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A Better Partnership

Publications

Dec 2007
01
December 01, 2007

Estate Planning Focus - Fall 2007

Topics included in this issue:

 

WOULD YOUR FAMILY BUSINESS BENEFIT FROM A FAMILY CONSTITUTION?

by Mark K. Harder

Many family-owned businesses have begun to adopt "Family Constitutions" as part of their succession planning. So what is a Family Constitution and would it benefit your family and business?

What Is a Family Constitution?

Family Constitutions come in a variety of forms and can mean different things to different people. However, in most cases the Family Constitution is a nonbinding document that ties together the family's estate and succession planning. It does not seek to answer every question that a family may confront with respect to the business. Instead, like the U.S. Constitution does for the United States government, the Family Constitution prescribes the core principles and values of the family and their business, which in turn guide the specific planning in which the family and the business engage.

When used in this fashion, the Family Constitution will contain statements summarizing the family's core values regarding the business and what it represents to the family as well as describe the relationship of the family to the business, the family's philosophy about ownership and its transfer, and the family's views on participation in the management of the family-controlled enterprise. It also may describe how the family will balance the sometimes conflicting desires to share and enjoy the economic success of the business while also investing in the business to secure its future.

Some Family Constitutions also include guiding principles for the governance of the family business. In these situations some or all of the Family Constitution may be binding upon the family. For example, the Constitution might prescribe how often family meetings will be held, the ages at which the younger generations may begin to attend, and whether in-laws are welcome. For larger families that use a family council, the Family Constitution may contain the rules for election to the council, prescribe the frequency of the meetings of the council, and set forth the scope and nature of the council's authority. Some Family Constitutions may also include guidelines for use by members of the family in appointing trustees of family trusts that may own the interests in the family business. Finally, the Constitution might include provisions for privately resolving intra-family disputes through mediation or arbitration.

Who Could Benefit?

Any family business that involves ownership among multiple generations might benefit from having a Family Constitution. They can be particularly useful for families facing significant transition milestones, such as the transition from the founder to siblings, especially when not all of the siblings are active in the business.

The Family Constitution is particularly beneficial in so-called cousin consortiums and in larger, more extended families. The connections among members of these families often are not as strong because members may be geographically separated, be widely separated by age, have diverse career interests, come from different economic circumstances, and have more tenuous connections to the business. In these cases, the Family Constitution can be a vehicle to promote family harmony by connecting members to one another and to the business, setting expectations, and providing a framework for the relationships.

 

TAX LAW CHANGES

by Trusts and Estates Practice Group

Many tax law changes already are on the books this year, and more may be on the way that will affect your 2007 tax returns.

Issues to discuss with your tax adviser include the Tax Increase Prevention and Reconciliation Act; Pension Protection Act of 2006; Tax Relief and Health Care Act of 2006; Small Business & Work Opportunity Act of 2007; and the Heroes Earned Retirement Opportunities Act of 2007. For business owners, the recent Michigan Business Tax also should be a topic of discussion with your adviser.

Still on the horizon is a Supreme Court decision (expected in December) regarding whether investment fees paid by a trust are subject to 2 percent limitation. Also new is Warner Norcross & Judd's ability to begin e-filing for the 2007 tax year.

Below are some figures that you might find useful come tax time.

Estate and Gift Taxes

 

2007 

 

2008  

Annual Gift Tax exclusion
Applicable exclusion amount for gifts
Applicable exclusion amount for estate tax
Available GST exemption
Top estate tax and GST tax rate

  

$12,000
$1,000,000
$2,000,000
$2,000,000
45.00%

  

$12,000
$1,000,000 
$2,000,000 
$2,000,000 
45.00%

Estate Income Tax
2007 Taxable Income


Rate

   

 
2008 Taxable income


Rate 

0-$2,150

15% of taxable income

 

0-$2,200

15% of taxable income

$2,150-$5,000
 

$322.50 + 25% over $2,150

 

$2,200-$5,150
 

$330 + 25% over $2,200
 

$5,000-$7,650
 

$1,035 + 28% over $5,000

 

$5,150-$7,850

$1,067.50 + 28% over $5,150

$7,650-$10,450

$1,777 + 33% over $7,650

 

