CLE outline, sample clauses
38
Traditional AB Trust – Disclaimer Plan/Effect
John Doe Trust
(could be joint trust)
Planning Steps
At John’s Death
Usual Method
Alternate Method
To Mary Outright
John Doe Marital
Trust
Fbo Mary
After Mary’s Disclaimer
John Doe Bypass Trust fbo Mary
(& children?) < $5.34 million. No
LPOA, no power to “rewrite” via
testamentary POA to adapt trust.
Mary cannot be trustee w/discretionary spray power, has no
lifetime or testamentary power of appointment (or disclaims it)
39
“OBIT” Trust – Disclaimer Plan/Effect
Planning Steps
At John’s Death
Usual Disclaimer Plan
John Doe Trust
(could be joint trust)
To Mary Outright or
Marital Trust
At Mary’s Disclaimer
John Doe Bypass Trust fbo Mary (&
children) < $5.34 million (AEA).
Keeps HEMS spray, gift-taxable
spray and estate-taxable
testamentary POA “rewrite” power
Mary has fiduciary POA limited by HEMS, “taxable” LPOAs to shift income
(life), testamentary GPOA power to increase basis (at death)
40
Better Ongoing Income Tax Planning
•
The biggest issue is that capital gains are defaulted
under §643 in most cases to be trapped in trust and
not carried out onto the beneficiaries’ Form K-1, even if
substantial distributions equal to or more than taxable
income are made. See comparison chart.
•
Example: Jane is a widow otherwise in 15%-25% tax
bracket, beneficiary of her husband’s trust, which
generates $100,000 of capital gains and $40,000 of
interest, dividends or rents. She takes $140,000 to live on
from the trust – the trust issues a K-1 for $40,000, taxed to
her. The remaining $100,000 is taxed, after $12,150, at
23.8% to trust (43.4% if short term capital gains!). That’s
59% higher LTCG tax, 189% higher STCG tax
If Jane makes > $406,750 taxable income anyway, there is no
“tax negative” to the trust, but this brings up other better options!
41
Ordinary “A/B” Trust – Ongoing Tax Effect
At John’s Death
Tax Effect to Spouse and Doe Family, during spouse’s lifetime
Above rates refer to trust income above $12,150 in 2014 (top rates), ignoring
state income tax, AMT, or special rates for collectibles, depreciation recapture
42
Income Tax Efficient Trust– Ongoing Tax Effect
At John’s Death
Income Tax effect to spouse and Doe Family during spouse’s life
This may change trust’s income above $12,150 from 43.4%/23.8% top rates to
15%, 25%, 28%, 33%, 35%, or 15% LTCG/QD, or even less to beneficiaries.
43
Ongoing Income Tax Planning
•
There are many investment solutions to manage trust
income taxation (individual stock/bond portfolio can
best manage tax loss harvesting and realization, some
tax-efficient ETFs and mutual funds are more tax
efficient than more managed funds, etc, and of course
using tax free muni bonds may play a role).
•
This outline will primarily discuss methods of
distributing the taxation or shifting whatever income is
generated by the trust assets between the trust and
the beneficiaries, using §678(a), §643 Regulations,
in kind distributions, powers to adjust, partnerships
and powers of appointment.
Outline assumes situation where the settlor’s goal is
not to create a restrictive distribution ceiling (e.g.,
income-only QTIP)
•
44
Ongoing Income Tax Planning – §678(a)
•
You can make a trust an IRC §678(a) “beneficiary-defective”
“Mallinckrodt” trust – giving the beneficiary the unfettered right to
withdraw income (a General Power of Appointment) not only over
net accounting income, but even capital gains – could also apply
via formula – this puts income directly onto the beneficiary’s
Form 1040, not the Trust’s Form 1041/K-1
•
Does NOT have to be over 100% of principal, despite common
wisdom
•
Can be over only certain assets
•
Beneficiary must have sole, unfettered right (e.g., not with
permission of trustee, trust protector, or HEMS limitations)
•
Unlike traditional trust K-1 accounting, a beneficiary does not
have to actually receive the income for it to be taxable to him/her.
