Topics included in this issue:
By Mark B. Periard
In the spring issue of Estate Planning Focus, the main features of the 529 College Savings Plans ("529 Plan") were highlighted, along with a checklist of considerations to take into account when selecting a particular 529 Plan.
Since that publication, articles in the popular press have warned of the high management fees charged to some 529 Plans by some money managers as well as the limited investment options available under many plans. As is true with many things, "buyer beware" is the mantra here.
Before choosing a 529 Plan, review carefully the investment management fees that are charged by the investment manager. In many cases, these fees are higher than what you would pay had you invested in a comparable fund available in the market. In fact, some investment management fees are so substantial that the fees can wipe out the tax-deferred benefit of the investment. Michigan's plan, managed by TIAA-CREF, assesses an annual expense of 0.65%, one of the lowest fees on the market.
It is also important to understand what investment options are available to you in the plan, and how often you can change your investment option.
Finally, creating a 529 Plan may affect the availability of financial aid for the recipient of the plan. Under current law, 529 Plan assets are not included in the federal financial aid formula or by some collegiate financial aid offices. However, there are no guarantees that the financial aid rules will not be changed to account for amounts in 529 Plans.
Despite these issues, however, 529 Plans can still be a great, low-cost vehicle to build up savings for college education expenses. But, as with any investment, you must carefully evaluate all factors, and not all 529 Plans are creatrd equal.
By Susan Gell Meyers
If you are a Florida resident and you own intangible property on January 1, 2003, you will be subject to Florida's intangibles tax. A Florida resident with a properly structured "Intangibles Trust," however, can avoid paying the intangibles tax.
The intangibles tax applies to intangible property owned by a Florida resident on January 1 of each year. Examples of intangibles property subject to the tax include corporate stock, corporate bonds, promissory notes and money market funds. Several types of intangible property that are exempt from the tax include cash, money market accounts, interests in limited partnerships, U.S. or Florida municipal bonds and property in retirement plans and IRAs.
Over the last couple of years, the tax rate has been reduced, and the Florida legislature appeared on track to eliminate the tax entirely. Pressure on the state budget, however, led the legislature (in December 2001) to delay implementation of otherwise scheduled increases to the exemptions from the intangibles tax until July 1, 2003. For both 2002 and 2003, the lower exemptions ($20,000 per person, $40,000 per married couple) remain in effect.
Florida will only continue to experience increasing revenue pressure because of decreased revenue from estate tax. This increasing revenue pressure has dashed any immediate hope for the complete elimination of the intangibles tax.
In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (the "Act") which gradually reduces the top estate tax rate and increases the estate tax exemption until the estate tax will be entirely repealed in 2010. In 2011, however, the estate tax will be reinstated under the Act.
There has been much discussion about whether estate tax repeal will actually occur. President Bush has supported the permanent elimination of the estate tax. On June 6, 2002, the House of Representatives passed the Permanent Death Tax Repeal Bill (the "Bill") (HR 2143) to permanently eliminate the estate tax in 2010. The Bill passed by a vote of 256-171. The Bill failed in the Senate, however, by six votes on June 12, 2002.
Since the defeat of the Bill, a new bill ("HR 5008") has been introduced in the House of Representatives which would eliminate the estate tax for estates under $3,500,000. HR 5008 would also limit valuation discounts associated with the formation of family business entities. HR 5008 was referred to the House Committee on Ways and Means on June 24, 2002. No action has been taken on the bill.
By W. Michael Van Haren
The tax climate for those who have formed or are considering forming a family limited partnership or a family limited liability company (hereafter "FLP") has improved. When properly established and operated, the courts recognize the validity of discounts from liquidation value and these discounts can be substantial. While not all of the battles have been taxpayer victories, FLPs remain a vital tool for families with wealth.
A typical FLP is formed by husband and wife or parent and children to own investment assets. Marketable securities and investment real estate are good candidates for an FLP. The FLP is controlled by those individuals specified in the organizational documents (i.e., Dad and Mom), yet the senior generation may gift interests in the FLP to family members or simply contemplate passing FLP interests to or in trust for their family members as an inheritance. The FLP changes the character of the assets that are gifted or inherited. The recipients own an interest in the FLP instead of the FLP assets themselves, and the FLP assets remain under the control of the entity.
Normally, there are multiple advantages to the FLP. Investments remain consolidated and easier to economically manage with consistent investment goals. If the recipients need assistance with asset management due to age (the young or the very old), or other reasons, the FLP avoids shifting the burden of management of those assets to the recipient because the FLP interests require no active management. FLP interests may provide some creditor protection (for example, from a failed marriage) and may shelter the recipients from the influence of wealth.
The FLP interests are not marketable and the organizational documents and state law impose restrictions or limitations on FLP interests. The restrictions, limitations and lack of marketability give rise to valuation discounts.
FLPs began their popularity in the early 1990s. The IRS has a harsh view of discounts claimed in the FLP context, and has attacked FLPs on several fronts. Those battles progressed to the courts, and the courts have rendered several opinions. In general, when an FLP is properly organized and operated, the courts have sustained discounts as high as 40%.
The IRS has enjoyed substantial victories, however, when taxpayers fail to properly form the FLP, or, after formation, ignore the entity and manage the assets as if the FLP did not exist. Courts have been quick to ignore FLPs when the taxpayer fails to follow the formalities of their own FLP or "retains" an interest in FLP. The lesson is clear: do not create an FLP unless you are prepared to follow FLP formalities.
