In response to his November 14, 2007 testimony before the Senate Finance Committee, noted estate and philanthropic planning lawyer Conrad Teitell of Cummings & Lockwood, LLC answers follow-up questions posed by the committee and urges the Senate to advance legislation to reform the federal estate tax "sooner than later"..."so certainty will reign for the foreseeable future."
Full Text:
Mr. Chairman, Mr. Ranking Member, Members of the Committee:
My charge at the hearing was not to talk about whether there should or shouldn't be an estate tax (and if so, at what rates), but to discuss the complexities in planning under current law (changing exemptions, estate-tax interruptus and resurrection).
A major topic at the hearing was, of course, the tax-or-no-tax issue. It was well framed by the other three witnesses. Investor Warren Buffett argued for retention of the estate tax with a $4.5 million exemption (indexed for inflation) and gradually sloping rates that would go beyond the current 45% top rate; businessman Eugene Sukup urged absolute repeal; and rancher Dean Rhoads said, in effect, that he could live with (die with?) an exemption of $4 million to $5 million (double that for a married couple).
I left the hearing with the belief that even the Committee's strongest advocates for estate tax repeal acknowledged that repeal isn't in the cards now. Thus the real issues are the size of the exemption and the rates.
Woody Allen once observed: "More than any time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness, the other to extinction. Let us pray that we have the wisdom to choose correctly."
No one asked me, but with important issues such as Iraq, healthcare and home-mortgage foreclosures, to name but a few, resolving the estate tax issue should be easy. People who need to plan their estates have been caught in the politically-charged crossfire for six years. It is time for a truce and a compromise -- now. I respectfully urge that the Senate Finance Committee report out a bill for Senate passage by this spring and that you ask both parties in the House to pass an estate tax bill also by that time. This to be followed by a conference committee and passage of legislation before the summer recess.
1) Mr. Teitell, at the hearing there was discussion about when a family business owner dies, the estate tax and interest due could be computed, but not collected until the business was sold outside of the family. What is your opinion of this proposal?
Conrad Teitell
Mr. Chairman, this proposal should be considered as part of overall estate tax revision. If the estate tax exemption is increased to $4 million to $5 million (double that amount for couples) and indexed for inflation, as suggested by some Members at the hearing, will the survival of family farms and businesses be in jeopardy? Under the current $2 million exemption (slated to increase to $3.5 million in 2009), with the current special use value and estate-tax-payment deferral rules, are farms and businesses in fact being sold to pay estate taxes?
Assuming that farms and businesses would have to be sold to pay estate taxes and
assuming special treatment should be given to those enterprises, here's
how the proposal discussed at the hearing could be structured --
followed by some comments by the Devil's Advocate.
The executor of the qualifying-business owner's estate at death would file an election on the estate tax return (1) to determine the value of the business as of the decedent's date of death and the amount of the federal estate tax, but (2) postpone the payment of the estate tax until the business is transferred outside the decedent's family (family would, of course, have to be defined). Upon the eventual sale to a nonfamily member, both the estate tax and the capital gains tax (on post-death appreciation) would be reported on the seller's income tax return. The tax paid would include (1) estate tax on the value of the business at the owner's date of death, as previously reported on the estate tax return plus (2) the capital gains tax on any increase in value after the decedent's date of death. Paying both taxes on the income tax return that reports the sale would facilitate the collection of the estate tax as part of the income tax enforcement system.
Mr. Chairman, your question deals solely with the estate tax being deferred until the business is sold outside the family. How much involvement must a family member have with the business before it is sold? Just a few of the many other questions that come to mind: What do you do about the estate tax that would have been payable by generations 2, 3 and 4 if a family member stays involved for 100 years? What scope of activities would you allow in a family business? Would you require the posting of a bond? What about liens? Reports to and monitoring by the IRS?
Personally, I wouldn't bet the farm that this proposal would be fair to the government and other taxpayers.
