Integrating Income Tax Planning Techniques into the Estate Plan

Transcription

1 Integrating Income Tax Planning Techniques into the Estate Plan by Jerome M. Hesch Of Counsel, Berger Singerman LLP Miami, Florida Director, Annual Notre Dame Tax & Estate Planning Institute South Bend, Indiana Adjunct Professor of Law University of Miami School of Law FIU School of Law Miami, Florida The University of Texas School of Law 61 st Annual Taxation Conference AT&T Conference Center Austin, Texas December 5, 2013

2 Jerome M. Hesch is Of Counsel to Berger Singerman LLP in Miami, Florida and Special Tax Counsel to Oshins & Associates in Las Vegas Nevada. He is the Director of the Notre Dame Tax and Estate Planning Institute, on the Tax Management Advisory Board, a Fellow of ACTEC, has published numerous articles, Tax Management Portfolios, and co-authored a law school casebook on Federal Income Taxation, now in its fourth edition. He has presented papers for the University of Miami Heckerling Institute on Estate Planning, the University of Southern California Tax Institute, the Southern Federal Tax Conference, and the New York University Institute on Federal Taxation, among others. He has participated in several bar association projects, including the Drafting Committee for the Florida Revised Uniform Partnership Act and preparing the ABA s comments on the IRS s proposed private annuity regulations. He received his BA and MBA from the University of Michigan and a JD from the University of Buffalo Law School. He was with the Office of Chief Counsel, Internal Revenue Service, Washington, D.C. from 1970 to 1975, and was a full-time law professor from 1975 to 1994, teaching at the University of Miami School of Law and the Albany Law School, Union University. He is currently an adjunct professor of law, teaching courses at the Florida International University Law School and the Graduate Program in Estate Planning at the University of Miami. Having grown up in Buffalo, NY he remains a Buffalo Bills fan.

3 Introduction With the now permanent $10,000,000 1 exemption for a married couple, far fewer individuals will feel there is a need for traditional estate planning. 2 Despite the perceived notion that there is no longer a need for traditional estate planning, these very same individuals will still have a need for income tax planning. Numerous income tax planning techniques are available that should become more important. The purpose of today s presentation is to briefly cover some of the available income tax planning techniques tax professionals should consider and introduce to their clients. 3 Given the numerous techniques that will be mentioned, today s discussion cannot go into depth, but will only sensitize the reader to these techniques. 4 Since we cannot go into detailed discussions, this paper will use numerical examples to quickly illustrate the impact of these techniques. Before starting, it is important to mention the four basic income tax planning principles that have been used since the passage of the original income tax act in 1913, 5 and despite all of the changes in the Internal Revenue Code during its first 100 years, they still remain relevant. They are: 1. Assignment of income to a taxpayer in a lower marginal income tax bracket. 2. Deferral of reporting income to later tax years. 3. Exclusions from gross income. 4. Conversion of ordinary income into capital gains. 1 The $5,000,000 per person exemption is indexed for inflation and is $5,340,000 for the 2014 year. For a married couple, this means that they can transfer up to $10,680,000 during their lifetimes that will be exempt from all gift, estate and generation skipping transfer taxes. For a couple in their 60s, adding annual exclusion split gifts ($14,000 for 2014) and the ability to pay the tuition for grandchildren, can add another $1,000,000 or so that can be gifted without creating any taxable gifts. For individuals living in states that have lower exemptions, saving state estate taxes will still be a concern. The exemption in many states is $1,000,000 and in a few states even lower. 2 Since saving gift and estate taxes is only one of several objectives an individual has when transferring wealth to the next generation, there will still be a need for trusts, even for individuals who are not exposed to the transfer taxes. See Oshins, Hesch and Schoenblum, Fine Tuning Dynasty Trusts as the Centerpiece of the Family Wealth Plan, 91 PRACTICAL TAX STRATEGIES 148 (October 2013). 3 For tax professionals who focus their practice almost exclusively on estate planning, far fewer of their clients will need traditional estate planning with the increased exemptions. Rather than watch their client base slowly erode, they need to reinvent themselves and develop other planning techniques to introduce to their clients. Otherwise, they will find themselves as the Eastman Kodak of the estate planning profession. 4 A more comprehensive discussion of these income tax planning techniques can be found in the many books and articles published in the past. 5 See the 16 th Amendment to the United States Constitution. 2

4 When deductions are involved, the four basic income tax planning principles are: 1. Assignment of deductions to a taxpayer in a higher marginal income tax bracket. 2. Acceleration of future deductions to the current tax year. 3. Conversion of personal expenses into income tax deductions. 4. Conversion of capital losses to more useful ordinary losses. Today s presentation will only mention planning for income and will leave the planning for deductions to your own research. Each of the techniques for income tax planning that we will discuss fall within one of the four basic planning principles as follows: 1. Assignment of income to a taxpayer in a lower marginal income tax bracket. a. Take advantage of the kiddie tax thresholds. b. Elimination of employment taxes for employment of minor children. c. Complex trusts to distribute taxable income to beneficiaries. d. C corporations that intend to retain earnings. e. Reduce an individual s adjusted gross income so as to decrease the phase outs of itemized deductions, personal exemptions and reduce exposure to the alternative minimum tax. f. Shift income from a C corporation that cannot convert to an S corporation to a pass through entity. An income tax freeze to reduce double taxation! 2. Deferral of reporting income to later tax years. a. Commercial annuities. b. Stretch IRAs upon the death of the income earner. c. Defer state income taxes by the use of complex trusts. d. Income taxable installment sales to complex trusts for individuals who intend to sell an appreciated asset in the future. e. Ownership of high cash value life insurance by the insured treated as a modified endowment contract (a MEC ). 3. Exclusions from gross income. a. Section 529 plans for children, grandchildren and even great grandchildren (the Educational Dynasty Trust ). b. Complex trusts for state income taxes (I ve been DINGed!). c. High cash value life insurance that is not a MEC owned by the insured or by an irrevocable trust. 3

5 d. Elimination of phantom gain for negative basis real estate. e. Charitable remainder trusts for the sale of appreciated assets. f. Using the grantor trust substitution power for low basis assets that are not exposed to the estate tax 4. Conversion of ordinary income into capital gains. a. Intra family installment sale to a complex trust of rental properties before conversion to condominiums. b. Early termination of charitable remainder trusts. As one can imagine, we will not be able to adequately discuss each of the above-listed techniques in the hour available. For some of the techniques we will go into detail, for others we will present an illustrative example and for the remainder we will only mention that the technique should be considered. Since the readers are already somewhat familiar with almost all of the above techniques, we hope that a brief mention of a technique will refresh the readers memories and that the readers will then add the techniques to their arsenal so that they can mention them to a client when appropriate. Hopefully, the reinforcement of these techniques in your memory will allow you to create new business for your practices. 4