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Friday, September 12, 2014

What is Portability? And What Does It Mean to You?

When Congress passed the American Taxpayer Relief Act (ATMA 2013), there were two permanent changes made in the estate tax law that have significantly impacted the way that many families plan their estates.

 The first permanent change was the increase to $5 million of the Federal Tax exemption (with annual increases for inflation). The 2014 exemption amount is $5.34 million for the estates of people who die this year. Since less than one percent of all estates are valued at more than $5 million, most families do not have and do not expect to ever accumulate a taxable estate.

 The second permanent change to the estate tax law was a provision that allows the unused portion of a deceased spouse’s exemption amount (called DSUEA) to be transferred or “ported” to the surviving spouse, effectively doubling the amount of exemption available to the surviving spouse, in most cases. In order for the surviving spouse to claim the DSUEA, the surviving spouse must file a federal estate tax return Form 706 for the deceases spouse and elect to receive the unused exemption amount.

 The following three examples demonstrate how portability works. Along with the examples are four potential pitfalls that may arise when trying to take advantage of the portability of a DSUEA.

 Example One: John and Jane Jenson have an estate worth $8 million. John does in 2014 and leaves $1 million to his children from a prior marriage and the remainder of his estate to Jane. The bequest to John’s children will not be subject to estate taxes because John has a $5.34 million exemption to cover the bequest. Jane can also file a federal estate tax return Form 706 and elect to receive the unused portion of John’s exemption, which would be $4.34 million. When Jane passes away, she will have her own exemption (currently worth $5.34 million), plus John’s unused exemption, giving her a total available exemption of $9.78 million.

 Pitfall (1): DSUEA must be elected by filing a federal estate tax return. The surviving spouse MUST file a complete federal estate tax return for the estate of the deceased spouse and make the DSUEA election, even if a federal estate tax return is not otherwise required. The means that a surviving spouse and the spouse’s advisors must be pro-active in the months following the death of the first spouse to determine whether to make the election and then to prepare a return.

 Example Two: Tyler and Tina Thompson have an estate valued at $2 million. Upon Tyler’s death, Tin does not file a federal estate tax return to elect Tyler’s DSUEA because the estate is well below the $5.34 million exemption amount. Five years later, Tina receives an unexpected inheritance of $8 million from her rich uncle. Tina now has a $10 million estate and just one exemption amount valued at $5.34 million, indexed to inflation. If she had elected Tyler’s DSUEA, she could have sheltered the entire amount from estate taxes on her death.

 Pitfall (2): The estate of the surviving spouse may grow faster than expected. The surviving spouse may not think that it is necessary to utilize the DSUEA upon the death of the first spouse, only to learn many years later that the estate has grown into a taxable estate faster than anticipated.

 Example Three: Hubby One and Wife One have an estate valued at $10.5 million. Hubby One dies in 2014 and leaves everything to Wife One. Wife One files an estate tax return and elects Hubby One’s DSUEA, giving her a total exemption of $10.78 million. Wife One marries Hubby Two. Hubby Two has an estate valued at $5.34 million, and he leaves that entire amount to his children when he dies. Wife One can only elect to receive the DSUEA of the last deceased spouse and Hubby Two had no DSUEA to give her because he used it all in the bequests to his children. Wife One effectively loses the DSUEA of Hubby One, and she now has $5.34 million of assets subject to a 40% taxation rate that were previously protected by the Hubby One DSUEA.

 There is a taxpayer-friendly rule that may allow Wife One a way out of her dilemma. IRS regulations provide that Wife One can use Hubby One’s DSUEA to make gifts prior to the death of Hubby Two, thereby possibly avoiding the forfeiture of Hubby One’s DSUEA if Hubby Two dies.

 Pitfall (3): Only the last deceased spouse’s DSUEA amount is portable. This means that a surviving spouse who remarries may lose the DSUEA of the first spouse, if the surviving spouse survives a second spouse.