$7,850-$10,700

$1,823.50 + 33% over $7,850

$10,450-

$2,701 + 35% over $10,450

 

$10,700-

$2,764 + 35% over $10,700

Individual Income Tax 

2007

 

2008

Personal exemption

$3,400.00

 

$3,500.00

Standard deduction

     

Joint return or surviving spouse

$10,700.00

 

$10,900.00

Single

$5,350.00

 

$5,450.00

Head of Household

$7,850.00

 

$8,000.00

Married filing separately

$5,350.00

 

$5,450.00

Additional for married 65 or over or blind

$1,050.00

 

$1,050.00

Additional for single/head of household over 65 or blind

$1,300.00

 

$1,350.00

Kiddie tax applies to children up to

18 years old

 

23 years old
if full-time
student

Married Individuals Filing Jointly and Surviving Spouses  

2007 Taxable Income

Rate 

 

2008 Taxable Income 

Rate 

0-$15,650 

10% of taxable income 

 

0-$16,050 

10% of taxable income 

$15,650-$63,700 

$1,565 + 15% over $15,650 

 

$16,050-$65,100 

$1,605 + 15% over $16,050 

$63,700-$128,500 

$8,772.50 + 25% over $63,700 

 

$65,100-$131,450 

$8,962.50 + 25% over $65,100 

$128,500-$195,850 

$24,972.50 + 28% over $128,500 

 

$131,450-$200,300 

$25,550 + 28% over $131,450 

$195,850-$349,700

$43,830.50 + 33% over $195,850

 

$200,300-$357,700

$44,828 + 33% over $200,300

$349,700

$94,601 + 35% over $349,700

 

$357,700-

$96,770 + 35% over $357,700

Single Individuals 

2007 Taxable Income 

Rate 

2008 Taxable income 

Rate

0-$7,825 

10% of taxable income 

0-$8,025 

10% of taxable income 

$7,825-$31,850 

$782.50 + 15% over $7,825 

$8,025-$32,550 

$802.50 + 15% over $8,025 

$31,850-$77,100 

$4,386.25 + 25% over $31,850 

$32,550-$78,850 

$4,481.25 + 25% over $32,550 

$77,100-$160,850 

$15,698.75 + 28% over $77,100 

$78,850-$164,550 

$16,056.25 + 28% over $78,850 

$160,850-$349,700

$39,148.75 + 33% over $160,850

$164,550-$357,700-

$40,052.25 + 33% over $164,550

$349,700-

$101,469.25 + 35% over $349,700

 $357,700-

$103,791.75 + 35% over $357,700

Heads of Households

2007 Taxable Income 

Rate 

2008 Taxable Income 

Rate 

0-$11,200 

10% of taxable income 

0-$11,450 

10% of taxable income 

$11,200-$42,650 

$1,120 + 15% over $11,200 

$11,450-$43,650 

$1,145 + 15% over $11,450 

$42,650-$110,100 

$5,837.50 + 25% over $42,650 

$43,650-$112,650 

$5,975 + 25% over $43,650 

$110,100-$178,350

$22,700 + 28% over $110,100 

$112,650-$182,400 

$23,225 + 28% over $112.650 

$178,350-$349,700

$41,810 + 33% over $178,350

$182,400-$357,700-

$42,755 + 33% over $182,400

$349,700-

$98,355.50 + 35% over $349,700

$349,700-

$100,604 + 35% over $357,700

Married Filing Separately 

2007 Taxable Income 

Rate 

2008 Taxable income

Rate 

0-$7,825 

10% of taxable income 

0-$8,025 

10% of taxable income 

$7,825-$31,850 

$782.50 + 15% over $7,825 

$8,025-$32,550 

$802.50 + 15% over $8,025 

$31,850-$64,250 

$4,386.25 + 25% over $31,850 

$32,550-$65,725 

$4,481.25 + 25% over $32,550 

$64,250-$97,925 

$12,486.25 + 28% over $64,250 

$65,725-$100,150 

$12,775 + 28% over $65,725 

$97,925-$174,850

$21,915.25 + 33% over $97,925

$100,150-$178,850

$22,414 + 33% over $100,150

$174,850-

$47,300.50 + 35% over $174,850

$178,850-

$48,385 + 35% over $178,850


NEW MICHIGAN BUSINESS TAX – PITFALLS & PERIL

by Jeffrey Power

Sociologist Robert Merton 70 years ago popularized what has come to be known as the law of unforeseen consequences resulting from the world's inherent complexity, perverse incentives, human stupidity, self-deception or other cognitive or emotional biases. All seem to have been factors in the July enactment of the Michigan Business Tax (MBT), a consequence of which is to make Michigan residency increasingly unattractive.

