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Publications | October 20, 2006
17 minute read

Estate Planning Focus – Fall 2006

Topics included in this issue:

  • Charitable Giving Incentives
  • The ESOP Adviser - ESOPs and Estate Planning for the Business Owner
  • Who Has Authority to Make Your Funeral Arrangements?
  • WN&J Probate Litigator Obtains $2.3 Million Jury Verdict for Coin Collection Misappropriated From Trust
  • Estate Planning Impact of the Pension Protection Act of 2006
  • New Flexibility for Inherited Retirement Plans

Charitable Giving Incentives

By Karen Kayes

In late July, the House of Representatives passed two tax bills: the "trifecta" tax bill, which included permanent estate tax relief, numerous extensions for tax provisions that have or will expire at the end of the year, and a minimum wage increase, and the "Pension Protection Act of 2006." A few days later the Senate unanimously approved the Pension Protection Act ("PPA"), and it has now been signed into law. Unfortunately, there were insufficient votes to proceed to the trifecta tax bill.

The PPA is a massive tax bill that makes numerous changes relating to pension plans and their beneficiaries. It also creates a "qualified charitable distribution" from an IRA.

Under pre-PPA law, a donor who wished to use his or her IRA moneys to fund a charitable gift would have to make a withdrawal from the IRA, pay the applicable taxes, and then obtain a charitable deduction for the gift amount. For many donors, this result was not as favorable as hoped because: (1) the IRA withdrawal put them into a higher income tax bracket which in turn (a) caused a greater portion of their social security to be subject to income tax, (b) made them subject to decreased tax benefits that are dependent on adjusted gross income such as medical expenses, etc.; or (2) the donor's deductions were not sufficient to use itemized deductions and therefore, although they paid a higher income tax due to the IRA withdrawal, they did not get an offsetting charitable deduction.

PPA allows individuals to make charitable contributions directly to a charity from a traditional or Roth IRA if the following conditions are met:

  1. The donor is 70½ or older.
  2. The contributed amount does not exceed $100,000 in each taxable year.
  3. The contribution comes directly from a traditional IRA or Roth IRA to the charity.
  4. The charity is qualified.

If these requirements are met, the IRA withdrawal is not reported as income, nor is a charitable deduction received. Therefore, under the right circumstances, this new charitable-giving provision can be ideal for those who do not itemize their deductions, for those whose charitable deductions are phased out due to adjusted gross income limitations, or for those who have significant charitable contribution carryforward that will expire in the current year.

As an example: Mary, age 75, has an IRA balance of $120,000. She must take a minimum required distribution in 2006 of $5,240. She receives $12,000 per year in social security and interest and dividend income of $14,000. If she were to take her $5,240 minimum required distribution and donate it to charity, her income tax liability would be $1,044. If instead she made a qualified charitable distribution of her minimum required distribution, her tax liability would be reduced to $430!

The new provision is effective only for contributions made after December 31, 2005, and before January 1, 2008.

The ESOP Adviser
ESOPs and Estate Planning for the Business Owner

By Vern Saper

Employee Stock Ownership Plans ("ESOPs") have been around for more than 30 years. However, not all professional advisers are familiar with the advantages ESOPs offer the business owner of a closely held corporation.

Let's take a little quiz:

  1. Can an owner sell some or all of his/her stock at a fair market value, but continue to control the Company?
  2. Can an owner sell some or all of his/her stock at a fair market value without paying capital gains tax or state income tax on the profit?
  3. Can employees purchase their employer using fully tax deductible dollars?
  4. After the purchase by the employees, can all future federal income tax on corporate profits be eliminated?

If you answered "no" to any of these questions, you need to brush up on the advantages of ESOPs and how they can be used as an estate planning tool for the business owner.


An ESOP is a qualified retirement plan, similar in structure to a 401(k) or profit-sharing plan. Each participant has an account which accumulates benefits to be paid at retirement or other termination of employment. However, unlike its cousins, an ESOP is designed to invest primarily in stock of the sponsoring employer.

