Dear Clients, Colleagues, and Friends,
During the past few weeks, concerns over the coronavirus has spread into our consciousness, our communities, our families, and our clients.
I want you to know that I am here for you to help in any way I can. Your health, well-being, and peace of mind are what matter most to me. While today’s environment is something none of us has ever lived through, my firm stands strong and ready to assist, whatever comes next.
Not long ago, a politician famously stated: “Never let a good crisis go to waste.” Such a crisis has arrived, and as a law firm specializing in comprehensive estate and income tax planning for the affluent client, our imperative is to identify planning opportunities when they occur even under these current conditions and communicate these to our loyal network of clients and Client Alert readers.
To that end, there is a once-in-a-generation estate and tax planning opportunity that will not likely again be available to those who wish to seize the opportunity brought on by the current crisis. The Great Recession of 2009 created similar opportunities and many of our valued clients seized the opportunity when presented.
In previous Client Alerts, we have described a strategy designed to “freeze” the value of your estate (even reduce value using allowable asset discounting) while shifting the future appreciation to a dynasty trust avoiding death taxes for literally 300+ years. We call this technique the Preferred Partnership Freeze (PPF). The PPF uniquely provides both the estate tax savings while taking advantage of income tax laws which permit a tax basis step up at death. Rarely does an estate tax planning technique allow both.
How Does the PPF Work
You identify assets expected to appreciate in value over time which might include closely held businesses, investment portfolios, and especially encumbered real estate, and then contribute those assets to one or more limited partnerships (“LP”) that are established with two classes of LP interests: 1) a class of Preferred LP shares; and 2) a class of Common LP shares. You keep the Preferred LP shares and then you gift or sell some or all of the Common LP shares to a newly formed dynasty trust, such as our HYCET Trust. This action freezes the current value (by the Preferred LP shares) while shifting the future appreciation to the Common LP shares you transferred to the dynasty trust and avoided estate tax for 300+ years.
At death, the “frozen” value of the Preferred LP shares is included in your taxable estate, but not the appreciated value of the Common LP shares. Because of certain special partnership tax rules, your estate will receive an income tax free step up in basis (outside basis) of the Preferred LP shares, the tax code allows this basis step up to be applied to the “inside” tax basis of the assets owned in the LP. Increasing the “inside tax basis” results in a higher tax basis for amortization and depreciation purposes (for sheltering rental income, for example) to the surviving limited partners. When the asset(s) is later sold, the increased tax basis reduces the capital gains on which the tax would otherwise be assessed.
In valuing Preferred and Common LP shares, discounts in the range of 25% to 40% or more are available for lack of marketability and lack of control, further reducing the value of the Preferred LP shares ultimately taxed in the estate.
Coupling these natural discounts associated with current low interest rates, taken together with declining asset values caused by the tumult in the markets due to the coronavirus, this is a once-in-a-generation planning opportunity to move the significant value of your taxable estate into a dynasty trust, like our HYCET Trust.
For those with larger estates who lack enough gift exemption to remove the assets to the dynasty trust without incurring gift tax liability, there is yet another solution. You can sell the Common LP shares to your dynasty trust for a long term (20 to 25 years) at a fixed interest rate (March AFR 1.44%, and likely lower for April). Why is this a potential solution? Any increase in value above 1.44% defers the estate tax for generations.
It’s important to remember the big picture in the midst of this day-to-day crisis. As you know, the generous lifetime exemption of $11.580M will be cut in half on January 1, 2026, and if there is a change in the White House this November, estate and gift tax exemptions could be repealed altogether while tax rates increase. Moreover, to help pay for the new stimulus package likely to be between $1T and $2T, look for these generous gift and estate tax exemptions to be rolled back well before 2026.
Again, this is a once-in-a-generation planning opportunity that will not likely be available once we recover from this current crisis.
Stay safe as we will weather this crisis as we have so many times in our great history. Also recognize in times like these, opportunities arise about which we wanted you to know. Please don’t hesitate to contact us if you wish to discuss this or any other tax planning opportunity.
Jeffrey M. Verdon, Esq.
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 the: Jeffrey M. Verdon Law Group, LLP at email@example.com or 949-333-8143.