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Current state of affairs for estate planning

By David H. Glusman, CPA.

In order to understand the issues inherent in the current concept of estate planning, the general issue of how federal estate law and taxation of estates operates needs to be reviewed.

At the present time, an individual is entitled to a $2 million “exclusion” for estate tax purposes. In addition, if the individual is married at the time of death, an unlimited amount of assets can be transferred to the spouse upon death. Any value in the estate above the combination of $2 million plus any amounts that are desired to be transferred to a spouse, are subject to federal estate tax rates of approximately 46 percent.

With 2006 coming to a close, and many physicians beginning to go through the process of compiling information for the 2006 return preparation, it is also a good idea to look at and review current estate and financial planning related issues. While many physicians may have recently updated their estate plans, there are some issues that really need to be reviewed periodically in order to make certain that your plan is current with regard to both the law and concepts that may have come in to use since the last full estate plan update was done. This article will cover a few of the important topics that you may want to look in to.

Life Insurance

Life insurance in almost all cases should be held in a trust, not held by any individual in their own name. For purposes of illustration, the “owner” is the individual who has the right to make changes to policy. The “insured” is the person whose life is being insured. The “beneficiary” is the person to whom life insurance proceeds will be paid upon the death of the insured. In many cases, the owner and the insured are the same, and the beneficiaries designated by the owner are frequently for a spouse. This is far from ideal planning in most circumstances. If the life insurance is owned by the insured, then the policy proceeds are likely to be counted in the estate for Federal (and in some cases State) estate tax calculations. When properly planned, the same life insurance policy can be presented in a fashion where it is completely outside the estate of the insured.

In order to accomplish this, generally a Crummey Trust will be utilized. In a Crummey Trust, the owner of the policy is the trust itself. The insured will be the individual upon whose life the insurance is being placed (for this purpose, the physician) and the beneficiary will be the trust as well. When each life insurance premium is due, the individual (normally the insured and/or the insured’s spouse) will make a “gift” and transfer sufficient dollars into the separate bank account of the Crummey trust to pay the premium. Additional correspondence must be created to document certain other facts in order to make a Crummey Trust work properly and the beneficiaries will then need to “waive” the removal of the funds being transferred into the trust. Once that has been accomplished, and many years later when the insured does die, if the insurance is still in place, it will pass on to the beneficiaries through the trust without estate tax.

Gifts During Your Lifetime

For 2006, an individual can make a gift of $12,000 per year. This amount is per donor, per donee, per year. The amount is scheduled to increase in the future based on inflation tables, and the IRS will determine these amounts from time to time. In order to properly make use of this gifting option, the underlying issues should be understood. Any gift made during one’s lifetime is no longer includable in the estate at the time of death. For this reason, individuals who expect to have estates at the time of their death substantially in excess of the federal estate tax limitation (currently $2 million) would be well-served to determine whether they can afford to make transfers during their lifetime to their ultimate beneficiaries. In most cases, this involves their children.

By making a gift between husband and wife to children, each child can receive $24,000 under the current tax law. For a couple with three children, this would equate to moving $72,000 per year (plus all future appreciation) out of one’s estate. In addition, many of the assets that are currently owned are likely to appreciate in value over the remaining lifetime of the physician. This is generally true for stocks, other investments as well as real estate. For this reason, it is frequently desirable to make gifts of assets, or an interest in the assets, that is likely to appreciate. We will discuss below the use of Family Limited Partnerships for this purpose. In each year, generally as early in the year as possible, the individual should formally make gifts to the children, and, in some cases, the grandchildren, in order to move assets out of their estate.

In addition to the idea of moving gifts to children, the same can be done for grandchildren. Depending on the age of the children and/or grandchildren, an additional area that can be utilized is the funding of post-graduate education. (In Pennsylvania, generally, parents are responsible for education through 12th grade, or the age of majority, but are not generally held responsible for college education.) Under the current law, an individual can make gifts into an educational trust – generally a 529 Plan under current Federal law – for up to five years worth of the gift provision. For that reason, a gift can be made by husband and wife for each child or grandchild’s education in the amount of $120,000 at a single time, utilizing essentially all of the available gifts to that child or grandchild for five years. However, if the belief is that under current rates of tuition, the individual is going to require a minimum of $120,000 in order to complete four years of college (today’s rates for top flight schools are well in excess of $30,000 per year, including room and board and tuition), then this may be a very viable plan.

Family Limited Partnerships

A Family Limited Partnership is a vehicle that is created by (routinely) a husband and wife. Initially, the husband and wife will own 100 percent of the entity, usually 98 or 99 percent as limited partners and one or two percent as general partners of this entity. In this way, the general partnership can still be run by the parents but, as noted below, certain portions of the investment can be transferred to children or grandchildren (as well as others).

In a Family Liability Partnership there is an additional benefit; because of the operation of an FLP, generally the assets will be reduced in terms of the valuation for the gift tax transfer because of the limitation both on the transferability of the limited partnership shares (this would all be part of the operating agreement of the FLP) as well as the inability of the limited partners to control the investments as well as the distribution of funds from the FLP. While the Internal Revenue Service is still fighting in some cases and litigating in others this issue, it is generally agreed that discounts in the range of 15 percent (at the very low end) to 30 percent at the mid-point will generally be available for gifts of minority interest in a Family Limited Partnership.

In operation this works as follows. Dr. and Mrs. Smith create a Family Limited Partnership on July 1, 2005. They place $100,000 worth of GoogleA9 stock into the FLP, as well as two small rental real estate buildings that are currently rented out. In January 2006 they make a determination that they are going to transfer a portion of the FLP assets to their two children, Dick and Jane. The Google stock is valued at the date of the transfer at $110,000. The two real estate properties are appraised and total $225,000. This yields a total “before discount” value of $335,000 for the combined assets of the FLP. (We are assuming there is no debt). If each of the children can receive $24,000 per year, this would initially appear to work out to 7.2 percent of the underlying property being transferred to equate to a $24,000 gift. However, if the operating agreement of the FLP is properly drafted, there will be significant restrictions on the ownership interest that is being transferred. For this reason, the underlying asset will be worth less than $335,000 divided by 100 for each one percent unit. In fact, the total value of the property and the Google stock under these circumstances would be approximately $268,000 if a 20 percent (very conservative) discount were being taken. In this way, the actual transfer to equate to $24,000 would be just under 9 percent of the underlying FLP units. Using this method, there is an increase of approximately 20 percent over the nominal $24,000 annual gift amount.

In summary, the estate and trust issues are opportunities to enhance family wealth and to utilize the tax law to your advantage. Consulting with your tax and estate advisors can assist in understanding how these issues can work for you.

David H. Glusman, CPA is a principal at Margolis & Company P.C. and is co-chair of the firm’s Healthcare Services Group.

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