As with other qualified retirement plans, ESOPs must meet general rules concerning eligibility to participate, vesting and nondiscrimination. However, there are several special rules which apply only to ESOPs. One is that an ESOP may borrow funds to purchase stock of the employer. This "leveraging" capability leads to many creative uses of an ESOP which cannot be duplicated by other plans.

The general tax attributes of an ESOP are the same as for other qualified retirement plans. Contributions to the ESOP are fully tax deductible, employees accumulate benefits under the plan without paying current income tax, the plan assets are held in a tax-exempt trust so no tax is currently paid on the earnings and terminated participants may roll over their distributions from the ESOP to an IRA and continue the tax deferral.


Congress has provided many major tax incentives to encourage creation of ESOPs, including:

  1. Fully deductible loan repayments. Employer contributions to the ESOP are fully deductible and can be used to repay an ESOP loan. Therefore, deductions are available for payment of principal as well as interest.
  2. Avoidance of capital gains and state income tax on sale of stock. An individual who sells stock of a closely held corporation to an ESOP may defer or completely eliminate taxes on the realized gain if (i) immediately after the sale the ESOP owns at least 30% of the employer stock, and (ii) within 12 months the sale proceeds are reinvested in stock or bonds issued by other U.S. corporations. The individual's basis in the employer stock is carried over to the replacement securities. If the replacement property is sold, the tax will be paid at that time. However, if the individual holds the replacement securities until death, the heirs receive a step-up in basis, so the taxes will never be paid.
  3. Dividends paid on ESOP stock are deductible. Cash dividends paid to an ESOP are deductible if they are distributed to plan participants (or retained by the ESOP at the participant's election) or used to repay an ESOP loan. If the corporation does not normally pay dividends, but desires to pay deductible dividends on ESOP stock, it may consider a recapitalization, with a separate class of dividend-paying common stock being sold to the ESOP.
  4. Reduction or elimination of corporate income tax. An ESOP is an eligible shareholder for an S corporation. Since the ESOP is a tax-exempt entity, this creates a tremendous tax-planning opportunity. Corporate profits attributable to the stock owned by an ESOP will escape federal income tax. The larger the ESOP ownership the greater the tax savings. If the ESOP owns 100% of the S corporation stock, federal income tax is completely eliminated.


A critical concern in estate planning for an owner of a closely held corporation is business succession. What will happen to the company when the owner retires or dies? Are other family members active in the business, and can they afford to buy it? Are key employees willing and able to purchase the company? Is a sale to an outsider feasible and desirable?

In answering these questions, the use of an ESOP should be considered. An ESOP may be an ideal solution for the owner. Let's look at some situations where an ESOP might be a good choice:

Example 1: Owner is age 55 and owns 100% of a corporation which was established 25 years ago. Owner has a very low basis in the stock, and the company has grown to a current value of $5,000,000. Owner has no children active in the business, and key employees are unable to purchase the company. Owner's net worth consists primarily of the corporation's value. Owner would like to begin diversifying his/her estate, but is not ready for retirement and sale of the corporation.

  1. Owner could begin diversifying his/her estate by causing the company to establish an ESOP. The ESOP would borrow perhaps $1,500,000 to purchase 30% of the owner's stock. Owner could choose to reinvest the $1,500,000 in other securities, with an immediate capital gains and state income tax savings of approximately 20%, or $300,000.
  2. The ESOP loan would be repaid with tax-deductible contributions made by the corporation. The borrowing cost is substantially reduced because the corporation can deduct the principal payments as well as the interest, resulting in an approximate tax savings of $500,000.
  3. If the corporation had redeemed a portion of Owner's stock, the result would have been ordinary income to Owner. Instead, by choosing to roll over the capital gain, Owner pays no current tax, and if the replacement securities are held until death, no tax will ever be paid on the gain.

Example 2: Assume the same facts, but Owner is now age 60. The ESOP loan has been repaid. Owner is still not ready to retire and completely sell the corporation, but would like to continue the diversification of his/her estate.

  1. Additional stock purchases can be made by the ESOP with the same tax benefits described in Example 1.
  2. Future sales could be made with another ESOP loan, or Owner could sell a small amount of stock each year for cash. The cash contributed to the ESOP by the company is fully deductible.
  3. Even if the ESOP owns more than 50%, Owner will continue to control the corporation by virtue of controlling the board of directors.

