Slides For IICLE Estate Planning Shortcourse Speech 2011 (Limiting Gifts )

Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; JSM, a Hong Kong partnership, and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown isassociated. The Mayer Brown Practices are known as Mayer Brown JSM in Asia.

Creative Ways to Limit the Value of a Gift

Pamela Lucina, JP Morgan(312) 336‐1694 [email protected]

Natalie PerryShefsky & Froelich312/836‐[email protected]

2011 IICLE Shortcourse

Agenda

• Introduction: legislation for 2011‐2012 created enormous estate planning opportunities:

– $5 million gift/estate/GST exemption

– Low AFR and 7520 rates

– No legislation (yet) re: short‐term, zeroed‐out GRATs or FLP/LLC discounts

– Illinois has an estate tax but does not tax gifts

• Do large gifts make sense? Is the risk/benefit worth it?

3

333

Wealth allocation example - Mr. and Mrs. Anderson

Mr. and Mrs. Anderson– Both are age 45– Three Children (Sophie, Bella and Josie)– Residents of Illinois

Investment Assets: $10 million in a fully diversified portfolio1 Family Business Stock Fair Market Value $15 millionCash flow requirements: Annual cash flow needs2

– Spending: $500,000)– Charitable gifts: $10,000Total: $562,000 (2.2% of investment assets)

Core financial goals– Maintain lifestyle: “We don’t want to run out of money.”– Financial cushion: $10 million liquid assets3 at age 95– Transfer “Enough” To Children

1 Balanced Strategic Portfolio asset allocation: 47% equity, 38% Fixed Income, 6% Alternatives, 9%Cash2 Adjusted for inflation at 3.0% annually3 Nominal valueNote: A $13K gift tax exemption may be applied per child per year.

Agenda

• Three common scenarios:– Individual “A” – Would like to gift a specific amount but has hard to

value assets and would like to cap gift tax exposure

– Individual “B” – Sees wisdom of wealth transfer but wonders whether she can afford it

– Individual “C” – Worries about leaving too much to children and becomes paralyzed

Individual “A” – Would like to gift a specific amount but has hard to value assets and would like to cap gift tax exposure

Limiting Gifts to What is Intended and No More – Defined Value Clauses

• Defined Value and Savings Clauses

• Why This May Resonate

• Types of Adjustment Clauses– Savings Clauses

– Defined Value Clauses


• Case Law

– Public Policy Argument – Procter v. Comm’r

– Condition Subsequent

• King

• McCord

• Christiansen/Petter


• Practical Tips for Structuring

– Multiple Parties

– Allocation of Excess

– Charitable Interest

– No Excuse to Skip an Appraisal

Individual “B” – Sees Wisdom of Wealth Transfer but Wonders Whether She can Afford It

Limiting Gifts for Individuals who Worry Whether They can Afford to Gift – Financial Modeling

• The Challenge

• Wealth allocation example

11

Wealth allocation planning process

1 Based on proprietary J.P. Morgan asset class projections.2 Typical markets are median markets.For further information, see Appendix pages entitled “Pre-tax equilibrium return and risk assumptions” and “Understanding ‘equilibrium’ estimates.”

“Core Needs”• Annual spending

(inflation-adjusted)• Financial cushion of

assets needed in oldage

• Target assetallocation andportfolio based onrisk/returnpreferences

Weak Markets

Typical Markets2

Strong Markets

Client-specific Ranges1

(95th percentile)

(50th percentile)

(5th percentile)

Aspirational goals• Personal Passions

- Consumption- Investments

• Wealth transfer tofamily

• Philanthropy

Client Goals• Financial

security• Aspirations

Financial facts• Statement of

financial assets• Statement of

cash flows• Taxes

Review the plan annually and adjust periodically

1Determine goals and financial position

2Ranges of projected future wealth

3 4Define allocation to core portfolio

Allocate and use surplus

12

121212

Wealth allocation example - Mr. and Mrs. Anderson

Mr. and Mrs. Anderson– Both are age 45– Three Children (Sophie, Bella and Josie)– Residents of Illinois

Investment Assets: $10 million in a fully diversified portfolio1 Family Business Stock Fair Market Value $15 millionCash flow requirements: Annual cash flow needs2

– Spending: $500,000)– Charitable gifts: $10,000Total: $562,000 (2.2% of investment assets)

Core financial goals– Maintain lifestyle: “We don’t want to run out of money.”– Financial cushion: $10 million liquid assets3 at age 95

1 Balanced Strategic Portfolio asset allocation: 47% equity, 38% Fixed Income, 6% Alternatives, 9%Cash2 Adjusted for inflation at 3.0% annually3 Nominal valueNote: A $13K gift tax exemption may be applied per child per year.

