Corporate Inversions: The Good, The Bad, and The Ugly!

Dear Clients, Colleagues, and Friends,

We are all familiar with Charles Dickens’ classic novel, A Christmas Carol. Ebenezer Scrooge is visited by the Ghosts of Christmas Past, Present, and Yet to Come. By reliving his memories and peering into the future, he grows as an individual, developing a more kind and compassionate mentality, thereby benefiting his employees and community. Well, in this 2015 season of the holidays, a different phantom may be visiting you – it is called Phantom Income Tax. But by heeding this warning, you could avoid its fate.

In late October, pharma giants Pfizer and Allergan announced preliminary merger discussions and, on November 22, 2015, the boards of the two companies unanimously voted to approve a merger agreement – a stock for stock swap which will involve $160 billion. The merger, if it goes through, will be what is called an inversion, with the new company headquarters and tax domicile in Dublin (where Allergan is already based), in order to take advantage of friendlier corporate tax laws than those currently offered by the United States. However, this inversion would come at a cost to Pfizer shareholders unless they take action.

As a result of the merger, Pfizer shareholders would recognize taxable gain, not a loss, for federal income tax purposes. This merger may therefore result in phantom income, since the tax effect will be the same whether the shareholder sells or not.1 Shareholders will be given an option to cash out, but the cash-out budget will be prorated among shareholders who elect the option if more than $12 billion of stock would otherwise be cashed in. But there are ways for the shareholder to handle this phantom.

First, it is important to understand that gifts or transfers to other taxpayers, including charity or trusts, must be done before the deal’s closing date to exploit any opportunity in order to avoid the “assignment of income doctrine.” If the deal is practically certain to proceed, any transfers are treated as if the donor held the asset at the time of sale and, therefore, the donor would still incur the tax. Pfizer and Allergan expect the deal to close in the latter half of 2016, but shareholder and regulatory approval must still be secured, and politicians and the Treasury are none too pleased with this sort of corporate tax maneuver. So, while the deal may not be certain to proceed, it may, and therefore a prudent planner would begin the planning process now.

Some of the planning opportunities include gifting shares to family members (through well designed trusts) whose income tax bracket is lower than that of the donor-shareholder or who has capital loss carryforwards or expects additional capital losses in 2016. Another option would be to create a family LLC or Limited Partnership (LP), with noncontrolling minority interest, non-voting, or LP interests that hold the Pfizer transfer, with the donor-shareholder retaining control over the management of the entity controlling the amount of distributions the entity makes to its owners. The Pfizer shareholder could make outright gifts of the stock to charity or a Donor Advised Fund (a form of charity that qualifies as a public charity with low formation and operating costs), thereby allowing for a charitable deduction of full fair market value, up to 30%2 of adjusted gross income, with any unused deductions carried forward for up to five additional years. Or they could make gifts to a charitable trust, thereby retaining an income interest for themselves.

Pursuing a different trust option, the shareholder could create an Incomplete Gift Non-Grantor Trust (an ING Trust, usually in Delaware “DING”, Nevada “NING”, or Alaska “AKING”). While these trusts do not help avoid estate taxes, they can be used to avoid state income tax until distributions are made from the trust.

There are solutions for these tax traps, but the prudent shareholder should act now to best heed the warning of the new holiday “phantom”. To discuss these, or other estate and income planning options, please contact our office.

Happy Holidays!

Death and Taxes: Two of life’s Surest Things

Dear Clients, Colleagues, and Friends,

“It’s a beautiful home,” the well-coiffed realtor gushed to Sally and Ned. “How much did you say you paid?”

Ned proudly told her what he spent on their “dream home” over 30 years ago.

The realtor’s eyes shot up in surprise, “You could get 30 times that today.”

The couple stopped short, shocked. They had no idea their residence could be worth so much. With such a highly appreciated asset, they wondered how capital gains taxes might affect their decision to sell.

When Congress finally passed permanent estate tax exemptions in 2013, many people popped open the proverbial champagne. But as Benjamin Franklin once said, “In this world nothing can be said to be certain except death and taxes.” That’s never been truer than with appreciated property, and estate planners and tax professionals are shifting focus from reducing an estate’s overall assets to finding new ways to lower income taxes on those assets.

Section 1014 of the Internal Revenue Code of 1986 provides an incentive to retain appreciated assets until the death of at least one of the spouses. Under this section, in certain situations, a married couple can avoid capital gains taxes on appreciated assets through a tax-free step up in basis upon the death of a spouse. However, whether the surviving spouse benefits from that tax-free step up in basis depends entirely upon the asset’s title and order of death. For example, if the spouse holding the appreciated asset dies first, it will normally qualify for the tax-free step up in basis, but if the other spouse dies first, the tax basis does not change and a sale or other disposition of the asset will trigger a capital gain1 . This type of crap-shoot has forced professionals to look for alternative methods of providing a step up in basis at the death of either spouse, regardless of who dies first. The GRISUT or grantor-retained interest step-up trust does just that. This strategy retools familiar estate planning techniques (like QPRTs, GRITs and GRATs) for income tax basis planning purposes.

A GRISUT is an irrevocable trust funded with appreciated property2 of one of the spouses. The donor spouse retains an interest in the trust for a period that will terminate upon the death of the first spouse. When that death occurs, the property of the trust is paid over to the donee spouse or his or her estate. It is included in the deceased spouse’s gross estate, though planning would necessarily need to be put in place to take advantage of the marital deduction, and the property receives a step-up in basis, resulting in zero capital gains should the property then be sold by the survivor before further appreciation occurs.

To achieve the double basis step up for their personal residence, Ned and Sally would form a SUPRT, known as a step-up personal residence trust or “SUPRT.” The SUPRT is designed to meet all the requirements of a standard qualified personal residence trust or “QPRT.” For example, Sally retains the right to the rent-free use of the property during the term of the trust and is entitled to all of the income. In addition, the terms of the trust provide that, upon the first to die of Ned and Sally, the property shall be paid over to Ned (if he survives Sally) or to Ned’s estate (if he predeceases Sally). This vested remainder interest (to Ned or his estate) means there will be no gift or estate tax benefit to Sally’s SUPRT. In his will, Ned leaves the property of his estate to or for the benefit of Sally in a form that qualifies for the estate tax marital deduction.

With this strategy, if the law’s requirements are satisfied, Ned and Sally’s home would qualify for a tax-free step-up in basis upon either of their deaths. The surviving spouse could then exercise easier decision-making about whether to sell the house because the house’s disposition would no longer trigger an onerous capital gain.

While death and taxes are still two of life’s surest things, taxes can be decreased with the help of a qualified professional. If you own highly appreciated assets or a personal residence or vacation property and would like to discuss the benefits of the GRISUT or SUPRT strategy for your estate, call our law offices now to schedule an appointment.

For more information on these and other comprehensive estate planning and income tax planning techniques, contact us for a complimentary consultation.