New Tax Law Creates Opportunity to Recover All of the Year 2008 and 2009 Real Estate Investment Losses

In our previous Client Alert, we described the vehicle by which you can create an Estate Freeze utilizing your $5M gift tax exemption ($10M for married couples) in conjunction with a special asset protection trust, and retain a “beneficial interest” in the $5M of cash or property given to the trust.

Very few people were immune from the losses to their real estate and securities portfolios in 2008 and 2009. Investors have become extremely conservative in their investment planning seeking preservation of principal vs. preservation of capital. This Client Alert will describe a tax and investment planning structure that will not only take advantage of the temporarily higher Estate and Gift Tax exemption amount, but to do so in a manner that will replace all or most of the investment losses using investment grade life insurance. Yes, we all hate life insurance – but just indulge me for a bit longer.

Example: Let’s assume Bob, age 66, and Mary, age 60, are both in good health. Their net worth has been significantly depleted by the Great Recession and are reluctant to take much risk in their investment philosophy, looking instead for preservation of principal. Bob and Mary love their children and would like to pass as much of their estate to their adult children and grandchildren as possible, but do not at the expense of sacrificing their own lifestyle. As we like to say in the firm: Fly First Class or Your Kids Will!

Bob and Mary set up an irrevocable trust in a qualifying jurisdiction and are named as “discretionary beneficiaries” within the trust instrument. Bob and Mary each make a tax-free gift of $1M in cash to the trust, utilizing their respective $5M unified gift tax exemption. Under the PLR 200944002, Bob and Mary will be deemed to have made a completed gift despite being able to access up to the entire gift made to the trust by the “independent but friendly” trustee. Thus, the $1M gift plus any life insurance proceeds will be removed from Bob’s and Mary’s taxable estate at their respective deaths.

The trustee of the trust applies for an investment grade low-load life insurance policy with a highly rated company on both Bob and Mary, and the trust is named owner and beneficiary of the policies. Bob’s one time $1M premium buys a life insurance policy of $2.7M death benefit, plus the policy has a cash value account of 99.6% of the premium paid. Mary’s $1M single premium buys a $3.7M death benefit and has 99.7% of the premium paid. In short, the life policies perform similar to a high yielding tax-free bond but with a bonus feature called “death benefit”. Under this structure, Bob and Mary have collectively turned $2M that would have been worth only $1,000,000 to their heirs into a $6.4M ($2.7M and $3.7M) secondary estate recovering all or most of their investment losses, both income and estate tax free wealth for their children and grandchildren whether death occurs now or after age 100.

Moreover, utilizing the benefits of the above-described PLR, during Bob’s and Mary’s lifetime, the trustee can access the cash value of the policies for Bob’s and Mary’s personal use, on a 100% income tax free basis, if desired. Each year, based on current assumptions, the cash value of the policies will increase at a rate of 5.25% and if interest rates increase, so will the interest rate paid on the cash value. Moreover, the increase in the cash value is not subject to income tax and may be removed from the policy income tax free. Bob and Mary suffered investment losses during the Great Recession. This plan allows them to replace up to $6.4M of those losses from the insurance company’s death benefit payment.

LIQUIDITY A PROBLEM? – Never: If you don’t have the cash to make the gift to fund the life insurance policy, consider financing the premium. For example: If Bob and Mary have the net worth and want to take advantage of the higher gift tax exemption but don’t have the ready cash to fund the policy, a bank that specializes in premium financing will loan Bob and Mary each $1M to purchase the life insurance. The policies can then be transferred to the trust qualifying for the gift tax exemption. The lender will take a collateral assignment (lien) of the insurance policy and its cash value while the loan is outstanding. Premium financing loans carry an interest rate between 2.75% to 5%, depending on the financial and credit strength of the borrower. The interest is paid annually on an interest-only basis so the cost to carry the policy is manageable. The policy will be designed to have sufficient equity to repay the lender when it is desired and the lender removes the collateral assignment and the death benefit and cash value will be free of liens. It is necessary to leave a sufficient amount of cash value in the policy so the policy doesn’t expire from lack of liquidity. In the meantime, the lender will look for repayment from the life insurance policy at the death of the insured provided the borrower continues to make the annual interest payments. Consider the result, $27,000 – $50,000 annually to create $6.4M income and estate tax free asset, the return on investment is very compelling.

The Loan Arbitrage Planning Pointer: For those with substantial liquidity and who want to supercharge their wealth transfer planning (and not give up the income stream), the following might just be for you: Bob and Mary have a substantial tax free bond portfolio with a 4% coupon rate. Bob and Mary want to maximize the use of their $5M gift tax exclusion but do not want to liquidate their fine bond portfolio. Bob and Mary use their bond portfolio as collateral for two $5M loans issued by a national premium financing lender. The lender will charge Bob and Mary 2.75% interest on the loan. Bob and Mary gift the loan proceeds to the trust, and along with their children and grandchildren, are discretionary beneficiaries of a qualifying trust under PLR 200944002. The trust purchases the aforementioned life insurance policy on both Bob and Mary naming the trust as the owner and beneficiary.

Under this scenario, Bob is able to purchase $14M of death benefit, and has a 1st year cash value account balance of $4,980,000. Mary is able to purchase a policy with a $19M death benefit and a 1st year cash value account balance of $4,985,000. Bob and Mary have a loan balance with the premium financing lender of $10M and annual interest payments of $275,000. They also have a tax free bond portfolio earning 4%, or $400,000 on $10M. Bob and Mary use a portion of the bond interest to pay the premium financing lender and make the interest spread of $75,000 each. Lastly, if either Bob or Mary die before the premium financing loan is repaid, the debt will constitute a liability for which the estate will receive a deduction in computing his or her taxable estate.