20.9 21.3 21.2 19.528.9

33.0

42.7

54.9

39.8

50.4

82.1

128.2

0

20

40

60

80

100

120

140

Assumptions1: initial wealth value = $25MM with an annual inflation rate of 3.0% and $500K in annual spending.

($MM)

Range of projected wealth values

Year 5 Year 10 Year 20 Year 30

Meets $10MM desired cushion

Balanced

Most probablecash flows1

95th percentile1

50th percentile1

5th percentile1

(Strong Markets)(Typical Markets)(Weak Markets)

Wealth projections show even in weak markets Mr. and Mrs. Anderson may exceed long-term financial goals

1 562K annual spending is inflation-adjusted2 “Most probable wealth values,” denoted by the darkly shaded area, indicates the range in and around the 50th percentile. The “50th percentile” indicates the middlewealth value of the entire range of probable wealth values. The “95th percentile” wealth value indicates that 95% of the probable wealth values will be equal to or belowthat number; the “5th percentile” wealth value indicates that 5% of the probable wealth values will be equal to or below that number. Another way of looking at it is that90% of the probable wealth values will be between those two figures.Note: This is a projection used for illustrative purposes only and does not represent investment in any particular vehicle. References to future wealth values are not promisesor even estimates of actual returns you may experience, and projected end values in year 30 are not present values. Monte Carlo simulation is an analytical technique whichuses a large number of calculations of uncertain or random variables. Statistics on the distribution of results can help us infer which values of the simulated portfolio variablesare more likely. See appendix for further information on Monte Carlo simulation. Calculations are based solely upon assumptions listed; see asset allocation page for asset allocation detail. For further information, see Appendixpages entitled “Pre-tax equilibrium return and risk assumptions” and “Understanding ‘equilibrium’ estimates.” Please refer to the “Analysis assumptions” for tax rates andcash goals (inflows and outflows) assumed in the analysis. 13

14

141414

Mr. and Mrs. Anderson allocate $1MM surplus capital to fund personal passions

• Second home• Global travel• Invest in a winery• Personal trading account

Mr. and Mrs. Anderson’s personal passions

Personal Passions$1MM

Surplus Assets

$4MM

Note: Examples for illustrative purposes only

15

151515

The Andersons also seek to provide wealth to future generations

• Intra‐family giving:

– Children (annual gift exclusions)– Grandchildren ($10MM available)

• They established and funded a Generation Skipping Transfer (GST) trust for the grandchildren, leveraging a portion of their combined lifetime gift exemptions

Mr. and Mrs. Anderson


Surplus Assets

$4MM

Family$2MM

Mr. and Mrs. Anderson

GST Trust

Future generations

Transfer $2MM assets to GST

May continue in perpetuity

GST funded with $2MM, partially utilizing Mr. and Mrs. Anderson’s lifetime gift exemptionsNote: The GST exemption amount for 2011 is $5,000,000 ($10,000,000 if you are giving as a couple).1

Illustration of Generation-Skipping trust

16

161616

The Andersons have substantial philanthropic interests

Mr. and Mrs. Anderson considered 2

philanthropic strategies:

• Make annual gifts

• Donor‐Advised fundStrategy selected by the Andersons


Surplus Assets

$4MM

Family$2MM

Charity$1MM

1 Private foundations’ Net Investment Income may be subject to a 1% or 2% excise tax.

Limiting Gifts for Individuals who Worry Whether They can Afford to Gift – “Recapture”

• Include Spouse as a Potential Beneficiary of an Irrevocable Descendants’ Trust

• Why this may resonate– Safety valve to get assets back to parents if they actually do run out of money

– Escape hatch to completely unwind the transaction if children behave badly

• Watch out for reciprocal trust doctrine


• Additional Flexibility – (caveat of implied agreement doctrine)– Spouse’s Testamentary Limited Power of Appointment

– Spouse as Trustee

• GRAT planning as possible application

• Consider Possibility of divorce


• Self‐Settled Trusts

• Why this may resonate

• Must carefully structure remainder trust under the laws of a state that permits self‐settled irrevocable trusts

• Implied Agreement – Emergency funds only

– Independent trustee


• Retention Powers

– Donor as Trustee?

