Best Last Minute Tax Deduction at the End of the Year: Charitable Remainder Trust

Have Taxable Income or Gain. If you had substantial income or have a large taxable gain in 2009 or will in future years, the best end of year tax savings technique is often the Charitable Remainder Trust (CRT). This is because with a CRT, you can obtain a large tax deduction even if you wait until the end of the year. Many of the other techniques that taxpayers used in the past for end of year tax deductions have been severely limited. With the CRT, you retain some control over the asset, receive income from it, get an immediate tax deduction and postpone or avoid capital gains on the sale of the asset.

What is a CRT? A CRT is a trust which you create and to which you contribute assets such as stocks or free and clear real estate. The CRT then sells the asset and because the CRT is similar to a charity which pays no income taxes for charitable activities, the CRT does not pay any capital gains at the time of the sale of the property. Depending on how you set up the CRT, you may never pay any capital gain taxes on the sale of the asset.

Major features of the CRT:

*Planning A Must. The first step is to plan the CRT, which involves integrating your CRT into your financial, business and estate plan:
*Not Too Big and Not Too Small Deduction. You generally want to maximize the deductions you will receive in the year of the gift. The deduction is calculated based upon IRS tables which predict how much the charity will receive. If you contribute $100,000 in 2009 to the CRT and the IRS tables say the charity is predicted to receive $30,000, you receive a $30,000 deduction from your taxes in 2009. If you exceed the maximum deductable level for charitable deductions in year 2009, you can carry forward the deduction to use in future years, with certain limitations. You do not want to give too much or too little.
*Charity Minimum Ten Percent. The charity has to receive at least 10% of the total gift. If you are below 50 years of age, you may not be able to use your lifetime as the time for the payments back to you from the CRT and may have to use a maximum of 20 years before the assets go to the charity. As part of the planning, we run computer calculations of the results of different options.
*Payout Rate. You have to decide the annual rate at which the CRT will pay you. It has to be at least 5% and not more than 50% and it can be fixed or dependent upon earnings or the value of the property. The pay out rate is the rate at which you will receive income for your life or the set period of the CRT.
*Distributions Taxed. You pay taxes on the distributions if they are ordinary income or capital gains, but not return of principal or tax exempt income.
*Postpone Income Taxes. If you will have high income for the next several years, high taxes and do not want to receive any payments which would be subject to taxes, you can set the CRT up so that the CRT does not make payments to you during the high income years through the use of financial instruments such as an annuity or family limited partnerships. You can turn the cash flow spigot on or off depending upon your future cash needs. The IRS is watching for abuses.
*Appraisals. If you contribute to the CRT real estate or a hard to value asset such as an interest in a closely held business, you must have an independent appraisal and a special independent trustee involved in the process.
*You are the Trustee. You can be the trustee of the trust, but there are self dealing limitations.
*Option to Change Charity Designated. You initially name the charity, but you can retain the right to change the charity. Properly planned, your family foundation may become a beneficiary.
*Exempt from Estate Taxes. The assets in the CRT will not be part of your taxable estate and you do not use up any of your exemptions from estate taxes by use of the CRT.
*Replace the Inheritance. Since the assets go to the charity upon your passing and not to your heirs, you can decide to replace those assets with life insurance. If is possible to so design a CRT in many cases where the net tax and other financial advantages provide enough additional cash to pay for the insurance.
*Money is in the CRT. Once established, you can not change the rules of the CRT and take back the asset. You have to be able financially to not have this as an asset that you must liquidate to pay bills. However, with the deferred income CRT, you can sell assets in the CRT when you need money so that you receive all of the distributions you did not receive over the prior years.

Your Team of Advisors. There are exceptions and many details to this planning not discussed above which you do not need to know in order to accomplish your goals. The key point is that there is a way to obtain large last minute tax deductions at the end of the year. The CRT will be used more in the future as capital gains rates, income tax rates and estate tax rates increase in the coming years. If you want to plan for the coming higher taxes, we will assemble your team of advisors to use the tools permitted under the law to lessen the blow of these higher taxes on you.

How to Protect Yourself: US Goes Bankrupt: Taxes Going Up, Services Going Down; President Obama Tells the Truth

You Can’t Handle the Truth: When I was in politics for ten years as a member of the Virginia legislature, most politicians believed that the “people” couldn’t handle the truth. My experience was that people didn’t like to hear about the harsh realities that government often faces.

Obama Tells the Truth. President Obama did a public service for the country when he said the US is going bankrupt unless we raise taxes and cut spending. Now, the President didn’t say it exactly that way, but the pending health plan in the Senate recommended by the President relies upon decreasing expenditures for Medicare and Medicaid and raising taxes. New Hampshire Republican Senator Gregg claims current and proposed spending will lead to bankruptcy for the United States.

Unsustainable Budget. In our private client letter mailed in December 2008, I quoted: “Under any plausible scenario, the federal budget is on an unsustainable path”-Peter Orszag, Director, Congressional Budget Office, December, 2007. This was before the historic spending of 2009. In our Prepare for the Return of the Estate Tax, we provided the numbers which show how the government is going broke. The Obama Administration is projecting a $9 Trillion deficit in the next ten years. This is more debt than America accumulated from 1789 to 2008 combined. The Heritage Foundation says the correct number is $13 Trillion over ten years with the national debt being equal to the entire production of the country (GDP) by 2019. At some point, the federal government will no longer be able to borrow money at acceptable rates to finance spending. The projected rates of spending will force punishingly high taxes on individuals, businesses and the economy. So, what do you do if the US government goes bankrupt?

Capital Gains. The 15% federal capital gain rate expires by law at the end of 2010. Rates will go higher. Strategies include selling of stock now with capital losses to store up loses against future taxes, use of charitable trusts to postpone or avoid gains and use of tax deferred exchanges for real estate.

Income Taxes. The maximum 35% personal rate expires at the end of 2010. Rates will probably go to $39.5%. With increases in state taxes, phase out of deductions and the raising of the ceiling on withholding taxes, the effective rate could be near 60%. Business owners will increase corporate perks and take another look at deferred compensation planning. Tax payers will seek charitable planning, annuities, life insurance and tax shelters.

Estate Taxes. We predicted the $1,000,000 exemption and 55% tax rate is coming back in Prepare for the Return of the Estate Tax. There are time tested techniques to legally reduce your estate taxes to zero even if you have a large estate.

Decline of the Dollar. If the US government goes bankrupt, the value of the dollar will decline greatly and the prices you pay will increase greatly. If all of your assets are in dollars denominations, you will have to work to able to pay your bills, if you can find a job that pays enough to live on. Talk with your financial advisor about whether you should diversify a substantial amount of your portfolio into assets in currencies other than dollars, assets that will retain their buying power or other defensive moves. There is a historically wide variation of opinion among economists as to whether we will have inflation or deflation.