45
Ongoing Income Tax Planning – §678(a)
•
This might be appropriate for a couple with special assets in
trust, such as a personal residence, or a couple wanting to
simplify tax reporting in spite of slightly less asset protection.
•
Query whether §121 would allow $250,000/$500,000 capital
gains tax exclusion for a trust drafted in this manner. See
revenue rulings in citations which should allow it. Also consider
application to many other tax provisions where grantor trust
status would be highly advantageous (S Corp, §179 expensing)
Not practical for some estate situations, but a flexible §678(a)
trust might have more tax flexibility. Unlike certain provisions re
capital gains in §643, can be changed year to year. This is
probably not a good option for second marriage situations
where corpus preservation is paramount, but appropriate for
someone otherwise considering outright, or a more liberal trust.
46
Ongoing Income Tax Planning – §678(a)
•
Can a QTIP Trust come under 678(a)? YES.
•
QTIPs do not have to require all net income be
paid, they can also qualify if the surviving spouse
has the unrestricted ability to withdrawal such
income at least annually. Hence, it is possible to
have a 678(a) trust as to not only accounting
income, but any greater amount if the settlor
would permit, such as the greater of all
accounting income or all taxable income.
47
Ongoing Income Tax Planning (§643 Regs)
•
Other exception to make capital gains taxed to
beneficiary – Treas. Reg §1.643(a)-3(b) – the MOST
IMPORTANT REGULATION YOU SHOULD READ
THIS YEAR, even more than Section 1411 Regs,
contains three paragraphs outlining when capital
gains can be part of DNI and hence taxed to the
beneficiary (if sufficient distributions made): “(b)
Capital gains included in distributable net income.
Gains from the sale or exchange of capital assets are
included in distributable net income…”. Let’s discuss
paragraphs (1),(2) and (3)
48
Ongoing Income Tax Planning(§643 Regs)
•
•
•
Treas. Reg. §1.643(a)-3(b)(2):
Easiest to do (in theory) – “(2) Allocated to corpus
but treated consistently by the fiduciary on the
trust's books, records, and tax returns as part of a
distribution to a beneficiary;”
Not possible if contrary Forms 1041 already filed.
Could decanting or amendment start a new clock
as to an arguably new trust, cleaning the slate?
Doubtful. Perhaps worth a try.
Unlike 678(a), requires distribution to beneficiary
49
Ongoing Income Tax Planning (643 Regs)
Treas. Reg. §1.643(a)-3(b)(1): “Allocated to
income…”
•
•
Or, trustee may allocate pursuant to trust and
state law, net capital gains to income, which
makes it part of DNI, hence distributions can be
deducted by trust, passed out as income to
beneficiary on K-1.
Unlike 678(a), requires an actual distribution, but
remember the 65 day rule may allow late
distributions if properly elected.
50
Ongoing Income Tax Planning (643 Regs)
Treas. Reg. §1.643(a)-3(b)(3): “Allocated to
corpus but actually distributed to the
beneficiary or utilized by the fiduciary in
determining the amount that is distributed or
required to be distributed to a beneficiary.”
•
Two alternate tests here – first seems to require
tracing- second is also awkward and unclear –
how does a trustee prove how they determine
this, and does there have to be trust language
justifying the practice? Few trusts would specify.
Some attorneys more optimistic than I about this,
but I have suggested language in material.
51
Other Techniques that Shift Capital Gains
•
IRC §643(e) in kind distributions – unless trustee
affirmatively elects, a trust distribution in kind would
not trigger capital gain. E.g. trustee distributes P&G
stock, Blackacre, etc – beneficiary generally receives
carry over basis (unless “loss” property), then sells
and incurs LTCG at their tax rate.
•
Qualified Subchapter S Trust (QSST) Election –
ongoing K-1s from S corp report directly onto the
beneficiaries’ 1040, even if some income passing
through is capital gains (not same if stock sold).
