The American Family Business Institute, an advocate for small businesses, has long argued that the burden of death taxes (estate and inheritance taxes) impairs the ability of keeping family businesses going after the death of the founder. They note that 70% of family businesses do not survive to the second generation, and 90% fail to reach a third generation. A recent study by the American Family Business Foundation concluded that repealing the estate tax entirely would add $119 billion to GDP and increase the incomes of American workers by $79 billion. Another study, by the former director of the nonpartisan Congressional Budget Office, Douglas Holtz-Eakin, found that death tax repeal would create 1.5 million small business jobs and decrease the national unemployment rate by nearly one percent.
Legislation to repeal the federal estate tax permanently is unlikely any time soon, given the new permanence of the $5 million federal exemption (inflation-indexed to $5.34 million in 2014). The higher exemption is welcome, but probably not sufficient for many family businesses to stay in business. Business owners are going to have to take action if they want to gain control over their death tax exposures. That’s what the Wandry family did.

Gifts of partial interests

Joanne and Dean Wandry created a limited liability company (LLC) to facilitate giving gifts to their heirs. On January 1, 2004, each of them gave to each of their four children $261,000 worth of units in the LLC. They gave $11,000 worth of units to each of five grandchildren as well. At that time, the annual gift tax exclusion was $11,000 and the lifetime federal gift tax exemption was $1 million. Thus, Joanne and Dean fully utilized these legal protections and owed no gift tax.
The exact number of LLC units (similar to shares of stock) covered by those dollar amounts was not determined at that time, but was to be calculated by an independent third-party professional at a later time. Most importantly, the document executing the gift also provided for an adjustment in the number of units in the event of an IRS audit.
When the $1,099,000 worth of gifts was reported on the federal gift tax return, the attached schedule described the children’s interests as a 2.39% LLC interest, and the grandchildren’s as a 0.101% interest. Upon audit, the IRS determined that the LLC was worth more than reported, so the 2.39% interest and the 0.101% interest were worth more as well. Enough more to trigger the requirement for a gift tax payment.

Careful lawyering

The Wandrys contended instead that the 2.39% and 0.101% fractions should be reduced until they matched the dollar amount of the intended gift. In an important Tax Court decision earlier this year, they won their point.
When stipulations have been attached to gifts that attempt to void or partially reverse a taxable gift in the event of an IRS audit, those stipulations have been held to be without effect for gift tax purposes. The Tax Court found that the improper “savings clauses” were not the same as the “formula clause” used by the Wandrys. A formula clause is permissible. The key difference is that no property is taken back with a formula clause. Although the value of each membership unit was unknown on the date of the gift, the value of a membership unit on any given date is a constant, and it is not changed by the revaluation of the firm as a whole upon audit.

The importance of the decision

This is the first time that the Tax Court has approved what estate planners call a “defined value” gift formula. With assets that are hard to value, such as an interest in a family business,
it can be tricky to make a gift of so exact an amount. A defined-value clause may resolve this problem in appropriate circumstances.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

In a desire to be fair to everyone, some parents assume that the solution is an equal division of what they own among their offspring. Too many times chaos ensues. Here are the stories of two families with whom we are familiar. They are based upon real situations, but the names are fictitious and some facts slightly altered.
Story one: Home front as war front
Alden left the family home equally to six children. Cassie has lived there her whole life, caring for her widower father and disabled brother. She wants to stay there. Two siblings flew in from across the country for the funeral, almost literally expecting to go home afterward with checks in their pockets from the sale of the house. The other two just want peace in the family.
Did we mention that Cassie is the executor of her father’s estate?
The battle lines were drawn even before Alden passed on. Cassie doesn’t have the funds to buy the others out. The others are half convinced that Cassie’s actions over the years prove her incapable of “thinking straight” about the house or handling the division of family assets properly. Everyone is contacting lawyers.
Is it too late? Cassie herself actually does understand that she cannot manage the settlement of her father’s estate alone. Her thinking is clearer than her brothers and sisters believe. She has enlisted a corporate fiduciary (in the role of “agent as executor”) to handle the administrative and investment responsibilities involved in settling her father’s estate.
Otherwise, it is too late to satisfy everyone in Alden’s family. This story, then, can serve only as an object lesson.