Health Care. It is well known and documented that the path to saving on personal health care expenses is to control your weight, exercise, get a good nights sleep, avoid fast foods, eat a Mediterranean diet, avoid harmful medicines, have a warm and loving family, avoid narcotics and excess alcohol consumption, reduce stress and feel you are making a worthwhile contribution to your community. Sounds simple enough-for the perfect person. A large number of people I know think that their health care is in their hands and that they will not be able to depend upon a government provided health care system. My personal recommendation is for you to read a book such as “Ultraprevention: The 6-week Plan that Will Make you Health for Life” by the two medical doctors who run the Canyon Ranch health spas. We will give away copies of this book to the first ten people who call Silvio at 571-633-0330 and to anyone who comes in for an appointment to plan their taxes, estate or business.

Be Ready. Call us to have a balanced plan for the coming years of more financial turmoil.

Is the Tiger Woods’ Pre Nuptial Agreement Protected Against Multiple Mistresses?

Tiger Woods. We are reading press reports that Tiger Woods may pay an additional $5 million and up to $80 million to his wife, Elin Nordegren, the mother of their two children, to stay with him after revelations of multiple mistresses. Under the reported original pre nuptial agreement, Tiger Woods agreed to pay Elin $20 million if she agreed to stay with him for ten years. The additional sums are payments to her to be the dutiful wife even though he has reportedly had multiple affairs.

A PreNup. A pre nuptial agreement is a legal agreement entered into prior to marriage waiving the normal legal rights of a spouse. In general, in the event of a divorce, each spouse often receives one half of all of the property acquired during the marriage. This could include any increase in the value of a business owned by a spouse, or real estate or a stock portfolio even though the business, real estate and stock portfolio was owned by the spouse prior to the marriage. If the wife is a stay at home mom, she may receive part of the pension fund of her husband, child support and alimony for a time period until she is able to re enter the work force.

Celebrities. You often hear about celebrities such as Tiger Woods, Paul McCartney, or Michael Jackson entering into pre nuptial agreements to protect against losing half of their multi millions in the event of a later divorce.

Business Owners Too. We have done pre nuptial agreements for stock brokers, owners of contracting companies, professionals and real estate developers who have wealth to protect, but are not celebrities. Usually, the man requests the pre nuptial agreement because he believes he “was taken to the cleaners”-i.e. lost half of his wealth in his last divorce. Sometimes the successful business woman or heiress of a substantial estate also is motivated to obtain a prenuptial agreement. We have represented the less wealthy spouse as well in many cases.

What it Says. Usually, both sides agree to give up their rights to take half of the property bought into the marriage and any growth in value of that property. They also agree not to make any claims against the retirement funds or separate investments of the other spouse made during the marriage. They waive any rights to alimony or to receive an inheritance from the spouse. For the spouse who is not as well off, often there is a promise of a minimum income or a life insurance policy in the event of the death of the wealthier spouse during the marriage. A pre nuptial agreement can be combined with an estate plan so that if there is divorce during the marriage, there is no inheritance, but if the wealthier spouse dies during the marriage, the surviving spouse will have enough funds to continue their life style and raise their children.

What it Should Say: To be enforceable, the pre nuptial should have the following:
*Full disclosure of all of the assets and income of each person.
*Separate legal representation by both spouse.
*Full understanding of what each spouse is giving up.
*How the ownership of the residence will be handled.
*Equal division of marital property upon divorce.
*Financial support for the stay at home mom who removes herself from the workforce and the ability save for retirement while taking care of the children.

What Not to Do: Preparing for a marriage and a prenup causes enormous stress, but in the long run the marriage will be stronger if you are fair and sensitive to the other person:
*Do not hide any assets from the other spouse. This will be strong grounds to set aside the agreement.
*Do not have one attorney draw up the agreement with no review by an independent attorney representing the less wealthy spouse.
*Failure to determine how money will be handled in the marriage.
*Failure to understand that the less wealthy spouse will feel that she is not being trusted by her new husband; she has to understand it is not about her, but about the emotional scars of her husband.
*Finalizing the prenup two days before the wedding after the family is in town and no one knows whether the wedding will take place. I have seen this happen a couple times and when I am one of the lawyers, it reminds me why I am not a divorce lawyer.
*Failure to integrate the prenup into the financial and business plans of the new family.

After the marriage. If you don’t follow your marriage vows, don’t expect the prenup to have much meaning or legal effectiveness. The courts often do not favor prenuptial agreements and will look for loopholes not to enforce them. But, a faithful spouse with an effective pre nuptial agreement will be protected in the event his spouse runs off with the pool boy or an errant husband with a cocktail waitress.

Get Five Times the FDIC Insurance Against Bank Collapse by Use of Your Living Trust

Bank Failures. There have been over 100 bank failures this year and many more are expected next year. If you have deposits in a bank, what happens to your money when the bank fails? [click here for a list of bank failures throughout United States] Because of the run on banks in the Great Depression of the 1930s, the Congress established the Federal Deposit Insurance Corporation (FDIC) to provide insurance when a bank fails. If another bank does not take over the failing bank and guarantee all of the deposits of the failed bank, then the FDIC steps in and pays the consumers who had deposits in the failed bank up to the maximum insurance limit then in effect. Until January 1, 2014, when the maximum insurance reverts to $100,000, the present maximum insurance is $250,000 per person.

Auntie Mae. Auntie Mae is worried that she may live longer than her money. She keeps nearly everything in cash and money market accounts. Her life savings, everything she inherited from her sisters and deceased husband totals about $800,000 which she has in her checking, savings, money market and other accounts. She put $100,000 in eight separate branch offices of a local bank, thinking that would protect her. She didn’t want to have to deal with several banks which she did not know and trust. She was afraid to put her daughter’s name on the accounts because her daughter is a pediatrician and although her doctor daughter has not been sued, pediatricians are often targets of lawsuits. When her bank failed and closed its doors, the FDIC paid her $250,000, the maximum insurance under this federal guarantee system, and she lost $550,000, most of her life savings. Auntie Mae will have to get a job at Wal Mart because she does not now have enough money to live on.

The Living Trust Solution. For years, there was confusion and uncertainty as to how FDIC insurance worked for accounts held in living trusts. This was clarified last year by the FDIC and there is now a “five-times” rule. Under the five times rule, if you have five or more beneficiaries of your estate in your trust, then you receive at a minimum five times the current maximum level of insurance on all of your accounts at the bank. With the five times rule, you will have a minimum of $1,250,000 of FDIC insurance for accounts held in your living trust at a single bank. You can have more than $1,250,000 in FDIC insurance with a living trust, but if there are over five beneficiaries, the FDIC will look at the actual amounts left to all of the beneficiaries and limit the amount by the lesser of $250,000 per beneficiary or the actual amount given. There is no extra charge to you for this additional FDIC insurance. The $1,250,000 of insurance will take care of most accounts. After 2013, this is scheduled to reduce to $500,000.