•
Partnership (LLC taxed as partnership): Distributions
from partnership usually accounting income (DNI),
even if K-1 from LLC shows capital gains. No help for
“phantom income”.
52
Tax Shifting to Other Beneficiaries
Ordinarily, we have very little power to shift
income tax burden without transferring the
underlying assets under the assignment of income
doctrine (fruit/tree). We can’t just give a paycheck
to kids/charity and expect our W-2 to change.
Want to shift $30,000 of annual P&G dividend
income? – give away $1,000,000 of P&G stock!
Exceptions:
• Gifts of agricultural products (case, Rev. Rul.)
• IC-DISCs (statute favoring export income)
• Partnerships (complicated allocation, gift tax rules)
• Non-grantor Trusts! (specific rules in
Subchapter J)
53
of Agricultural
Planning Gifts
Steps & Strategies
1)
2)
3)
Products
Farmers/Ranchers are unique in the ability to get around
this “assignment of income”. If any agricultural product
produced by the farmer is given away (e.g. to an account in
a charity’s (DAF) name at a grain elevator), when the
product is sold it does NOT trigger any tax to donor. This
may often be much better than gifting cash. Unlike
gifting appreciated securities, which might get around some
LTCG tax, gifting “grain” can get around ordinary income
AND employment tax AND state and local income tax.
Similar tax-wise, but perhaps even better, than a Qualified
Charitable IRA Distribution.
The IRS fought this for years, lost a few court cases, and
finally acquiesced. The IRS does force farmers to back out
their deductions/costs associated therewith (e.g. if they
gifted 10% of their crop, and spent $100,000 on fertilizer,
they could only deduct $90,000 for fertilizer expenses).
Ditto – the same concept applies to gifts to children, who
would pay either long but probably short term capital gains
54
Tax
Shifting
for exporting business owners
Planning
Steps & Strategies
1)
2)
3)
4)
5)
6)
IC-DISCs (interest charge domestic international sales
corporation) also allow tax shifting for qualified export
income
Vastly overlooked, but must be US made goods going
abroad (incl. agriculture, parts, can include via distributor
but probably not through secondary US mfr)
Can include software, engineering/agricultural
Allows shifting of tax to IC-DISC owners at qualified
dividend rates. Charity would have to pay UBTI, but it still
allows above the line shifting.
Ditto – the same concept applies to children, who may
easily be in a 0% LTCG/QD bracket
Email me if you’d like a separate 30 minute presentation on
IC-DISCs and various income, estate and charitable
planning strategies
55
Tax Shifting to Other Beneficiaries - Spray
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•
•
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There is a tremendous tax planning power to have
spray provisions to allow distributions to other
beneficiaries, potentially including charities.
However, from a practical administrative perspective,
spray powers are “messy” at best – trustees often
hate them - accounting, reporting, more conflicts.
Beneficiaries may be in low bracket, even 0%
LTCG/QD bracket (if MFJ beneficiary makes under
$72,500 TI, which might be about $90,000 AGI after
deductions etc), or even live in no-tax state of
residence – should all bypass trusts have this
capability – if properly limited/circumscribed?
Personal powers of appointment, however, are nonfiduciary, with no attendant duties whatsoever on the
powerholder. Power can be “collateral” – held by a
non-beneficiary, similar to “distribution trustee”.
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See page 116-120 of CLE outline
Tax Shifting – Drawbacks to QTIP Trusts
QTIPs are necessary for large estates, but terrible for
a basic foundation and with portability may be
overused. It’s not because they force a step down in
basis unnecessarily, have §2519 issues, Rev. Proc
2001-38 uncertainty, more chance for decreased
basis via discounting, and less flexibility via decanting
or amendment, but because they prevent tax shifting
•
§2056(b)(7) appears to disallow any power to
distribute anything to other than spouse, or any POA
•
Surprisingly, you can make a good argument that
a QTIP might be able to shift income with a 5/5
GPOA power, following regulation and PLR, but I
would not count on it.