– Donor as Co‐Trustee?

– Spouse/Close Friend as Trustee?

– Distribution Standard

– Limited Power of Appointment


• Grantor Retained Annuity Trusts (GRATs)

• Why this may resonate

• Financial modeling is key– Valuation discounts

– It is ok to give back more than initial fair market value

• Incorporate flexibility to reallocate remainder

• Protect trustee (or special trustee)


• A tax efficient charitable giving “option” using a private placement variable annuity (PPVA)

• Why this may resonate– Interested in giving to charity but worried about running out of money

– Segregate in income tax friendly vehicle but allow individual to recapture


• What is a PPVA?• Annuities offer a stream of distribution in the future in exchange for an upfront payment

– Income tax is not paid until the owner receives income

– 10% excise tax for those under age 59 ½ applies

• Retail annuities usually have hefty fees and charges in exchange for guaranteed return

• Private placement annuities strip out the bells and whistles associated with annuities

– Investment flexibility

– Lower costs


• What is “private placement”

– Non‐registered investment vehicle

– Available only to accredited investors/qualified purchasers

– Available only through Private Offering Memorandum


• How may a PPVA strategy accomplish client’s goals?

– Client allocates investment assets to a PPVA contract

– Investments inside PPVA contract grow income tax free

• In some products, client can withdraw assets any time in any amounts, or cancel annuity contract at any time without fees

• Any distributions out of PPVA contract back to client in excess of basis taxed as ordinary income

• If charity is beneficiary, no estate or income taxes at death

Individual “C” – Limiting Gifts for Individuals who Worry About Descendants Receiving Too Much Money

Limiting Gifts for Individuals who Worry About Descendants Receiving Too Much Money

• Profile– Often first generation wealthy

– Paris Hilton effect

– Entitlement/Stewardship

• The Dilemma – Sees value in planning

– paralyzed

Limiting Gifts for Individuals who Worry About Descendants Receiving Too Much Money

• The Challenge: To present flexible planning options to the individual that allow for tax‐efficient transfer of wealth but provide a “safety valve” so the individual doesn’t feel locked‐in to a strategy that might transfer too much

• Two Approaches:– Payment or “Stipend” Approach

– Diversion Approach

Limiting Gifts for Individuals who Worry About Descendants Receiving Too Much Money – Stipend

• Stipend Approach

• First Step: Modeling for “right amount” or what is “enough” per clients vision

– How many generations does grantor wish to support?

– Quantify costs to fund lifestyle targeted by grantor.

• Is trust a backup support? (implies discretionary payments)

• Or true stipend? (implies mandatory or periodic payments)

• Or combination of the two?

Estimated Estate Disposit ion for Jane Smith (having survived John Smith)

Executor: William SmithSuccessor executor: JPM

Jane Smith's non-probate estate Jane Smith's probate estate

401(k) & IRA Residuary M arital Trust

Death Benef it of Life Insurance13

Jane's Interest in Real Estate

Tangibles Outright Bequest of ABC Company

under John's Will14

Jane's 9.9% Interest in LLC14

Insurance proceeds Jane

received at John's death

10% of Residuary Jane received

Outright under John's w ill

M arketable Securit ies

1996 Charitable Remainder Unit rust 11

254,413$ 112,668,484$ 156,000$ 10,852,868$ 2,711,214$ 568,451$ 1,485,000$ 10,135,000$ 21,846,827$ 5,000,000$ -$

Children Trust for Siblings's Children

Foundation Trust for Children Children 1% of ABC Company to Each

Child(2% total)

1% of LLC to Each Child(2% total)

Cash Gif ts to Individuals

Charit ies

10% 20% 70% 1/3 to Foundation2/3 in Trust for

Children74,091$ 5,313,624$ 22,533,697$ 37,195,366$ 2,711,214$ 11,369$ 29,700$ 1,200,000$ 14,876,119$ 11,943,302$ $

Note: Note: Note: Note: Note: Note: • Residuary t rust divided into 3 shares:• 10% to Trust to be divided into shares as any brothers and sisters of John and brothers and sisters of Jane have children then living and issue of predeceased child. Each share for issue of a sibling who has at tained age 35 goes outright . For issue (“ benef iciary” ) under age 35 share held in t rust .