How it works. Auntie Mae puts all of her checking, savings and bank money market accounts into the name of her living trust. She does this by going to her bank and having the ownership of the account changed to the name of her living trust. Auntie Mae has left 50% of her estate to her daughter Ellen, 20% to her nephew, $10,000 to the aide who helps her each week, $10,000 to the Salvation Army and $10,000 to a friend. This means she has five beneficiaries; the old requirement of family members as the only qualifying beneficiaries is gone. As a result, the bank and FDIC now provide her accounts up to $1,250,000 in FDIC insurance even though all of her accounts are in one bank. She does not have to spread her money into different accounts at different banks, which could lead to great confusion and complexity. If her bank went under, all of her $800,000 will be protected by FDIC insurance.

Transfer Your Bank Accounts to Your Trust Now. Many people put off putting their personal savings and checking accounts into the name of their living trust. Now, you have a very strong reason for doing this-getting five times the FDIC insurance.

Dad Died and the Bank Took Everything

Successful Contracting Company. Jimmy Jones had a successful contracting company which was worth several million dollars. Over his lifetime, he had seen the business go up and down with the economy. To put away some funds for the future, he bought an apartment building and a small shopping center. Jimmy worked until his seventies and never found the right person to take over his company. His daughter Jane is a successful CPA with her own practice but his son Jimmy Jr. drifts from job to job. Jimmy gave his children everything when they were growing up because he didn’t want his children to remember being poor as a child.

Great Banking Relationship. Jimmy has had a great relationship with his local community bank where he had his business accounts over the years. He had a line of credit and commercial loans on his apartment building and shopping center all with the same bank. He thought he saved on legal fees when he obtained or renewed his loans by not having a lawyer review the documents.

MegaBank Takes Over. On Friday the 13th of November, Jimmy had a heart attack and died. All of the loan documents for his business and his real estate have a clause in the loan documents which say that if Jimmy died, the bank could demand full payment immediately on all of his loans. Recently, his local community bank had been acquired by MegaBank which now has all of Jimmy’s loans. MegaBank has been kept out of bankruptcy by billions of dollars from the federal government. The federal regulators want MegaBank to have higher cash reserves in case of loan defaults and to get rid of all risky loans, which the regulators classify as including all commercial loans on local real estate to individual owners. Jimmy had always paid all of his loans on time and the business and real estate generated enough cash flow most months to pay all of the loans; Jimmy was an excellent credit risk. Now, because Jimmy has no successor in place to take over his construction business and manage his real estate, MegaBank feels itself insecure, is being pressured by the regulators and therefore declares due and immediately payable all of the loans that Jimmy had with the bank based upon the clause in the loan documents that the bank can demand immediate full payment if the borrower dies.

MegaBank Wins in Court. Jimmy’s daughter Jane hires an attorney to try to stop the foreclosures on the business and the real estate. Jane loses in court because the loan documents clearly allowed MegaBank to foreclose if Jimmy died. Jane pays $120,000 in legal fees out of her savings and MegaBank adds its legal fees of $150,000 to the balance due on the loans owed by Jimmy’s estate. Due to the depressed construction industry during the recession and the decrease in values for the real estate and the shortage of loan money, Jane can not get loans to stop the foreclosures. After MegaBank foreclosed, Jimmy’s construction company closed its doors and 32 people lost their jobs. The real estate was sold at fire sale prices for less than the balances on the loans. MegaBank came after Jimmy’s savings and wiped out any other money he had that did not go by right of survivorship to Gerry, Jimmy’s widow. Jimmy’s widow sells her house to have money to live on and moves in with her sister and her sister’s crude and rude husband. Jimmy’s children, who could have each inherited millions, will get no significant inheritance from their parents.

Prevention. This could have all been prevented. “Death is a default” is a standard term in commercial loan documents that can be removed through negotiations. If Jimmy had hired our firm to represent him with his commercial loans, we would have insisted that the loan commitment letter state that the loan could not be called by the bank if Jimmy died. We would have worked with Jimmy to have a business succession plan in place that we would show to the bank to convince them that they would still be paid if Jimmy died. We have always been able to obtain bank agreement that the loan could not be called in the event of the death of the principal borrower. MegaBank would not have had the right to foreclose and the Jimmy Jones family assets would have been saved and Gerry would not have had to move in with her sister and her rude husband. Many entrepreneurs do not use competent legal counsel to review the commercial loan commitment letter before their sign it. This story shows what can happen to a lifetime of work and a family if you do not obtain the proper loan terms.

Don't Put Children on Title to Your House

Add Ellen to the Deed. When I did a weekly talk radio show for WRC in Washington in the 90s on real estate, every week a little old lady would call me about putting her daughter (Ellen) on the title to her home. The mother wanted to do this as a cheap and easy way to plan her estate. If she died with the house in the joint name of her and her daughter with right of survivorship, the house would automatically go to the daughter. No probate, no will and no need for a living trust or to talk to a lawyer. I always spoke against this idea.

Joint Liability. When the mother puts her daughter Ellen on title, the daughter becomes a joint owner. As a joint tenant, most states treat this as tenants in common for the purposes of liability. Ellen has a car accident and a judgment for $2,000,000 is entered against her. Ellen’s insurance limit is $500,000. The trial lawyer who got the judgment comes after all of Ellen’s property. Now that Ellen is a co owner of the home, the trial lawyer can get a court order requiring the sale of Ellen’s interest in mom’s home and mom gets evicted from her home, or has to buy off the trial lawyer. If Ellen gets divorced, a half of mom’s house may be part of the divorce property settlement with the ex son in law.

Medicaid Denial. Under current Medicaid rules, a transfer to a child would be a gift and would disqualify the mother from Medicaid for up to five years, depending upon the appraised value of the house at the time of the gift and other factors.

Can’t Sell. Mom can’t sell the property to a legitimate buyer without Ellen’s signature. When the house is sold, Ellen is under no legal obligation to give any of the house proceeds to mom. What happens if mom needs the money for a nursing home and Ellen needs the money for a life threatening illness of one of her children? If mom has Alzheimer’s, has a stroke or becomes incompetent, no one can sell the house until Ellen engages in an expensive and time consuming guardianship court procedure. When parents put children on title to their homes and later take them off to get a loan or sell the property, we have often found that there are title problems that prevent a later sale.

Vulture Takes Mom’s Home. A vulture investor may be willing to buy out Ellen at bargain prices for a payment of quick cash to Ellen. Mom can’t legally stop the vulture investor from then obtaining a court order for the sale of mom’s home.

Gift Tax. Mom has made a gift to Ellen which will probably be subject to a gift tax. If mom’s house is worth $500,000 and she owns it without debt, the gift to the daughter is $250,000, $237,000 more than the annual exemption of $13,000 from gift taxes in 2009. Should mom file a gift tax return? If mom intended a gift, then she is required by the tax law to file a gift tax return and use $237,000 of her $1,000,000 exemption from gift taxes. If mom sells the house and Ellen agrees that all of her share, worth $250,000, should go to mom, then Ellen has given $237,000 to mom and should file a gift tax return.