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Tax Shifting – Powers of Appointment
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•
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Example: Bypass Trust has $40,000 interest,
dividends, $100,000 capital gains. What if the surviving
spouse doesn’t need the $140,000 and the spouse
would prefer the income go to children, grandchildren
etc and be taxed at their rates? (or parents’ via kiddie
tax, but remember, it doesn’t affect 3.8% surtax!)
A trustee spray power (fiduciary) can do this.
A non-fiduciary lifetime limited power of appointment
held by a non-beneficiary (collateral power) can do this.
A lifetime power of appointment held by the spouse can
do this. It may trigger a gift, using lifetime gift tax
exclusion if over annual exclusion amounts. When? If
the spouse is entitled to all income (Regester case), or
perhaps even a nominal gift if not (PLR), or if GPOA.
Distributions from trusts that are taxable gifts are NOT
tax-free to beneficiary pursuant to IRC 102(b).
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Efficient Tax Shifting to Charity – §642(c)
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Many middle class clients make charitable donations –
taxes are not primary motivation usually, but people
always want the maximum tax benefit possible
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What if you made it discretionary with independent (or
even family) trustee? Accounting/reporting? Most
people do not trust independent trustees to do what
they want, perhaps for good reason, and don’t want
fiduciary duties as trustee to their charities, even if
wholly discretionary to a Donor Advised Fund.
Instead, why not allow charity to be permissive
appointee under a lifetime power of appointment?
Use a private foundation or donor advised fund?
Families prefer this route. 642(c) should still apply,
see citations.
•
See pages 102-105 of CLE outline
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Efficient Tax Shifting to Charity – §642(c)
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•
Unlike IRC §170, §642(c) can benefit foreign charity,
it is not subject to the 20%/30%/50% of AGI rules, and
it is not subject to the Pease limitations that affect
individual taxpayers! Because Ohio bases its trust
income tax on the taxable income on the Form 1041
after the 642(c) deduction, this indirectly allows Ohio
income tax deduction (unlike personal). Moreover,
you don’t have a 65 day rule, you get a full 1 year rule!
However, it probably must be traced to gross income
(taxable income, incl. CG, not accounting income, so
not muni) from current or immediately prior year, but a
professional trustee is good at tracing that. Abbin’s
treatise argues tracing should not be necessary, but
best practice would be to assume it does for planning.
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Efficient Tax Shifting to Charity – §642(c)
•
Trust might even limit charities to a % of gross income
only (not prior principal), even excluding non-taxable
income (muni) and/or preferential tax rate income
(LTCG/QD)
•
A trust or trustee cannot just allocate higher rate
income to charity, unless the trust limitation on the
charity’s potential income has “economic effect” per
the Regs. For example, if the trust document limits
the charity’s potential distribution to short-term capital
gains, non-qualified dividends, interest (43.4%
potential rate income), non-business income (watch
out IRC §681), this should have the economic effect
of curtailing their potential income.
See page 102-105 of CLE outline
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Issues for “Stretch” IRA - QRP planning
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Remember, powers of appointment may be an elixir for
trust income tax planning, but they can be POISON for
stretch IRA “see through trust” planning
•
For a “conduit trust”, you want to ensure that no IRA
distributions can be distributed to anyone older, or any
entity, while the “designated beneficiary” is living. Any
lifetime distribution to younger beneficiary kills spouse
“sole beneficiary” advantages (delayed RBD, recalc LE)
•
For an “accumulation trust”, POAs should limit to
younger individuals, but even after death of current
beneficiary. All good reasons for separate or
standalone trusts for IRA/QRP.
See separate CLE material, articles on see through trusts
with a pre, post-mortem checklist on trust/IRA issues.
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Planning Steps
& Strategies
Efficient
Income
Tax Shifting with “DINGs”
•
A DING (OING) allows “above the line” deductions
from trust income, so that K-1 income can go to
children in lower tax brackets. Any distribution to nonsettlor makes the gift complete as to those assets, but
gift eligible for annual exclusion $14/$28,000, plus,
people may want to shift income with taxable gift)
•
More importantly, as discussed above, lifetime limited
powers of appointment can be used to spray income
to a donor advised fund getting an “above the line”
deduction, undaunted by the Pease limitations or
20/30/50% limitations, achieving state income tax
deduction, and it’s flexible and discretionary!