Example 3: Assume the same facts, but Owner is now age 70. The ESOP owns 60%. Owner is ready to retire and sell the remaining 40%.

  1. Owner could arrange for a sale to a competitor or another outsider. This would provide retirement security, but Owner would be subject to capital gain and state income tax on the sale proceeds. There would be no employment security for the long-term employees and key management.
  2. Owner could cause the corporation to redeem the stock by using a commercial loan. However, the redemption would be expensive because Owner would pay tax on the sale proceeds, and the corporate loan would be repaid with "after-tax" dollars.
  3. Instead, the remaining stock can be purchased by the ESOP with the same tax benefits described in Example 1. Owner can choose to pay no capital gain and state income tax on the proceeds, and the loan can be repaid with "pretax" dollars, significantly reducing the cost of the sale.
  4. If instead of retirement Owner dies owning the stock, the ESOP can still be used to purchase the shares. Although the rollover of gain would not be necessary because of the stepped-up basis in the company's stock at death, using the ESOP would substantially reduce the cost of the transaction.

Example 4: Assume the same facts, but the ESOP now owns 100% of the corporation. The board of directors is looking to grow the business and become more competitive.

  1. The board can direct the ESOP, as the company shareholder, to cause the corporation to be taxed as an S corporation. Since the ESOP owns 100% of the stock, all federal income tax on business profit is eliminated.
  2. This reduction in cost of doing business allows the company to retain additional cash for growth, and to reduce prices, increase margins and become more competitive.


An ESOP may not be appropriate for every corporation. Many factors need to be explored before implementing an ESOP. However, when the desire for shareholders to sell some or all of their stock on a tax-free basis is combined with the company's opportunity to borrow funds on a fully tax-deductible basis, the ESOP presents tax-savings possibilities which are unequaled by any other alternative.

If there are others within or outside your organization who might benefit from this newsletter, please send their names, organizations and e-mail addresses to and we will add them to our mailing list.

Who Has Authority to Make Your Funeral Arrangements?

By David Waterstradt

A recent amendment to the Michigan Estates and Protected Individuals Code ("EPIC") may change how you go about making funeral, burial and cremation arrangements. Under prior law, it was not clear whether the decedent or the next of kin had the final authority in making these arrangements. The Occupational Code for Mortuary Science provided that the next of kin had final authority. EPIC provided that the personal representative of the estate was to follow the wishes of the decedent. Public Act 299 of 2006 amended EPIC to clarify that it is the decedent's family that has final authority on these decisions. The amendment further sets forth a priority scheme for identifying persons with the authority to make funeral arrangements. The surviving spouse, if there is one, has first priority. If there is no surviving spouse, the descendants of the decedent, age 18 and older and in the closest degree of consanguinity, have the next highest order of priority. If the decedent had no descendants, the heirs of the decedent, as determined under state law, have the next highest order of priority. If there is more than one person with decision-making authority under this scheme, the rights and powers shall be exercised as decided by a majority of the individuals. If a majority cannot agree, any one of the individuals may file a petition with the circuit court. If no heirs exist or exercise the rights and powers available to them, the amendment allows the decedent's guardian (if one was appointed during the decedent's lifetime) or the personal representative under the will to exercise the rights and powers. The amendment also allows for the appointment of a special fiduciary for the sole purpose of making funeral-related decisions. Finally, the amendment contains a provision authorizing a person without priority to file an action in circuit court to challenge the statutory presumption to be determined as the individual who has the authority to exercise the rights and powers.

It may seem shocking to many that an individual does not have authority under state law to make his or her own funeral arrangements. Therefore, it is important that individuals discuss their desired arrangements with the person or persons who have authority under the new statutory scheme. If you have any reason to doubt that these persons will carry out your wishes, you may wish to take further actions. For example, you could seek to obtain the written consent of those with decision-making authority and provide this to the funeral home where you make your arrangements prior to death. You could also consider adding a "terror" clause to your will or trust that would disinherit an heir who failed to carry out your desired funeral arrangements. Finally, the person of your choice could file an action in circuit court seeking to be declared as the person with decision-making authority under EPIC.