If interest rates begin to rise, the trustee can withdraw $5M from the cash value account (tax free) and distribute the funds to Bob and Mary to be used to repay the premium financing lender. In short, using life insurance, Bob and Mary have turned their $10M gift into a secondary estate of $33M, income and estate tax free (at their deaths) using assets they already own.

The foregoing will vary according to your age and health. If you are unable to qualify for life insurance, consider applying this modeling for your adult children. You may make a gift to the trust and qualify for the $5M gift exclusion. Your children, as trust beneficiaries, can be the insured on the life policies and at their death, the death benefit will pass to their children (your grandchildren) estate tax free. In the meantime, you can continue to access the cash values of the life insurance policies as described above.

What Congress giveth Congress can take away… In my view, when Congress realizes the extraordinary gift they have thrust upon the American taxpayer, they will not extend the gift tax exclusion beyond 12/31/2012. Therefore, we are advising our clients to maximize their gift tax exclusion or “lose it.” Once the gift is made to the trust, it will be grandfathered and any subsequent change in the law will not apply to previously made gifts.

For more information about any of the information discussed in this Client Alert, or any other income or estate tax planning or asset protection planning assistance, please contact Jeffrey M. Verdon Law Group, LLP at or (800) 521-0464.

Paying Estate Tax May Now Be Voluntary

This is our 3rd installment of the planning opportunities available under the new estate and gift tax laws created under the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the Act).” This edition of Client Alert will focus on an effective estate planning technique which literally may make paying estate taxes voluntary and “bullet proof” your assets from a financially ruinous lawsuit.

The Act increased the amount that one can give away or die possessed of from $1M to $5M without being subject to gift or estate tax through December 31, 2012. (The new law sunsets in 2013 and reverts back to the 2001 law so take advantage of these benefits while they last.) Married couples can combine their exemption to $10M. Any unused exemption may be added to and used by the surviving spouse.

A common goal in estate planning is to remove future appreciating assets from the estate, especially when the assets are currently depressed in value, and ultimately transfer the future growth to a future generation of beneficiaries without incurring any immediate gift tax. In this manner, the estate tax to be imposed on the future appreciation won’t be collected for one or more generations, allowing the asset values to increase for the benefit of one’s descendants.

Example: An owner of income producing real estate owns an apartment building that used to be valued at $3M but due to the real estate recession is only worth $2M. The owner would want to gift the apartment building to a trust for her children and grandchildren, and with the increased exemption, pay no gift tax. If the apartment building appreciates to $10M over the remaining life expectancy of the parent, the value of the real estate will not be subject to estate tax at the parent’s demise. This estate freeze has the effect of removing $9M of appreciation from death taxes and passing them to her heirs in a highly tax efficient manner. Based on a 50% estate tax rate, the heirs save over $4M in taxes.

Unfortunately, to achieve this result, the parent must give up all “dominion and control” including any of the cash flow (rental income) produced from the property. If an income stream was needed, the foregoing plan was not a very practical planning tool.

Recent developments in the tax law combined with the significant increase in the gift tax exemption, now provide a unique opportunity to make your estate taxes voluntary, while retaining the ability to enjoy the income stream from the gifted asset. In several recent private and public rulings, the IRS has held that a taxpayer who establishes a trust in a jurisdiction with laws that will not allow the taxpayer’s creditors to reach the trust’s assets will be permitted to be a discretionary beneficiary of the trust , allowed access to the income and corpus on a “discretionary” basis, and the value of the assets held in the trust will not be included in the taxpayer’s estate at death. Although certain states restrict a creditor’s ability to levy against trust assets transferred by the taxpayer, there are numerous uncertainties as to whether the states’ laws (other than those of Nevada and Alaska) comply with these IRS rulings. (It isn’t clear whether a non-resident of Nevada or Alaska may gain the protection of the state’s asset protection trust.)

Planning Pointer: The Offshore Trust: There are certain offshore jurisdictions whose laws do comply with the IRS rulings mentioned above. For example, the Cook Islands is one location where regardless of the state in which you reside, you can set up a trust domiciled in the Cook Islands in which you are a discretionary beneficiary and the trust’s assets will be completely outside the reach of your personal creditors. (Even though the Trust is “offshore” for income tax purposes, the trust is taxed as a U.S. grantor trust and the income is reported on the trustor’s personal tax return.) It is not illegal to have an offshore trust provided you tell the IRS you have it and file the necessary tax forms. The assets, themselves, do not have to be offshore, just titled in the name of the trust. These assets can remain at your favorite bank or brokerage firm, or in the case of real estate or entities holding real estate, these assets can be U.S.-based (provided they are held in the offshore trust).

Variations of this technique can be effectively implemented for non-resident aliens owning U.S. real estate and for those wishing to immigrate into the U.S., eliminating U.S. estate tax for such persons.

If you have an interest in learning if this technique can be implemented by you to achieve the foregoing benefits, please feel free to contact me. I would also be happy to speak with your tax professional.

In the next issue of Client Alert, I will describe a structure that will not only allow you to do an estate freeze and retain the use of the cash flow from the assets, but also supercharge the value of the asset being passed on to the heirs.

For more information about any of the information discussed in this Client Alert, or any other income or estate tax planning or asset protection planning assistance, please contact Jeffrey M. Verdon Law Group, LLP at or (800) 521-0464.