 Pitfall (4): DSUEA does not apply to the GST exemptions of a deceased spouse. The ATRA 2013 increased the Generations-Skipping Transfer (GST) Tax exemption to $5.34 million and indexed it to inflation. That means that the state tax exemption and the GST tax exemption are the same. But the GST tax exemption is not portable and may not be elected by the surviving spouse. If the first spouse to die does not take advantage of the GST tax exemption (by leaving assets in a GST tax exempt trust, for instance) the GST tax exemption is wasted or lost.

 So what does portability mean to you? Most of our married clients who have estates of $2 million or more provide that upon the death of the first spouse, the share belonging to the deceased spouse will be directed to a Family Trust to ensure that it is not subject to estate taxes at the second death. The Family Trust also provided bloodline protection for the children, asset protection for the surviving spouse, and divorce protection if the surviving spouse remarries. But some clients who do not expect their estates to ever exceed $10 million are now opting to leave everything to the surviving spouse, rather than creating the Family Trust, and allowing the surviving spouse to elect portability to protect the estate from federal taxes. If you think it is time to review your estate plan because of changes in the tax law or other changes in your life, give us a call.

Wednesday, February 20, 2013

Umbrella Insurance: What It Is and Why You Need It

Lawsuits are everywhere. What happens when you are found to be at fault in an accident, and a significant judgment is entered against you? A child dives head-first into the shallow end of your swimming pool, becomes paralyzed, and needs in-home medical care for the rest of his or her lifetime. Or, you accidentally rear-end a high-income executive, whose injuries prevent him or her from returning to work. Either of these situations could easily result in judgments or settlements that far exceed the limits of your primary home or auto insurance policies. Without additional coverage, your life savings could be wiped out with the stroke of a judge’s pen.

Typical liability insurance coverage is included as part of your home or auto policy to cover an injured person’s medical expenses, rehabilitation or lost wages due to negligence on your part. The liability coverage contained in your policy also cover expenses associated with your legal defense, should you find yourself on the receiving end of a lawsuit. Once all of these expenses are added together, the total may exceed the liability limits on the home or auto insurance policy. Once insurance coverage is exhausted, your personal assets could be seized to satisfy the judgment.

However, there is an affordable option that provides you with added liability protection. Umbrella insurance is a type of liability insurance policy that provides coverage above and beyond the standard limits of your primary home, auto or other liability insurance policies. The term “umbrella” refers to the manner in which these insurance policies shield your assets more broadly than the primary insurance coverage, by covering liability claims from all policies “underneath” it, such as your primary home or auto coverage.

With an umbrella insurance policy, you can add an addition $1 million to $5 million – or more – in liability coverage to defend you in negligence actions. The umbrella coverage kicks in when the liability limits on your primary policies has been exhausted. This additional liability insurance is often relatively inexpensive in comparison to the cost of the primary insurance policies and potential for loss if the unthinkable happens.

Generally, umbrella insurance is pure liability coverage over and above your regular policies. It is typically sold in million-dollar increments. These types of policies are also broader than traditional auto or home policies, affording coverage for claims typically excluded by primary insurance policies, such as claims for defamation, false arrest or invasion of privacy.

Tuesday, August 14, 2012

Buy-Sell Agreements and Your Business

If you co-own a business, you need a buy-sell agreement. Also called a buyout agreement, this document is essentially the business world’s equivalent of a prenup. An effective buy-sell agreement helps prevent conflict between the company’s owners, while also preserving the company’s closely held status. Any business with more than one owner should address this issue upfront, before problems arise.

With a proper buy-sell agreement, all business owners are protected in the event one of the owners wishes to leave the company. The buy-sell agreement establishes clear procedures that must be followed if an owner retires, sells his or her shares, divorces his or her spouse, becomes disabled, or dies. The agreement will establish the price and terms of a buyout, ensuring the company continues in the absence of the departing owner.