WN&J Probate Litigator Obtains $2.3 Million
Jury Verdict for Coin Collection Misappropriated From Trust

By David Skidmore

In June, WN&J partner and probate litigator David L. Skidmore obtained a jury verdict of more than $2.3 million for his clients in a lawsuit arising from a trustee's misappropriation of a valuable coin collection that rightfully belonged to the trust beneficiaries. The case involved a revocable trust established by a Grand Rapids man who had collected coins for 75 years. When the man died at age 95, his coin collection was owned by his trust, and the collection was supposed to be sold and the proceeds divided evenly among his five adult children.

The decedent's son, a co-trustee of the trust, took possession of the coins and the logbooks which listed all the coins during his father's final illness. The son expressed great disappointment when he learned that the coins had not been left solely to him, and it took him about three months to return the coins. The coins that the son returned were professionally appraised as having only a modest market value. The low appraisal put the co-trustee's siblings on notice that something was wrong, because their father had indicated that his collection had a significant value.

The siblings concluded that their brother had improperly taken the most valuable portion of the collection. Identifying the missing coins presented a challenge, though, because the logbook identifying the oldest coins in the collection was also missing. Working from their memories and a coin collector's guidebook, the siblings constructed a list of the coins that their father had shown them and that were now missing. A professional rare coin dealer reviewed the list of missing coins and concluded that they had a market value of at least $1 million.

The lawsuit culminated in a three-day jury trial before the Kent County Probate Court. The jury unanimously held that the co-trustee had breached his fiduciary duties to the other trust beneficiaries by misappropriating the missing coins and awarded damages of more than $2.3 million to the trust beneficiaries. [The case is now on appeal.]

Estate Planning Impact of the Pension
Protection Act of 2006

By Justin Stemple

President Bush recently signed into law the Pension Protection Act of 2006, which creates sweeping pension reform but also contains provisions impacting estate planning. Those changes include the following:

  • 529 college savings plan features that were scheduled to expire in 2010 have been made permanent, including the key provision that distributions from these plans to pay college expenses are tax free.
  • In 2006 or 2007 only, an individual over age 70½ may make charitable lifetime gifts of up to $100,000 per year directly from an IRA. These gifts are not included in the donor's income, and will count toward the IRA owner's required distribution for the year. Donor-advised funds and supporting organizations are not eligible under this rule.
  • Trustee-to-trustee transfers are now allowed from a company retirement plan to an inherited IRA of a non-spouse beneficiary of a deceased employee. This allows for distributions over the life expectancy of the beneficiary that may not have been permitted under the terms of the company retirement plan.
  • The rules governing the charitable donation of property have been changed. Donations of used clothing and household items are deductible only if in good, used condition or better. The donation of fractional interests in tangible personal property now requires the donee to take full possession of the property within 10 years or at the donor's death, whichever occurs first.

New Flexibility for Inherited Retirement Plans

By Susan Gell Meyers

The Pension Protection Act of 2006 provides new flexibility to beneficiaries who inherit 401(k) plans, 403(b) plans or 457 plans. Beginning December 31, 2006, a non-spouse beneficiary who inherits a 401(k), 403(b) or 457 plan may make a direct trust-to-trust transfer to an IRA. This is a big deal.

Many retirement plans require the benefits to be immediately paid out to beneficiaries on the death of the participant. While spouses can roll over inherited retirement plans to an IRA, non-spouse beneficiaries could not. Because distributions are taxable income when received, this immediate payout to a non-spouse beneficiary accelerates the income taxation of the retirement benefits. If, instead, a nonspouse beneficiary elects to transfer the inherited retirement plan to an IRA, distributions may be able to be "stretched out" over the life expectancy of the beneficiary! Stretch out options will vary depending on the facts and circumstances at the time of the participant's death, but overall this is a huge savings for taxpayers.

Estate Planning Focus

Editor: Karen L. Kayes

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 attorney or any member of the Firm's Trusts and Estates Group.