Another area of concern with FLPs relates to the use of FLP interests for annual gifts that qualify for the annual gift tax exclusion. The annual exclusion shelters from gift or estate taxation gifts of up to $11,000 per year per donee. One court has held that gifts of interests in an FLP will not qualify for the annual exclusion. This case has been criticized by legal commentators and the result of this case can be avoided with proper planning.
Finally, for FLPs that do business in Michigan, recent changes to the Michigan Single Business Tax ("SBT") expose intangible FLP income and potentially even capital gains or gross proceeds from the sale of investments in an FLP to the SBT. The SBT gross receipts over $250,000 in 2002 and $350,000 thereafter. Changes in 2001 to the definition of gross receipts call into question the taxation of intangible assets. Again, planning may mitigate this tax.
Careful formation, planning and operation of the FLPs are keys to success. Our experience has been favorable when dealing with the IRS, consistent with the court cases.
By Susan Gell Meyers
The IRS-prescribed interest rates commonly known as the "applicable federal rate," or "AFR," have fallen for November yet again. The lowest AFR for a 3-year (or less) loan can be as low as 1.8%. A 9-year loan can charge interest as low as 3.02%. With these new low rates, now is an ideal time to make loans or installment sales of assets to family members, or refinance existing loans.
The IRS rate for GRATs, a frequently used tool for gifting stock in a family-owned business, is at an all-time low of 3.6%, making their use highly attractive. Call your Warner Norcross & Judd attorney to find out more about these and other planning opportunities.
By Susan Gell Meyers
If a couple divorces and there is no pre- or postnuptial agreement, all assets owned by the couple will be divided as the couple agrees, or if they cannot agree, as the judge determines. Most courts in Michigan consider all assets acquired during marriage, whether owned individually or jointly, as "marital" assets. Marital assets are typically divided equally between the couple, regardless of how the asset is actually titled, subject to adjustments.
The process typically works like this. The value of all assets owned by a husband and wife will be combined into one "pot" and then divided equally between the spouses. Adjustments to this division may then be made depending on the circumstances. Assets may be pulled out of the "pot" if they should be considered either party's "separate" property. Examples of separate property include assets acquired by gift or inheritance, or acquired by either spouse prior to the marriage. In any event, typically assets may be excluded from division only if it will not create undue hardship on the other spouse or create an unfair division of property. Unfortunately, there is no black-line test or definition for the terms "undue hardship" and "unfair," and it is a subjective analysis by the parties and the court. Courts will consider the style of living to which the couple may have become accustomed to living as part of this analysis.
If an individual dies while married and without a pre- or postnuptial agreement, the surviving spouse has certain rights in the estate that can be enforced regardless of what the deceased spouse's will provides. These rights are:
- To take 1/2 of what would have passed to him or her by law if the spouse had died without a will, reduced by 1/2 of all property passing to the surviving spouse outside of the will (e.g., joint property and property passing by beneficiary designation to the spouse). If there are living children, this would be $82,500, plus 1/4 of the balance of the deceased spouse's estate (reduced by 1/2 of all property passing outside of the will).
- To receive a homestead allowance of $17,000, a "reasonable" family allowance of an undefined amount, and household goods, automobiles and personal effects up to $11,000.
Given the uncertainty and subjectivity that exists in a division of property at death or in a divorce, many people will consider entering a pre- or postnuptial agreement. The following are a few reasons to do so:
- To keep "heirloom" assets in the family. Typical heirloom assets are ownership interests in a family business (stock if the business is a corporation). Without a prenuptial agreement, this asset may be subject to division, with up to 1/2 of the asset or its value passing to a spouse.
- To protect a family business, financially. If stock of a family-owned business is transferred to a spouse in a divorce, and the stock is subject to a buy-sell agreement with the company, often that buy-sell agreement will require the stock to be purchased back from the ex-spouse. This can present a financial hardship on the company at a time when it cannot afford to purchase the stock.
- To protect the confidentiality of family business information. If stock in the business is subject to division in a divorce, it will need to be valued. This gives the spouse and his or her attorney the opportunity to review financial records of the company, which may reveal information the family would rather keep confidential, such as salaries of family members.
- To avoid an artificial inflation of your net worth. If you have ownership interests in a company, or are a beneficiary of a trust that has discretion to make distributions to you, the value of these assets may be included in your net worth in a divorce. These assets may inflate your net worth on paper, but artificially so if you have no way of actually realizing the value of the asset. That is, you can only realize that value of stock if you sell it, or if the company pays dividends or makes other distributions to you by virtue of your ownership. Likewise, you can only realize the value of a trust if distributions are actually made to you. In a divorce, you may be able to keep your stock or trust, but you may have to transfer other assets of equal value to your spouse to do so. This may require you to transfer many of your "liquid" assets to your spouse, putting yourself in a financially difficult situation, or force you to liquidate some of your ownership interests in the company.
To protect future gifts or inheritances. Gifts and inheritances can often be excluded from the "marital" estate that is subject to division, but not always. A pre- or postnuptial agreement can make clear that past and future gifts or inheritances, particularly interests in businesses or trusts, are to be excluded from division in a divorce.
Estate Planning Focus
Editor: Susan Gell Meyers
Trusts & Estates Group Chairman: Mark K. Harder
Estate Planning Focus is published by Warner Norcross & Judd LLP to inform clients and friends of new developments. It is not intended as legal advice. If you need additional information on the topics in this issue, please contact your Warner Norcross attorney or any member of the Firm's Trusts and Estates Group.