• 70% to t rust for children. Unt il benef iciary at tains age 21, Trustees to pay income and, unt il benef iciary at tains age 35, to pay principal as Trustees determine. Af ter age 21, benef iciary has right to withdraw income. Af ter age 30, benef iciary has right to withdraw 10% of FMV of t rust . Upon at taining age 35, benef iciary has right to withdraw 1/3, and upon age 40, ½ of t rust ; and at age 45, the remaining t rust ; provided that Trustees may withhold if pending legal claims payable by the benef iciary. Upon benef iciary’s death, t rust goes as benef iciary appoints by will (general POA). In default , to benef iciary’s issue per st irpes, provided that any property going to a benef iciary who has a t rust shall be added to that t rust .• Trusts end at expirat ion of perpetuit ies period.

• Ruby & diamond engagement ring; and emerald & diamond pin that belonged to mother in law, to Mary.• Emerald & diamond ring; and t riple st rand pearl necklace with emerald & diamond clasp to John.• Balance of jewelry is divided between children as they agree.• Jane directs Executor to sell works of art and ant iques with value each of $20,000 or more and add proceeds to residuary though children have 1st opt ion to purchase. Balance of tangibles goes to children.

• Jane makes cash gif ts if the individual survives her:• $400,000 to brother.• $200,000 to each of niece and nephews• $100,000 to Mary• $100,000 to JakeThese gif ts pay their share of death taxes.

• A port ion of this t rust w ill be includible in Jane's estate. • Upon Jane's death: greater of $1 million or 25% to Middlesex School and 75% to Family Foundat ion.

Estimated gross estate: $165,678,257Est imated administrat ion expenses: ($3,313,565)Debts: ($861,154)Est imated estate taxes16: ($65,569,162)Est imated income taxes17: ($45,894)

Residuary15

• 1/3 to Family Foundat ion and 2/3 iis divided into shares for each child and for issue of predeceased child (“ benef iciary” ) and unt il benef iciary at tains age 21, Trustee to pay income and, unt il benef iciary at tains age 35 (note—this is dif ferent age than under John's will which uses age 30), to pay principal as Trustees determine. Af ter benef iciary at tains age 21 he or she has right to withdraw income. Af ter age 30, he or she has right to withdraw 10% of FMV of assets. At age 35 (note-is dif ferent than age 30 under John's will) may withdraw 1/3 of t rust ; at age 40, ½ of t rust ; and upon age 45, may withdraw the remaining t rust ; provided Trustees may withhold distribut ion if there are pending legal claims. Upon the death of benef iciary, t rust goes as benef iciary appoints by testamentary general POA. In default , to benef iciary’s issue per st irpes, or if none, to Jane's issue per st irpes; provided that property going to a benef iciary who has a t rust shall be added to that t rust .• Trusts end at expirat ion of perpetuit ies period.

Estimated estate disposition for wife (having survived husband) under will dated month day, 20XX using ATLAS

Limiting Gifts for Individuals who Worry About Descendants Receiving Too Much Money – Stipend

• Second Step: Trust considerations for the stipend approach– Lifetime distributions to childe, balance to charity

– CRT

• CRAT

• CRUT

Limiting Gifts for Individuals who Worry About Descendants Receiving Too Much Money – Diversion

• Diversion Approach

• Donors Power to Divert– Why this may resonate

– Trustee


• Power to Add Beneficiaries– Why this may resonate

– Who should hold the power?

• Donor

• Donor’s spouse

• Beneficiary

• Trustee (individual or corporate)

• Special Trustee

– Limits to power



• Powers of Appointment– Why this may resonate

– General Power of Appointment

– Limited power of Appointment

• Beneficiary – Lifetime/Testamentary

• Non‐beneficiary

– Delaware Tax Trap



• GRATs revisited– Capping the Distributions

– Power to Add Beneficiaries

• 529 Plans– Why this may resonate

– Ability to Change Beneficiaries

• Tax Consequences

• Member of the Family

• Changes to Non‐Family Members

• Changes to Next Generation

Limiting Gifts for Individuals - Conclusion

• First Step: Financial Modeling

• Second Step: Incorporate Flexibility into Plans

IRS Circular 230 Disclosure:J.P. Morgan Chase & Co. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with J.P. Morgan Chase & Co. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

.

Please keep in mind

Slides For IICLE Estate Planning Shortcourse Speech 2011 (Limiting Gifts )

Documents

Transcript of Slides For IICLE Estate Planning Shortcourse Speech 2011 (Limiting Gifts )