Pay Capital Gains Tax Unnecessarily. If mom filed a gift tax return or if Ellen can’t prove to the IRS that mom didn’t really give her anything in the house, then Ellen received one half of mom’s house based upon her mother’s basis in the property. Mom and dad (now dead) had paid $50,000 for the house and Ellen can’t find the receipts for improvements made during the lifetime of her parents. Therefore, mom’s basis in the property is $50,000. Ellen receives a basis of $25,000 in Ellen’s one half interest in mom’s house; one half of the mother’s basis of $50,000 is $25,000. When Ellen sells the house for a net of $600,000 after mom dies, Ellen unnecessarily pays a capital gain tax on one half of the house of about $55,000 at current rates and more with higher rates in the future.

Loans. How it happens, I don’t know. But, there are cases where a child goes out and gets a loan on the house without telling mom, the child pockets the money and later is unable to pay the loan. Mom loses her house in her old age to foreclosure. Or, mom wants to get a reverse mortgage and can not because the daughter is on title to the house.

Family Destruction. Mom had two daughters and son and mom’s will says everything goes in an equal split one third to each child. But, mom’s house passes outside mom’s will so her daughter Ellen receives not one third of the house, but 100% of the house. The will usually does not equal this out. Ellen must now decide whether to take money from Ellen’s family and give two thirds to her siblings and use up part of Ellen’s gift and estate tax exemptions for her gift to her siblings. If Ellen doesn’t do that, her sibling will believe that Ellen plotted this from the beginning so that Ellen could steal mom’s house from her brother and sister.

Living Trust. If mom had instead set up a living trust and named herself and Ellen as the trustees of the trust, she could have avoided all of these problems. We will cover the issues later that arise from putting a home in a living trust. After mom got off the radio talking to me, did she follow my advice? Probably not.

Funding Avoids Probate

Probate. In Living Trusts Do Not Avoid Probate, we discussed probate and living trusts. Probate is the court supervised process of transferring property after a person passes away and the property is in the name of the person at the time of death. The majority of people who die with assets have estates that have to go through probate; even though most people while they were alive did not want their loved ones to suffer through the costs, stress, delay and lack of financial privacy that is probate.

Living Trusts. A living trust is a legal entity you create when you sign a trust agreement with the required language and in some cases, when your transfer assets to the trust. Trusts are the first step to avoiding probate, but are not enough. To avoid probate, you have to take the second step to “fund” the trust.

Funding. Funding is the word that lawyers use to describe the transfer of assets to a living trust and the making the trust a beneficiary of qualified retirement plans and certain insurance contracts. My experience is that most non lawyers are not familiar with this use of this word. An example is where Ellen Smith signs a living trust agreement on Monday. On Wednesday, she goes to her bank, meets with an employee at one of the desks in the lobby and requests that the bank transfer the name of her account from her name individually to the name of her living trust. On the bank records, the name of her bank account was in the name of “Ellen Smith”. After the bank account is “funded” into the living trust, the name on the account will probably be “Ellen Smith, Tee (Trustee) utd (under a trust dated) 11/2/2009 (the date she signed the trust). Or, it may be “Ellen Smith Living Trust”.

Titling. The name of the owner of each asset of Ellen must be changed to the name of the trust for it to be in the trust. The title to her house, brokerage account, furniture, jewelry, vacation home, stocks, business and in some cases, insurance, must be changed to her trust. Each one of these assets has special rules as to how to complete funding. You do not transfer your pensions, IRAs or qualified annuities to your trust while you are alive, but do change the beneficiary designations of each of these accounts.

Bank Accounts. As an example, due to concerns about terrorists setting up bank accounts to finance terrorist attacks in the US, to change the name on your bank account to your trust, you have to physically go to the bank with your identification and all of the people who will be immediate trustees to sign the bank forms. An attorney can not do this for you. Some banks will make you open a new account in the name of the trust. Other banks will not make you open a new account, but will require that you obtain new checks with the name of your trust on your checking account. You would prefer not to have the name of your trust on your checks that go through all sorts of hands and businesses. Some stores are reluctant to accept checks from a trust because they think they may be business checks. You will prefer to work with a bank that does not require a new account or requires that you put the name of your trust on your checks. If one of your children or sister or brother is helping you with your banking now and is a co signer on your account, you will probably want to name that person a Cotrustee and they will have to go with you to the bank. Under IRS rules, because you have the legal power to revoke your trust at any time, you continue to use your social security number when your bank account is in the name of the trust.

Five Times the Insurance. There are many advantages to having a bank account in the name of your trust, rather than in your own name and the name of your cosigner. For example, in these times of failing banks, you can get five times the federal insurance against losing your money if you have your bank account in the name of your trust at no extra charge from the bank. More on this later.

Living Trusts Do Not Avoid Probate

Most, Not All. One of the primary purposes of setting up a living trust is to avoid probate. But, according to our informal survey of the experiences of thousands of estate planners nationally, most living trusts do not avoid probate.

Probate. When someone dies with property only in their name, then generally there is a legal process called probate. The designated person, often called the executor, if the person dying had a will, files the will with the court where the deceased lived. Then, typically, the executor or executrix must file an initial list of the assets in the estate, often called the inventory, and pay any court fees and applicable inheritance taxes. There may be annual reports and a later court approval of how the money is distributed to the heirs. The procedures are basically the same even if there was no will.

Dacey: Avoid Probate. Norman Dacey, who died on October 21, 2009, created a huge controversy when he wrote “How to Avoid Probate” in 1965. Dacey criticized the probate system and advocated that people use living trusts to avoid the costs, delays and publicity of the probate process. According to the New York Times, Dacey sold over two million copies of his book and was subject to lawsuits that claimed, because he was not a lawyer, he was practicing law without a license to do so. Dacey lost a case over this in Connecticut, but won one in New York. Many non lawyers saw this as an attempt by the Bar to protect the lucrative probate business of lawyers.

Living Trusts. What was new in 1965 for most Americans, the living trust, is now relatively commonplace today. This is part due to Dacey and the many attorneys advertising the advantages of living trusts. A living trust is a legal entity under US and English law which provides instructions for taking care of your property and you during your lifetime and after death. The way the trust avoids probate is that you change the title to your assets so that the trust is now the owner of your assets. When the person dies, the trust continues in existence and the designated trustees (usually children) take over all of the assets owned by the trust and split them up outside of probate.