At its core, the MBT consists of a tax on "business income" and a tax on "gross receipts." A taxpayer may have to pay both taxes. Both residents and nonresidents are subject to the tax beginning Jan. 1, 2008. Persons subject to tax include partnerships, limited liability companies (LLCs), and subchapter S corporations, even though these are all pass-through entities not ordinarily subject to any federal income tax, and individuals' trusts.

Therein lies a problem.

The business income tax is imposed at the rate of 4.95 percent on business income with respect to every taxpayer who has business activity in Michigan. Business income for a Michigan partnership, LLC, S corporation or trust includes items of income and expense that are separately reported to the partners, members, shareholders or beneficiaries. In other words, the business income is taxed at the entity level rather than being passed out to the partners, members, shareholders or beneficiaries. Business activity is sufficiently broadly defined to include buying and selling marketable securities in an investment portfolio. The consequence, by way of example, is that net realized capital gains are subject to the business income tax at the entity level.

A partner, member, shareholder or beneficiary also will be potentially subject to Michigan business income tax. The good news is that the taxpayer will be able to subtract from his, her or its business income tax base the federal taxable income that is attributable to the partnership, LLC , S corporation or trust, thus avoiding double business income taxation. The bad news is that a partner, member, shareholder or beneficiary subject to Michigan individual income tax will have to pay a second tax on the pass-through income at the new 4.35 percent (up from 3.9 percent) income tax rate.

The gross receipts tax is imposed at a 0.8 percent rate on the gross receipts tax base allocated to Michigan. Any taxpayer, including an individual, estate or trust, with a sufficient nexus to Michigan is subject to tax. The act states that the tax is levied upon the privilege of doing business and not upon income or property. It won't feel that way when you pay it.

In fact, the scope of the gross receipts tax appears sufficiently broad to tax dividends, interest, and net realized capital gains. This is because the basic definition of gross receipts includes the entire amount that the taxpayer receives from any activity carried on for gain. The act excepts the gross proceeds from the sale of a capital asset, less any gain included in federal taxable income. In this roundabout way net realized capital gains become gross receipts subject to tax.

So where does this leave you if you are a Michigan resident holding an interest in a pass-through entity. Before 2008 your income from that interest was taxed for Michigan purposes at 3.9 percent. Beginning with 2008 your tax on net realized capital gain within the partnership, LLC, S corporation or trust will soar to 10.1 percent. If you are a nonresident holding an interest in a partnership, LLC or S corporation that is fully subject to Michigan business taxation, your rate will rise from zero to 5.75 percent.

So what's the problem? Aren't we just wringing more money out of the relatively few filthy rich taxpayers who actually pay 90 percent of all state individual income taxes? Well, no. Many of those individual taxpayers are or will soon be mobile capitalists. Many investment entities and trusts are freely portable to other states. The MBT regime creates another large incentive to change residency to states that impose little or no tax burden on passive investment income and capital transactions, principally Florida. The consequence is that Michigan loses both a stream of income tax payments for the rest of their lifetimes and much or all of the beneficial effects of their local spending. The only large taxpayers who will move to or stay in Michigan will be those who have no choice. The MBT makes more likely the evolution in Michigan of a new Appalachia rather than Gov. Jennifer Granholm's Cool Cities.


STATE LAW ALLOWS REIMBURSEMENT FOR MEDICAID
COSTS OF NURSING HOME PATIENTS

by David Waterstradt

Recent action in the Michigan Legislature makes it unanimous:  The state can make claims against the estates of persons who receive Medicaid for nursing home care.

On Sept. 30, Michigan became the 50th state to establish an estate recovery law, which will allow the state to seek reimbursement for the cost of nursing home care from the estates of individuals who received Medicaid assistance prior to their deaths. The law has been a federal requirement since 1993.