See page 124-125 of CLE outline
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Efficient
Ohio
Income
Tax
Avoidance
with
Planning Steps & Strategies
“Deferred Distribution Power Trusts”
•
•
A DING (OING) can also be structured to avoid Ohio
income tax on non “source income” (which is Ohio
based business, real estate, tangible property, Ohio
lottery winnings, etc)
When is such complexity going to be worth the
trouble? Generally, large sales of out of state
property, publically traded securities, etc – consider
the recent KMP, AbbVie, etc transactions recently in
the news!
See page 124-125 of CLE outline, Probate Law Journal of
Ohio article
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“Personal
tax
inversions”
for
client
owns
Planning Steps & Strategies
stock undergoing corporate tax inversions
•
•
•
•
When people think of deferring tax, we think of
Charitable Remainder Trusts – life or 20 yr term
Just because there is an announcement/intention to
undergo an inversion does not mean it is a “done
deal” and too late for CRT planning!!! You don’t have
to read the Palmer case and IRS rulings to know
these deals are hardly complete! Read the news!
Consider the Deferred Distribution Power Trust to
avoid Ohio income tax on the deals as well – perhaps
portions of stock are contributed to each type of trust
Consider – the non-charitable beneficiary of a CRT
does not have to be an individual – it can be a nongrantor incomplete gift trust, enabling both the deferral
of federal income tax, and perhaps further avoidance
of Ohio, and even income tax shifting to boot.
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Conclusions – Optimizing Basis and Income
Tax Efficiency
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Optimal basis increase trusts (OBITs) have all the upside
of a traditional bypass trust, but negate the two principal
downsides, even turning them into positives (optimizing
basis, better income tax by spraying income and/or 678a)
•
Avoids all the negatives of outright bequests or marital
trusts (step down in basis, fractional discounting, trapping
income with no spray/gifting ability, 2519 risk);
•
QTIPs/portability may still be needed or desired for various
narrow situations (e.g. QRP/IRA rollover, $9-$10 million
estate w/kids from same marriage), but suffer from weaker
ongoing gifting/shifting options – see comparison chart
•
Negative? – No “off the shelf”, NOLO press online trust
form, these require a real attorney, new drafting!
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Conclusions – Sample Forms
•
Updated material and clauses will be periodically added to
white paper at http://ssrn.com/abstract=2436964
New Articles:
•
The Art of Avoiding Ohio Income Tax Using Trusts, Ohio
Probate Law Journal, May/June 2014 issue
•
Ed Morrow & Steve Oshins on Ferri v. Powell-Ferri: Asset
Protection Lessons, Perils and Opportunities with
Decanting, LISI Asset Protection Newsletter #240
•
The Upstream Crummey Optimal Basis Increase Trust –
CCH Estate Planning Review, May 2014 issue
•
Clark v. Rameker: Supreme Court Holds that IRAs are Not
Protected in Bankruptcy - Are Inherited Spousal IRAs and
Even Rollover IRAs Threatened? LISI Asset Protection
Newsletter #248 (June 16, 2014). 50 State IRA Creditor
Exemption Chart with Commentary. LISI Asset Protection
Newsletter #256 (August 7, 2014).
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Questions?
•
Email edwin_p_morrow@keybank.com or
edwin.morrow3@gmail.com
•
I always welcome constructive criticism and discussion on
tax and trust issues related to this outline, and I am well
aware that many good attorneys find some of them to be
completely unheard of, crazy, novel or all of the above!
However, I do aim to be practical, hence the 30 pages or
more of sample clauses. Take them with a grain of salt, I
have not been in private practice for 8 years! But hopefully
they will give you a start for your own forms, or ideas for
better drafting. Let me know how you improve on them!
Thanks!
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