Most Do Not Work. Many lawyers who write living trusts only provide the document and related will and powers of attorney. But to avoid probate, there must be an actual change of the title to the house, bank accounts, brokerage accounts and where appropriate, life insurance, to the name of the trust. If you have $100,000 in a bank account in your name only and you pass, then, in many states, probate has to be initiated before any of the $100,000 can go to your heirs. Of course, if the account was owned with someone else with right of survivorship, then the money would go to the survivor and not yet be subject to probate. The reason why most living trusts do not avoid probate is because the client or the lawyer does not take this crucial second step of transferring the assets to the living trust. More on this process called “funding” in future articles. The minority of living trusts – those that do own all of the deceased person’s property – do avoid probate.

Protect Your S Corporation with an LLC

Protect Your Shares. In our last blog, we showed how to Protect your Corporation with an LLC if you operate your business as a regular C corporation. One of these methods is to have an LLC own all of your shares in your C Corporation; such LLCs can have more than one member. You benefit from this because there is no real protection against a creditor getting a court order to seize your shares in a Corporation. In contrast, your membership interest in certain LLCs in Virginia, Delaware and some other states and countries should be protected against court seizure and sale.

S Corporation. The S Corporation is designed for the small business where the owners want to avoid the double tax of the C Corporation. Under normal circumstances, an S Corporation pays no tax. Instead, all of the income and most of the deductions usually flow though to the owners of the S Corporation. This means an annual savings of 15% or more of federal taxes on each dollar earned.

Real People Are Owners. The S Corporation comes with a lot of restrictions. The government does not want large corporations to use S Corporations to avoid paying corporate taxes. This means that the shares in S Corporations can only be owned by a human being or certain trusts for human beings. Shares in S Corporations can not be owned by C Corporations or partnerships or by many LLCs. So how can we use an LLC to protect your S Corporation stock?

Vanishing LLCs. Current tax regulations allow you to “check the box” as to whether you want your new business to be taxed under the partnership or the corporate rules. A partnership means there are two or more partners. You can not have a partnership with only one owner. You can have a Corporation and also an LLC with only one owner. IRS regulations say that where you have only one owner, called a single member LLC, the “LLC” is a “disregarded entity” for tax purposes. This means that as far as the tax man is concerned, the single member LLC does not exist for tax purposes even though it exists as a legal entity under state law.

Single Member LLC. Well then, could you have a single member LLC own the shares in an S Corporation, have the LLC disregarded, and treat the human being who owns 100% of the LLC shares as a human being that owns the S shares? The IRS has said yes in several private letter rulings. A private letter ruling is where someone writes to the IRS for a ruling on their situation. The ruling protects the persons who got the IRS blessing, but no one else. However, this has been a consistent position in several of these rulings and the logic of this is very sound. So check with your tax advisor, but one way you could increase the protections of your shares in your S Corporation is to have them owned by a single member LLC. One letter ruling even approved of a limited partnership owning S shares where the general partner was a single member LLC owned by X and X was the only limited partner. For tax purposes, the limited partnership was ignored, but should be treated as a limited partnership under state law.

Cautions. Single member LLCs may offer less protection than multimember LLCs. Also, if you forget and bring in another person (who is not a spouse) as a member of the LLC, you will immediately blow your S election because now a real partnership owns the S Corporation.

IRS Circular 230 Disclosure.

IRS rules impose requirements concerning any written federal tax advice from attorneys. To ensure compliance with those rules, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under federal tax laws, specifically including the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Protect Your C Corporation with An LLC

C Corporation. If you own shares in your own business, you should consider owning your shares in an LLC. This week we discuss regular C Corporations and not the special restrictions on S Corporations. A “regular” corporation is a corporation that is subject to paying corporate income taxes and is taxed under Subchapter C of Chapter 1 of the US Internal Revenue Code, hence the reference to “C” Corporations.

Transfer to LLC. If you own shares in any corporation and there is a personal judgment against you, then a court usually has the power to order a sale of those shares to pay off the personal judgment against you. This applies equally to your ownership in Google or Sam’s Deli, Inc. For an example, see Don’t Own Your Corporation. In contrast, with a LLC formed in Virginia, Delaware and certain other states, the court should not have the power to sell your membership interest in an LLC to satisfy a personal judgment against you.

Solution: Use an LLC to own your C Corporation shares. You do this by transferring your shares to the ownership of the LLC as long as you do not have the problems listed below.

Advantages:
1. Deter Lien Holders. It will be difficult to be able to take over your corporation if your shares are owned by your LLC.
2. Tax Neutral. If you select your LLC as a flow through entity, the ownership of the shares should not increase your taxes.
3. Spread Ownership. You can spread the ownership of your shares to family members without giving family members any rights to direct what happens with your corporation.
4. Income Tax Reduction. If some members of your LLC are in a lower tax bracket than you, this will reduce income taxes. This will be more important when dividend tax rates increase. Beware of the kiddy tax.
5. Estate Planning. The LLC can assist in the smooth transfer of shares in the event of death or disability and reduce estate taxes and avoid probate.


Cautions:
1. Make Sure Tax Neutral. Although such a transfer should be tax neutral, do not make this contribution until your tax advisors have reviewed it.
2. Buy Sell Agreements. If you have a buy sell agreement or other arrangement on share ownership with others, get their approval of the change. The LLC can be required to sell under the conditions of the buy sell agreement.
3. Corporations Owning Corporations. In many cases, there are tax advantages for one corporation to own its subsidiaries. You would probably use this LLC technique for the upper tier corporation. What we are talking about here is a closely held company without complex tiers of ownership.
4. Lender Restrictions. You may have to get permission of your lenders to do this.

Don't Own Your Corporation

Small Business Corporations. Many small businesses are run through corporations. You have heard the radio ads that you must protect your home and banking accounts from business liabilities by running your business though a corporation.

Stock Not Protected. But what protects your shares in your corporation that owns your business? In contrast to a Virginia or Delaware LLC, a court may order the seizure and sale of your corporate shares to pay judgments against you.

Peter Plumber. Peter Plumber has a successful plumbing company (Peter Plumber, Inc.) with 20 employees, ten trucks and $3,000,000 a year in sales. One night he has a terrible auto accident while he was driving home from work. He ends up losing the lawsuit over the accident and a judgment for $5,000,000 is entered against him personally. His auto insurance only pays $500,000 of the judgment. The trial lawyer for the accident victim comes after Peter for the remaining $4,500,000. The trial lawyer obtains a court order for the sale of all the stock Peter owns in Peter Plumber, Inc., in addition to losing most of his assets.

Just Another Asset. Whether in Microsoft® or shares in Peter Plumber, Inc., corporate stock is treated as an asset just like a bank account or real estate and can be sold on the courthouse steps. In my experience, most business owners do not know this.