A properly drafted buy-sell agreement takes into consideration exactly what the owners wish to happen if one owner departs, whether voluntarily or involuntarily.  Do the owners want to permit a new, unknown partner, should the departing owner wish to sell to an uninvolved third party? What happens if an owner’s spouse is involved in the business and that owner gets a divorce or passes away? How are interests valued when a triggering event occurs?

When drafting a buy-sell agreement, business owners should be prepared to consider the following issues:

  • Triggering Events - What events trigger the provisions of the agreement?  These normally include death, disability, bankruptcy, divorce and retirement.
  • Business Valuation - How will the value of shares being transferred be determined? Owners may determine the value of shares annually, by agreement, appraisal or formula.  The agreement may require that the appraisal be performed by a business valuation expert at the time of the triggering event. 
  • Funding - How will the departing owner be paid?  Many business owners will obtain insurance coverage, including life, disability, or business continuation insurance on the life or disability of the other owners.  With respect to life insurance, the agreement may provide that the company redeem the departing owner’s shares. Alternatively, each of the owners may purchase life insurance on the lives of the other owners to provide the liquidity needed to purchase the departing owner’s shares (“cross purchase agreement”).   The agreement may also authorize the company to use it’s cash reserves to buy-out the departing owners.  

If you are a business owner and share ownership interest in your company, Foley & Foley can assist you in crafting this essential document to preserve the value of your contribution to the company.  For more information on the necessity of buy-sell agreements, see this recent article in Forbes by Robert W. Wood:  "In Business? Get A Buy-Sell Agreement!"

Wednesday, May 30, 2012

Family Business: Preserving Your Legacy for Generations to Come

Are you a business owner? If so, you need to consider the following truth: Someday you will exit your business.  For most closely-held business owners, this reality is hard to imagine, but without taking time to plan for the inevitable, you will not be able to ensure that your business and the wealth that you have created are protected and pass smoothly to future generations.

More than 70 percent of family businesses do not survive the transition to the next generation. Ensuring your family does not fall victim to the same fate requires a unique combination of proper estate and tax planning, business acumen and common-sense communication with those closest to you. Foley & Foley can help business owners develop a sound exit planning roadmap and assist in the preparation of strategies and business organizational requirements to help assure a smooth business transition from one generation to the next.  Below are some steps you should consider taking as part of your business succession plan. 

  • Meet with an estate planning attorney at Foley & Foley to develop a comprehensive plan that includes a will and/or living trust. Your estate plan should account for issues related to both the transfer of your assets, including the family business and estate taxes.
  • As part of the estate planning process, communicate with your family members about their wishes concerning the business. Enlist their involvement in establishing a business succession plan with your attorney to transfer ownership and control to the younger generation. 
  • Make sure your succession plan includes:  preserving and enhancing “institutional memory”, who will own the company, advisors who can aid the transition team and ensure continuity, who will oversee day-to-day operations, provisions for heirs who are not directly involved in the business, tax saving strategies, education and training of family members who will take over the company and key employees.
  • Discuss your estate plan and business succession plan with your family members and key employees. Make sure everyone shares the same basic understanding.
  • Plan for liquidity. Establish measures to ensure the business has enough cash flow to pay taxes or buy out a deceased owner’s share of the company. Estate taxes are based on the full value of your estate. If your estate is asset-rich and cash-poor, your heirs may be forced to liquidate assets in order to cover the taxes, thus removing your “family” from the business.
  • Implement a family employment plan to establish policies and procedures regarding when and how family members will be hired, who will supervise them, and how compensation will be determined.
  • Have a buy-sell agreement in place to govern the future sale or transfer of shares of stock held by employees or family members.

You have worked very hard over your lifetime to build your business, but you should resist the temptation to retain total control of your business well into your golden years. There comes a time to retire and focus your priorities on ensuring a smooth transition that preserves your legacy – and your investment – for generations to come.  If you want to better understand how we can assist your business make this transition, contact us today for an initial business planning consultation.



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