Major Tax Changes – Administration’s Proposed Tax on Dynasty Trusts

Dear Friends, Colleagues, and Clients,

This week, the Obama Administration released its report detailing the myriad of changes coming to the tax laws, many of which are slated to take effect by the end of this year. This announcement should come as no surprise to our Client Alert recipients, as we have been warning of this coming tidal wave of change for the past two years.

Under the guise of the fair and equal treatment of millionaires and billionaires, the Obama Administration is proposing to substantially alter many key areas of the tax code, with many changes poised to prevent affluent taxpayers from utilizing several of the traditional wealth transfer planning structures.

This Client Alert is not intended to be a complete review of the changes (subsequent Client Alerts will cover these), but it will highlight the important changes that will certainly diminish the wealth transfer opportunities presently available.

One of the Obama Administration’s 2013 Revenue Proposals would limit the duration of the generation-skipping transfer (“GST”) tax exemption. The GST tax is imposed on transfers that skip a generation, for example, transfers from a grandparent to a grandchild. Upon the transferor’s death, to the extent distributions are made from the trust to the transferor’s grandchildren or other skipped persons, the GST tax will be payable on the value of the transfer at the highest estate tax bracket applicable in that year. Under current law, a person has a lifetime GST tax exemption ($5,120,000 in 2012) that can be allocated to all gifts in trust.

This is important because many states have repealed or limited the application of the Rule Against Perpetuities, so that trusts may continue forever (Florida allows trusts to last for up to 360 years). These trusts, commonly referred to as Dynasty Trusts, are a popular estate planning technique. By placing assets in a Dynasty Trust and allocating the GST exemption to those gifts, the assets can be held in trust without being subject to any further gift, estate, or GST taxes from generation to generation. However, the new Revenue Proposals would tax a trust on the value of all of its assets at the proposed new 45% estate tax rate every 90 years.

Fortunately, a trust created before the enactment of the new law will be forever exempt from the new GST tax. The proposed change to limit the GST tax exemption, coupled with the Obama Administration’s additional proposal to reduce the GST tax and gift tax exemptions back to their 2009 level of $1,000,000 (as compared to the $5,120,000 available this year) creates a sense of urgency for anyone thinking of making a gift in trust during the remainder of 2012. Such gifts must be made prior to the enactment of the proposed legislation, which may occur by the end of this year.

In summary, such trusts formed and funded after the implementation of the tax change would be taxed every 90 years. On the other hand, a trust created and funded before the enactment of the new law will be forever exempt from the new GST tax. Therefore, we recommend that you consider making a gift in trust, even if it is of a small amount, as soon as possible to take advantage of having a trust that is exempt from the proposed 90 year tax on Dynasty Trusts. Most importantly, once a GST tax exempt Dynasty Trust is in place, it can be used as a platform for future estate planning without having to worry about exposing the trust to an estate tax every 90 years.

Furthermore, with the Obama Administration’s proposal to limit the gift tax and GST tax exemptions to $1,000,000, anyone considering gifts in trust in excess of $1,000,000 should also take advantage of this limited opportunity available for the remainder of 2012.

If you have any questions regarding this Alert and need assistance in implementing your gift, please contact Susan Jerome, Director of Client Services, to schedule a no charge consultation.

Immediately following this Client Alert will be another one summarizing additional important and impactful suggested tax law changes under the Obama Administration’s Revenue Proposals.

Jeffrey M. Verdon, Esq.

Jeffrey M. Verdon Law Group, LLP

Asset Protection for Multiple Partners and Business Owners

Dear Friends, Colleagues, and Clients,

Individuals often implement asset protection strategies to protect their personal assets from the individual’s unforeseen creditors. In today’s litigious society, it is necessary that the prudent businessperson consider utilizing asset protection strategies not only to protect one’s individual assets, but also to protect those assets owned by the company. This Client Alert will focus on two techniques used to protect the assets of both the business and the business owners from exposure to liability: (1) establishment of a foreign asset protection trust by the company itself and (2) settlement of a group foreign asset protection trust for a business with multiple business owners or associates.

Entity Asset Protection Trust

In earlier Client Alerts, we described the design and benefits of forming a foreign asset protection trust (APT), usually in the context of protecting one’s individual assets. The Cook Islands is a jurisdiction with very favorable trust laws, providing significant protection from a Settlor’s creditors even where the Settlor is also the beneficiary of the trust. A business can also form an offshore APT, which we call an “entity asset protection trust” (EAPT), and name the business entity as the sole beneficiary of the EAPT. However, the EAPT can be designed to allow direct distributions to the business owners so long as the distributions are in the best interest of the business and are made “on behalf of the business.”

If properly formed, the EAPT is considered a grantor trust for income tax purposes, meaning that the income from the trust assets is attributed to the company and not to the EAPT.

Furthermore, contributions by the company to the trust will not constitute a “completed gift,” thus avoiding any gift tax issues. The EAPT should be established for a business purpose, such as forming a separate investment vehicle for trust assets and to preserve those assets against unforeseen liability, so that the trustee may distribute assets back to the business and to the business owners without incurring individual tax liability for the owners or for the trust. Ideal assets to be held in the EAPT are the company’s liquid assets including its retained earnings and intellectual property, i.e., patents, trademarks, licenses and other similar assets.

If the trust is established for the personal planning needs of its owners, any distributions from the business to its owners will likely trigger negative income, gift, and estate tax consequences. Business owners should carefully document the “business purpose” by describing it in the company’s minutes, including the company’s beneficial interest in the trust as an asset on the company’s financial statements, and notating each distribution to a business owner as one made for the direct benefit of the company.

In addition to being the Settlor and sole beneficiary of the trust, the business can also be the trust protector. As protector, the business would have the authority to veto trustee investment and distribution decisions, allowing the business to still retain some control over the trust assets. Moreover, naming the company as the trust protector offers further evidence that the trust was created for the benefit of the business rather than for the owner’s personal benefit. Finally, the EAPT can also be designed so that these protective provisions only apply so long as the business is controlled by persons that acquired his/her ownership interest through a bona fide voluntary sale or gift from a previous owner.

Group Asset Protection Trust

Another option to consider is the group asset protection trust (GAPT). This structure is particularly useful for business owners who share ownership with multiple individuals, such as is often the case with CPAs, lawyers, physicians and consultants, all of whom may be subject to future unforeseen liability claims. The GAPT is a very cost effective way to reduce the expense to each owner to create effective “firewalls” that insulate certain assets owned by the business owner and his or her family. With a GAPT, instead of the APT having a single settlor, each participating owner is a settlor with the other owners in a common or group APT. The GAPT will have a sub-APT created under the master GAPT document for the benefit of each participating group member. That way, each owner of the company can place his or her selected assets in the GAPT and enjoy the protections afforded by the APT just as though the APT was established for the individual without other members.

The downside to using a GAPT is that each Settlor of the GAPT is limited to using the same method for distributions of the trust’s assets to their intended heirs, rather than having the ability to use the customized dispositive provisions associated with individual APTs. However, at any time, the Settlor of a GAPT may split off from the GAPT and convert his or her sub-trust into a personal APT (such as when the level of assets held in the sub-trust becomes large enough to warrant formation of an individual APT). In this litigious world, the GAPT may be a very cost effective structure to provide effective asset protection planning at a very reasonable price tag.

Contact Susan Jerome, Director of Client Services, for further information (susan@jmvlaw.com or 800-521-0464).

Jeffrey M. Verdon , Esq.

Jeffrey M. Verdon Law Group, LLC