What to do. To protect your shares in your corporation, here are some of the techniques. Each of them has advantages and disadvantages:
1. Buy Sell. Have a buy sell agreement that mandates the sale of your stock in the event it is taken as a result of a court judgment.
2. Use an LLC. Consider setting up your business as a Limited Liability Company (LLC) in a state where LLC interests are protected. Consider making a corporate tax election for the LLC. More on this later.
3. Convert. If you have a corporation, review with your advisors the feasibility of converting to an LLC. Be aware that the IRS considers such conversions a sale and do not do this if you have to pay a lot of taxes.
4. Segregate Assets. Have all of the assets that you use in the business owned by separate LLCs and rent those assets from these LLCs. For example, Peter Plumbing, Inc. does not own the vehicles or its warehouse. The vehicles are owned by a separate LLC as is the warehouse.
5. Have LLCs own your Shares. If you have a C Corporation that pays corporate taxes, have your shares owned by an LLC that is protected. If you have an S Corporation that pays no corporate taxes, there is a special type of LLC to use. More on this later.

You Used Your Name: LLC Mistake Number Three

Dr. Fred F. Funkel LLC. Fred F. Funkel sets up his own LLC to own his money market funds, stocks, bonds and savings accounts. Fred does this because he wants to protect these assets from a future creditor. Fred is a medical doctor who delivers babies and therefore is at high risk for medical malpractice claims. Fred proudly names his LLC the Dr. Fred F. Funkel LLC. Fred sets it up in a state where the state law is not clear as to whether a creditor is able to obtain a court order requiring that Fred’s LLC membership interest be sold on the courthouse steps. (See “You Choose the Wrong State: LLC Mistake Number Two” blog)

Investigator Finds Funkel LLC. A couple lost their baby while Dr. Fred F. Funkel was the attending physician. There is no clear medical reason as to cause of death and Fred does not think he is at fault. The grieving couple consults Tom Triallawyer to see if they should sue Fred. Tom does an asset search and does not find that Fred personally has much liquid assets. (Fred’s liquid assets are held by Fred’s LLC). Tom also does an internet and name search and finds that Fred owns the Dr. Fred F. Funkel LLC. Tom retains an investigator who finds out that the Dr. Fred F. Funkel LLC has about $2,000,000 of liquid assets. Tom looks at recent judgments in his state and finds that a botched baby delivery is getting an average of $5,000,000 in jury awards. Tom decides to take the case of the couple on a contingency fee basis-that is the couple pays the expenses of the lawsuit, but no legal fees unless Tom gets a settlement or wins the case.

Tom Files Against Fred. Tom Triallawyer files the medical malpractice case against Fred. Fred consults Susan Sharp, his own personal lawyer, separate from the lawyer appointed by Fred’s malpractice insurance carrier.

My LLC Was Supposed to PROTECT ME! “I thought my LLC would stop people from suing me”, Fred painfully complains to Susan. Susan sees Fred is in pain and doesn’t say “I told you that I should set up your LLC because of all of the mistakes you could make”. Instead, Susan says in a soft voice: “The investigator’s job was a lot easier finding you because you used your own name as the name of the LLC. I recommend that we change the name of the LLC in the future to make it harder to find your assets.”

My LLC is Secret. Fred replies: “Well, I will just won’t tell them what my LLC owns.” Susan: “At a point in the litigation, the other side will require a statement of all of your assets and at that point, the court can force you to list the value of all of your assets in your LLC. This can happen in any lawsuit, whether or not they know that you have an LLC.”

My Assets Are Safe in My LLC. Fred: “At least I have the LLC. My assets in my LLC should be safe even if I lose the lawsuit”. Susan: “Unfortunately, the law of Maryland is not clear on this point. In general, a state court judge has the power to enforce judgments and this may include the authority to reach the assts in your LLC. For example, if Tom Triallawyer obtains a judgment for $5,000,000 against you in the existing litigation and your insurance carrier pays $3,000,000 of the judgment, the remaining $2,000,000 could be collected against you. After entry of the judgment, Tom Triallawyer will schedule a deposition of you to force you under oath to disclose everything you own, including the assets of your LLC. If you have a bank account in your name, then Tom Triallawyer will request that the Judge place a lien on your bank account, remove the funds from your bank account and deliver the resulting funds to Tom Triallawyer. The general power of a judge may authorize the court to order that your membership interests in your LLC be sold to the highest bidder in a court supervised auction sale. Tom Triallawyer buys your membership interests at a low price at the sale, takes over your LLC, liquidates the LLC, retains a third of the proceeds and disperses the remainder to his clients.

Fix My LLC Now! Fred: “What can I do to fix this? Could I move the LLC to another state?”

Too Late for Now. Susan: "If you had formed the LLC in Virginia, Delaware and several other states, we would have a strong argument that the judge does not have the power under those laws to have your LLC sold. However, since you have been sued, we can not now change the state of your LLC because this could be held by the court to be an action that hinders or delays an existing creditor. This is called a fraudulent conveyance and may be grounds to set aside the move of the LLC from Maryland to Virginia.” (Susan says to herself that when Fred consulted her about setting up an LLC she told Fred about this and Fred decided to save some legal fees and set up the LLC himself.) Susan gently adds: “We need to examine a strategy for the future after this awful time is past you.”

Fred Loses $1,000,000 from his LLC. In the settlement of the case, Fred is forced to pay $1,000,000 out of his LLC because of the possibility that Triallawyer could penetrate the LLC. If Triallawyer didn’t know that Fred had an LLC with $2,000,000, Triallawyer may not have taken the case. If the LLC had been stronger, Triallawyer probably would have settled for just a payment from the insurance company without a significant contribution from Fred.

Don’t Use Your Name. Fred let his pride make the mistake of using his own name in his LLC that was intended, but failed, to provide protection of his cash and securities assets. Fred could have named it the FFF LLC, or Chesapeake Three LLC or some other name, not used or trademarked by someone else, which does not so quickly lead the asset investigator directly to Fred’s doorstep.

When to Use Your Name. This is different if Fred conducts his medical practice in an LLC. In that case, if Fred is promoting his name “Fred Funkel” as a preeminent obstetrician, the name of Fred’s medical practice would be the Dr. Fred Funkel MD LLC. Or, if Fred’s practice uses medically sound natural childbirth techniques, the practice could be the Natural Child Birth Center LLC. You should have a conversation with your advisors as to the best name for your LLC.

Insider Secrets to Maxing Your IRA

Little Used Powerful Tool. This is about a little known planning tool, the Retirement Benefits Trust, which can provide dramatic benefits for generations of your family.

Great Wealth Accumulation. There is a way to create great wealth using IRA (Individual Retirement Account) and other retirement benefit planning. This is basically done by using the tax deferral available from IRAs for multiple generations. It will become much more important because taxes on your earnings and the earnings of your children and grandchildren are going up dramatically in the coming decades. For many, income taxes will take away 50% of your income. Because you can roll over your company retirement plan to an IRA when you retire, your IRA can have millions of dollars. Without proper planning, most of your retirement savings could go to taxes.

Tax Deferral. People use IRAs for postponing paying taxes during their lifetime. What is not well understood is how your IRA can continue to save on taxes even after you’re gone from this Earth (I am not talking about space travel).