While nursing home costs are expensive, the estate recovery law does mean Michigan can dip into qualifying estates and take everything. There are some estate planning procedures that can be implemented to protect the assets.

Because of the nature of the Medicaid application process, the principal assets likely to be subject to estate recovery are an individual's home and automobile. The law applies only to the probate estate. Assets in revocable trusts are expressly exempt from the reach of estate recovery. Assets that pass by joint ownership, beneficiary designation, transfer upon death designation and by expiration of a life estate will also not be reached by the new law.

Even if assets are in the probate estate, there are several exemptions that may make the law inapplicable. First, family farms and other income-producing property are exempt if they are the principal source of income of survivors. Second, if the homestead is subject to estate recovery, only that portion of the value of the homestead which is above 50 percent of the average price of a home in the county where the home is located is subject to recovery. Third, the homestead is completely exempt from recovery if the surviving spouse, dependent or disabled child or sibling joint owner continues to live in the home. The same is true if a relative lives in the home who provided care for the Medicaid recipient for at least two years that allowed the Medicaid recipient to avoid admission to a nursing home.

Several features of the new law heighten the importance of estate planning for those who are receiving or may need Medicaid long-term care benefits. Such individuals should have their estate plans updated to make sure assets are held in such a way as to avoid estate recovery.


DEFECTIVE TRUSTS ARE EFFECTIVE ESTATE-PLANNING TECHNIQUE

by Jennifer Remondino

A sale to an intentionally defective trust is a great estate planning technique for wealthy clients with income-producing property that is likely to appreciate in value. This sophisticated planning technique can save these clients thousands and even millions of dollars in federal transfer taxes.

Generally, the federal government taxes the transfer of wealth from one individual to another, usually from generation to generation. An individual can transfer a specified amount of wealth free from transfer taxes during his or her lifetime or at death. If an individual makes more than $1 million in lifetime gifts, any gifts made above this unified credit amount will be subject to gift tax. Assets that remain at death also may be subject to estate tax. In 2007, an individual can transfer up to $2 million at death without incurring estate tax.

The gift and estate tax consequences can be significant for those wealthy individuals who cannot avoid taxation because the value of their estates exceeds the unified credit amounts. In 2007, the tax is set at a flat rate of 45 percent. With the consequences of the transfer tax system, it is not surprising that many individuals are looking for ways to reduce their taxable estates. The IDIT is a planning technique to do just that.

The IDIT is an intentionally defective irrevocable trust. Before the sale can take place, it is recommended that the grantor fund the IDIT with a "seed" gift. Ideally, the initial gift would equal roughly 10 percent of assets that the grantor intends to transfer to the IDIT. Typically the grantor creates the IDIT for the benefit of his or her children and/or grandchildren. The grantor sells income-producing property at the fair market value to the IDIT in exchange for an installment note with interest at the applicable federal rate. The income produced from the property is used to pay off the note over time.

Upon the transfer, the value of the property is removed from the grantor's estate as well as any future appreciation associated with the property. If the grantor dies while the note is outstanding, only the unpaid principal of the installment note is included in his or her estate. Accordingly, if the note is paid in full, nothing is included in the grantor's estate for estate tax purposes. (In addition, because the transaction is a sale, no gift tax will be incurred from the transfer of the property into IDIT.) Accordingly, it is to the grantor's benefit to pay the note off sooner rather than later. No gain or loss would be recognized due to the sale because the grantor is treated as the owner of the IDIT.

It is recommended that the IDIT is structured so that the grantor is treated as the owner of the trust for income tax purposes. By the grantor's paying the income taxes associated with the property, the grantor is further reducing his or her taxable estate, thereby avoiding gift and estate taxes. The grantor is taxed on income that he or she does not receive, so the grantor is reducing his or her estate by the amount of the tax. Accordingly, the payment of tax by the grantor on the trust income amounts to a tax-free gift to the beneficiaries. Tax payment reduces the grantor's estate and is an indirect gift to the beneficiaries. In addition, due to the grantor trust statutes, no income tax will be due because of the interest payments from the notes.

If you think you might be a good candidate for the IDIT, your attorney at Warner Norcross & Judd LLP can recommend the appropriate structure for your individual circumstances.

 

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