Story two: Don’t invite them all to dinner
Beatrice made offhand remarks such as these all the time: “You may want the pearls when I’m gone.” “The china should stay in the family, it goes back generations.” “Dad’s matchbook collection reminds me of our best times together.” The comments raised expectations about inheritances, and paved the way to conflicts.
Beatrice’s will divided her estate “equally” among her four children. The failure to identify who was to get what from a substantial estate that included valuable antiques, works of art, and jewelry (not to mention items of sentimental value) was disastrous, leading to arguments so fierce that one sibling remarked to another, “At least after this is over, we won’t have to see each other again.”

A more formal approach. There are no simple solutions when it comes to the division of personal property among heirs. Beatrice could have used the annual Christmas gathering to give everyone the opportunity to discuss inheritance preferences. She could then have been the arbiter, with specific will instructions (Suzy gets the pearls; Arthur takes custody of the matchbooks; etc.). Alternatively, they could have come up with a process to resolve conflicts amicably. It also would have been a good time for Beatrice to make “annual exclusion” gifts (up to $14,000 per child in 2014), removing the gift amounts from her estate and from
potential taxation.
A glimmer of hope. Beatrice’s sister, unhappy with how things have turned out, has “brokered a deal” with her nieces and nephews. Everyone has agreed to formal appraisals of the most valuable items and informal prices for other pieces.
Prior to a get-together, everyone will receive a complete inventory of Beatrice’s possessions (including those with sentimental value). They may hold an “auction,” with each of them having “bidding money” that is equal to one-fourth of the value of the appraised items. The winner of each item has its value subtracted from his or her inheritance. (Online auctions are possible when beneficiaries are far-flung.)
Another option that some families consider is to pull numbers from a hat. Number one chooses what he or she wants and then on down the line. After the first round, the order is reversed.
Foolproof? No. But if everyone perceives that the process is fair, who knows? The process of estate settlement could put the heirs on the way to mending some fences, rather than exacerbating divisions.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

“I sincerely ask that all beneficiaries are sensible and do not argue.”
This wish, expressed by Australian coal-mining billionaire Ken Talbot in his will, has gone unfulfilled. Talbot’s will was drafted in 2002, when his fortune was estimated at $130 million. At his death in an airplane accident in the Congo in 2010, his wealth was believed to be just over a billion dollars.

Talbot apparently was concerned about the effect that his wealth could have on his four children. Accordingly, they can access 10% of their inheritances at age 30, the balance at age 36. But before they do so, they must “obtain written confirmation from three independent doctors that they are not alcoholics or drug users.”
The Talbot Family Foundation was slated to receive 30% of Talbot’s estate. The balance of the estate was to be divided 48% to the children of Talbot’s first marriage, 52% to his surviving spouse and the two children that he had with her.

This might seem like a sensible and fair division. However, when the math is worked out, the two children from the first marriage will have a 24% share, the surviving spouse an 18% portion, and the two youngest children will receive 17%. That would come to an estimated $119 million for each of them, falling well short of the $168 million that the older children will inherit. Perhaps Talbot assumed or directed that the younger children eventually will inherit their mother’s share. We can’t know for certain, because a two-page memorandum that Talbot provided to the family explaining the philosophy behind his estate plan has not been made public.
Despite Talbot’s pleas, a will contest has erupted. The surviving spouse’s father, grandfather to the younger two children, has challenged the apparently unequal treatment of all the children. His affidavit states: “I seek an order from this court that adequate provision be made for Alex and Claudia out of the estate of the deceased.”
Avoiding family squabbles is perhaps the thorniest aspect of estate planning. To reduce the chances of misunderstanding, some planners recommend sharing the outlines of the estate plan with heirs well in advance, to avoid surprises and hurt feelings.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

The idea of “planning” a gift to charity may not spring as readily to mind as investment or retirement planning. Yet there are many ways to give, and many kinds of gifts to consider, especially when your philanthropic impulse is strong.

Initial steps
Of course, the very first step in your planning is to identify the object of your philanthropy. Then consider what you intend your gift to accomplish: how you would like your gift to make a difference both in general and specific terms. At this point you probably will make contact with the director of development at your chosen charitable organization to discuss your gift
With the procedural steps out of the way, creativity begins. How can you shape your gift? For instance, your gift need not be cash. You may own certain assets that you may want to donate, and your charity will be more than glad to receive. And, of course, however you make use of your resources, you’ll want to fashion the gift in such a way that you can take maximum advantage of all available tax deductions.