Traditional IRA. There are two types of IRAs: Traditional and Roth IRAs. Under the traditional IRA, you are able to deduct the contributions you make to the IRA, there is no tax on gains inside the IRA for qualified contributions and when someone takes the money out of the IRA, the tax must be paid on all distributions at the then current ordinary income tax rate. The owner of the traditional IRA must start taking required minimum distributions from the owner’s IRA April 1 of the year after the owner turns 70 1/2. You must take out each year the required minimum distributions based upon the applicable IRS tables that project how long you will live. If you live as long as the IRS thinks you will live or longer, you may have taken everything out of the IRA.

Roth IRA. For the Roth IRA, you do not get a tax deduction when you make the contribution, you do not pay taxes on the earnings inside the Roth IRA and when someone takes funds out there is no tax on the money put in or on the earnings. The owner does not have to take out minimum distributions during the owner’s lifetime. But after the owner dies, the person inheriting the Roth IRA must take out distributions over their life expectancy under the IRS tables.

Tax Free Growth Does It. The trick is to legally postpone taking distributions as long as possible. That is because you get wealthy by consistently making money over time, reinvesting the earnings, getting a healthy rate of return and not paying taxes on the earnings.

Stretch it Out. The goal, then, is to have the IRA go to the youngest person possible after the owner dies. This does not happen in most cases because people leave the money to their surviving spouse who is usually about the same age (Anna Nicole Smith being the exception) or to children, nieces or nephews who take out the money and spend it. Only a few advisors understand Retirement Benefit Trusts (RBT).

Willy Wise and his Retirement Benefits Trust. Willy Wise wants to provide a legacy for his children, grandchildren and a favorite niece. He can see for that for the next 50 years or so, federal and state governments will be imposing higher and higher tax rates on income. He sets aside a life insurance trust and other assets that provide for all the needs for his wife. He has eight children and grandchildren and his niece. He sets up a “Retirement Benefits Trust” for his eight children, grandchildren and niece during his lifetime. Willy can amend this Retirement Benefits Trust during his lifetime so if Willy Wise III turns into a bum, Willy can cut Willy Wise III out of his RBT. Willy leaves the largest percentages in his RBT to his grandchildren, thereby maximizing the tax deferral and the growth of the assets. Willy does this for both his traditional and Roth IRAs. Willy’s advisors prepare beneficiary designation forms for Willy using the same percentages for his IRAs as is set forth in his RBT. Willy’s IRAs provide for the future education, capital for investments and a sound retirement for his eight descendants and his niece. When Willy dies, his spouse, children and advisors take all the necessary steps for each of the nine subtrusts of the Willy RBT to qualify to be an IRA beneficiary.

Multiple Benefits:

1. Maximum Tax Savings. Each child, grandchild and niece can use their life expectancy to determine minimum distributions. So for ten year old Wonda, with a 100 year life expectancy, Wonda’s trustee would only have to take out 1/100 each year and the remaining amount accumulates tax free.
2. Asset Protection. The assets inside the IRA are protected from the creditors, predators, spouses and relatives of the child, grandchild or niece.
3. Heirs Can’t Blow the Money. The heirs do not have to have the power to take out all of the money and blow it.
4. The Other Guy’s Kids Don’t Get Willy’s Money. Willy’s heirs get the money rather than a second spouse of the surviving spouse or someone else’s children.

Watch for Announcements. There are downsides, details and technicalities that need to be discussed with your advisor. Look for announcements on valuable workshops we will be having on this topic.

The Big IRA Book. This discussion is based upon the Big IRA Book from experts Robert S. Keebler, Cecil D. Smith and Carol H. Gonnella, but none of these individuals are responsible for any of the content of this article.

Circular 230 Disclosure Notice
Pursuant to recently enacted U.S. Treasury Department Regulations, we are now required to advise you that, unless otherwise expressly Indicated, any federal tax advice contained in this document, including attachments and enclosures, is not intended or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed in this document.

Going to Jail for Having A Bank Account

Go to Jail. If you have a bank account with more than $10,000 outside the country and have not reported it to the US government every year, you could go to jail for five to ten years and pay fines from $100,000 to $500,000.

End of Swiss Bank Privacy? The IRS recently announced that the US government has worked out an arrangement where the IRS will receive the names of US citizens who have not reported their Swiss bank accounts to the IRS. There were media reports that the IRS sought information on 52,000 accounts, however, a recent settlement calls for UBS to give the IRS between 4,500 and 5,000 names. Once the IRS has these names, the IRS can then initiate criminal prosecutions for tax evasion. Several US citizens with UBS accounts have recently pleaded guilty of not reporting foreign bank accounts, with their information being posted on the IRS website.

Grandmother Lee. Grandmother Lee fled Vietnam when the North Vietnamese Communist government took over South Vietnam and she settled in France. In 2006, she died and left her money equally to her three children in her bank account in France. Dr. Lee, one of her daughters, is a US citizen living in Virginia and is a medical doctor. In 2006, Dr. Mae Lee found out that she had inherited $80,000 in a savings account in a French bank from her mother. Dr. Lee left the money in France, thinking that when she had time from her busy medical practice, her family would have a great vacation in France. The first time Dr. Lee received a statement of the interest income from this French Bank account was in 2008. Dr. Lee filed a personal tax return for 2008 reporting the interest income from the French Bank account. The IRS examines the return and started a criminal investigation of Dr. Lee for failing to timely file Form TD F 90-22.1, Report of Foreign Bank and Financial Account, commonly known as a FBAR, for three years.

Who Has to FBAR: 1.) Any US citizen or a US resident or certain persons doing business in the US or domestic trusts, corporations or partnerships AND
2.) This person had signature authority over a foreign account with a bank or foreign financial institution AND
3.) The foreign financial account had a combined value of more than $10,000. Of course, as with all tax regulations, there are many broad definitions and a lack of clarity on many points. If you want more detail, contact us for a confidential consultation. This short B-LAW-G can not be relied upond for legal or tax advise.

How to FBAR: File an annual TD F 90-22.1 by June 30, 2009 to a designated address in Detroit. You report the maximum value of the account during the year, the type of account, the name of the financial institution and its address and the account number. This form is not filed with your tax return. As a US citizen, you have to report your worldwide income on your regular 1040 personal tax return. Use Schedule B to inform the IRS of the existence of a foreign bank account. Even if you reported the income on your personal 1040 return, you would still be in trouble if you did not file the separate TD F 90-22.1 (FBAR form).

Penalties. If you fail to file the FBAR form, you can be subject to severe civil or criminal penalties or both. A non willful violation is subject to a $10,000 fine. The civil penalty is limited to the greater of $25,000 or the balance in the account up to $100,000. So for Dr. Lee, her penalty could be $80,000 and she forfeits the entire $80,000 she inherited. The IRS has six years to assess the FBAR penalty. Criminal violations can result in a fine of up to $250,000 and 5 years in jail. Where the failure to file the FBAR is part of tax evasion, the fine may go as high as $500,000 and up to ten years in prison.