Gifts of property
Generally, you are entitled to a federal income tax deduction for your gifts to charity. There’s a tax bonus when you make a gift of a long-term capital asset that has appreciated in value during the time that you owned it.
Here’s how it works: You plan a substantial gift and are considering selling some securities that you have owned for years and which have grown significantly as the means to fund the gift. You’ll pay a long-term capital gain on the sale and then can pay what’s left over to your charity. If you make a gift of the securities themselves, you will pay no capital gain. The charity can sell the securities without incurring any tax. You also will be entitled to an income tax deduction for the fair market value of the gift of securities.
A more creative approach is to make a gift of personal property, such as a work of art or valuable collectibles. You can deduct the current market value of a gift of appreciated personal property, but there are two caveats: One, if the contributed property is related to the exempt purpose of the organization—rare books to a library, for instance—the full deduction is available. However, if the property is unrelated to the charity’s purpose—the books to a hospital to sell and use the proceeds—your deduction is limited to the property’s cost basis. Two, although you may make deductible cash donations equal to up to 50% of your adjusted gross income (AGI), the limitation on gifts of appreciated property is only 30% of AGI.

Gifts of real estate
For some people a gift of a parcel of land for many years and that has appreciated significantly in value may be an especially attractive possibility.
As with other appreciated property, you will have the opportunity to take an income tax deduction for your charitable contribution equal to 100% of the property’s fair market value, which, if you have held the property for some time, may be substantial. In addition, you pay no capital gain on the past appreciation. An added bonus: You are reducing your taxable estate by the value of your gift.
If you would rather take a “wait-and-see” approach, you can fashion the real estate gift as a bequest in your will. Although you receive no current income tax deduction, your estate receives a full deduction for the real estate’s fair market value at your death.

Gifts of insurance
Do you have an existing insurance policy that you no longer need? That often happens when there’s insurance on the life of a business owner and the business is sold; or income replacement insurance is in force after retirement.
Why not consider making a gift of that policy instead of the cash donation that you were planning? As long as all of the rights of ownership are completely transferred to the charity, you receive a current income tax deduction equal to the lesser of your cost basis or the fair market value of the policy (roughly equal to the cash surrender value).
There are other ways to tailor a charitable gift of life insurance. For instance, if you have named your spouse as beneficiary, you might name a charity as successor beneficiary in the event that your spouse predeceases you. Although there are no immediate tax benefits, if your spouse does predecease you, and no successor beneficiary is named, the policy’s proceeds would be included in your estate. Or if your named beneficiary no longer needs the insurance protection—adult children—for example, you may change the beneficiary designation and name your charity. Your estate then would receive a charitable deduction for the proceeds paid to the charity.
An extremely cost-efficient approach is to allow your charity to purchase a policy on your life. Every year you give the charity a tax-deductible amount equal to the annual premium payment. At your death the proceeds are paid to the charity. With this approach you can make a relatively large gift at a very reasonable cost.

Gifts in trust
Fashioning your gift in trust adds a great deal of flexibility to your gift giving.
There are many ways to establish your trust. For example, you may set up your trust during your lifetime or through provisions in your will. You can arrange for the trust to provide you with income from the trust for your life, or income for someone whom you name in the trust document. You can provide for the gift of income to yourself or the named beneficiary or beneficiaries for a period of time, followed by a transfer to the charity (a charitable remainder annuity, or unitrust); or the reverse—a gift of income to the charity followed by a transfer of assets to the named beneficiary (a charitable lead trust).
You may fund your trust with cash, or be more creative by using the aforementioned appreciated securities, real estate, or life insurance policy. When your donation is placed in the trust, you receive an income tax deduction for the charitable part of the gift. Usually, somewhere between one-fifth to one-half of the value of the property will be deductible, depending on several factors—the age(s) of the trust’s income beneficiary or beneficiaries and the size of the income payments that the creator of the trust chooses.
An “income-only” charitable remainder unitrust should be considered if retirement is still several years away, and you already are taking maximum advantage of your tax-deferred retirement plans. In a nutshell, this kind of trust permits your trustee to invest the trust’s assets for long-term growth until you retire and need income from the trust.
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You’ll need to cross all the “t’s” and dot all the “i’s” in order to reap all the possible tax benefits from a charitable gift in trust. Be sure to confer with your attorney, trust consultant and the charity itself when considering any of these creative ways of giving.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.