Collapsing Offshore Tax Shelters. In the past, prosecutions have been rare. But with the step up in enforcement against offshore tax evasion, prosecutions may increase. For people who are not part of a tax evasion scheme and only recently realized they need to file FBAR reports, the IRS has a temporary voluntary disclosure program.

Saving Dr. Lee. Dr. Lee had no idea that she was committing a crime because she inherited money in 2006 in the form of an account in France from her departed mother. She could be subject to a civil fine of $80,000 and a possible criminal tax prosecution. She retains an attorney, not a CPA, because there is an attorney client privilege against disclosure of past crimes with an attorney, but not with a CPA. The attorney may retain an experienced CPA to do most of the work. Though her attorney, Dr. Lee participates in the IRS voluntary disclosure program. If there is unreported income from these accounts, she will have to file amended returns and pay the tax and penalties on the unreported income. The IRS warns that if Dr. Lee just filed amended returns and did not participate in the voluntary disclosure program, Dr. Lee could be subject to criminal prosecution. If Dr. Lee does participate in the voluntary disclosure program, then Dr. Lee would not pay $80,000, the entire inheritance as a penalty, but 20% of the account or $16,000. Once the IRS has started a criminal investigation, Dr. Lee is no longer eligible for the voluntary disclosure program.

Six Months Window. The voluntary disclosure program ends September 23, 2009; it was started March 23, 2009. “There are no plans to extend the deadline past September 23, 2009”, said Neil Shulman, head of a FBAR Task Force of AICPA, a national association of CPAs.

Get Out of Jail Card. In the board game of Monopoly, you can roll the dice and end up on the square “Go to Jail”. If you should have filed your FBARs and didn’t, your Get Out of Jail Card is about to expire.

Prepare for the Return of the Estate Tax

It’s Coming Back! The Estate Tax is coming back. That is the growing consensus of observers of what is happening on Capital Hill.

$3,500,000 exemption for 2009. This year, 2009, each person has an exemption from federal estate taxes of $3,500,000. This means that unless you have life insurance, real estate, savings and retirements funds in excess of $3,500,000, you do not pay any federal estate tax. If you live in Virginia, you don’t have any Virginia estate tax. But, if you live in DC or Maryland, you have estate taxes if you have more than $1,000,000.

Easy to be a millionaire. For many people, it is surprisingly easy to have an estate over $1,000,000, but difficult to exceed $3,500,000. Let us say you bought a house for $50,000 and it is now worth $500,000. You have a retirement fund of $150,000 and other savings of $75,000. We are talking about someone who considers themselves as middle class and not rich. They also have a small term life insurance policy with a death benefit of $250,000 and another $150,000 life insurance from their work. The death benefit of the life insurance is part of their taxable estate if they die while the insurance is in effect. Under the estate tax calculations with a $1,000,000 exemption, you have a taxable estate of $1,150,000.

Wealthy Escape at $3.5 million. Compare this to Mr. And Mrs. Wealthy. They have $1,000,000 in real estate, $1,000,000 in investments, another $2,000,000 in a family owned business, and insurance of $2,000,000. Their total taxable estate is $6,000,000, but they pay no estate tax when the estate tax exemption is $3,500,000 per person and their living trusts both use their $3,500,000 exemption (Two times $3,500,000=$7,000,000 which is greater than $6,000,000).

Bush Taxes Cuts Expire. The $3,500,000 exemption is part of the phase out of the estate tax under the Bush tax cuts. Next year, there is a complete elimination of federal estate taxes. But at the end of 2010, the Bush tax cuts expire. Rumors are that at the end of 2009, Congress will extend the $3.5 million exemption for only one year, through 2010. Without further legislation, the exemption automatically goes back to the $1,000,000 exemption in 2011 with rates as high as 55%.

$3,500,000 Was Here to Stay. President Obama’s election platform included a promise to keep the exemption at $3,500,000 and he implements his promise in his budget assumptions for future years by use of a $3,500,000 exemption. Earlier this year, I and many people who follow developments in Congress predicted that Congress would extend the $3,500,000 exemption for years to come. Most estate tax commentators saw the $3,500,000 exemption as the logical answer.

Impact of New Spending. What has changed so soon? Look at some numbers from the Heritage Foundation report of July 2009:

*Spending Surging. Spending and deficits are surging at a pace not seen since World War II.
*$33,932 per household. Washington will spend $33,932 per household in 2009 which is an increase of $8,000 from 2008.
*2008 Deficit $466 B. Federal spending was $3,031 billion in 2008 with a deficit of $466 billion.
*2009 Deficit $1,845 B. Federal spending in 2009 will be $4,004 billion with a deficit of $1,845 billion.
*Large Deficits Through 2019. Federal Spending is projected to continue to exceed revenue by a large gap through 2019.
*32.1% Jump in 2009. Federal spending grew by 4.9% in 2008 and by 32.1% in 2009.
*Spending Will Stay High for 10 years. President Obama’s budget proposal has per household spending at $33,392 in 2009 and ten years later in 2019 at $33,312, indicating a continuing high level of spending.
*Annual Increase is 8%. Since 2001, spending has increase at an average annual rate of 8%. If this rate continues for the next ten years, there will be massive requirements for new revenue.
*Social Spending To Consume All Taxes. By 2050, spending just for Social Security, Medicare and Medicaid will consume all of the federal taxes that the federal government usually collects as a percentage of the economy.
*Massive Tax Increases Needed. To just pay for Social Security, Medicare and Medicaid, taxes will have to increase from less than $1000 per household in 2010 to $3,000 by 2020 and over $12,000 per household by 2050.
*Spending Increases without 2009 Problems. This spending is not temporary and will continue to increase even without the global war on terror, the 2009 financial bailouts and the 2009 stimulus bill.
*Popular Programs Rapid Increase. Spending on popular programs is growing rapidly.
*Education up 169%. K-12 spending has surged 169% since 2001.
*Veteran Spending Doubled. Veteran spending has doubled since 2001.
*Medicare up 68%. Medicare Spending has jumped 68% since 2001.
*Interest Will Consume 2/3s of Deficit. By 2019, net interest costs will be two thirds the size of the entire budget deficit.

Looking for Found Money. Congress is considering cap and trade and health care legislation which involve large tax increases. There is a major search by Congress through the tax code for ways to pay for desired projects and plans. Most plans target the “wealthy” for increased taxes.

Do Nothing and Get an Automatic Tax Increase on the Rich. An obvious target: Do nothing, and by law, the exemption for estate taxes will be $1,000,000 with rates as high as 55% in 2011. The estate taxes do not generate much revenue, but given what is happening, even a few measly $100 billion extra here or there might help pay for parts of a few programs.