Senator Baucus
2) In your testimony, you said that some taxpayers, and even estate planners, are practicing a "wait and see" attitude in regard to the estate tax.
a) How widespread is this problem?
b) Do a lot of taxpayers postpone estate tax planning because of the current law?
c) What's the range in cost for taxpayers having to change their estate plans so often?
d) Your testimony states that, as estate planners, you try to enable a survivor to take some post-mortem tax-savings actions. How is this done?
Conrad Teitell
Although our law firm's experience has been that many clients did adopt a wait-and-see attitude regarding their estate planning during the three or four year period following the 2001 Tax Act, the recent flow of our estate planning practice supports the conclusion that most of our clients have lost patience with the Congress and are now attending to their estate planning needs. Conversely, I wouldn't be surprised if attorneys who aren't specialists in estate planning find it exceedingly difficult to assist clients in making decisions in light of a tax law where the result may differ so dramatically depending on the year of death.
The change in the estate tax law that has caused the greatest burden for many of our clients in terms of the added cost of estate planning has been the elimination of the state death tax credit by the 2001 Tax Act. Under the prior law, although the maximum federal rate was as high as 55%, the federal government shared as much as 16% of the 55% with the state where a decedent was domiciled at the time of death. When the 2001 Tax Act reduced the federal estate rates and increased the estate tax exemption, it also eliminated the state death tax credit thereby causing many of the states to enact their own estate taxes.
The elimination of the state death tax credit has added complexity and confusion to the estate planning process. In today's world, where clients not infrequently move from state to state and where it is not unusual for many of our clients to own homes in several states, we face the increasingly difficult challenge of having to take into account the estate tax laws of multiple states. Even if a client is domiciled in a state that doesn't have an estate tax, the client may have real estate located in a state that does have a state estate tax and that must be considered in the estate plan. Because of the complexity of planning for multiple residences and changes of domicile from state to state, the elimination of the state death tax credit has increased the cost of planning. Also, each state will want to impose its own estate tax and that could result in domicile disputes at death and the substantial expense of litigation.
Here is yet another complexity: When the federal exemption is $2 million (currently), a state's estate tax exemption, for example, is $1 million. The taxpayer cannot take full advantage of the federal exemption at death without paying state estate tax or creating a second trust for the differential between the federal and state exemptions and qualifying the second trust for the state's marital deduction. This is an extra expense in planning the estate of the first spouse to die and administering the estate and continuing trusts.
Population movements in the country shouldn't be caused by death tax differences between states. I'm reminded of a play that I saw many years ago, The Latent Heterosexual, written by Paddy Chayefsky and staring Zero Mostel. Zero Mostel turns to the audience and asks: "Did you ever hear about the man who got married in order to file a joint return, got divorced in order to preserve his Liechtenstein tax status, and who finally kills himself on the advice of his accountant?"
Mr. Chairman, you ask, "What's the range in cost for taxpayers having to change their plans so often?"
Your question assumes that taxpayers are changing their plans often. As stated earlier, many individuals have adopted a wait-and-see attitude -- although our law firm's recent experience is that many clients can no longer play the government-imposed waiting game and are once again planning the tax aspects of their estate plans.
As lawyers, we deal with the changing exemption, estate-tax interruptus and resurrection of the estate tax by using formula clauses in wills (and living trusts) that direct the assets be placed in one trust rather than another and direct assets to some beneficiaries rather than others -- depending on the law in effect at death.
Of course, we don't let taxes rule. The first consideration has to be the client's wishes (apart from tax savings) and needs of the beneficiaries. But keeping that in mind, our firm's aim is to provide tax-efficient estate-planning documents. Disclaimers also provide a mechanism for shifting assets -- taking into account family needs, and the estate tax law in effect at death.
Finally, Mr. Chairman, in response to your question about the range in costs for estate planning: Before becoming a lawyer, when asked a difficult question, I had a three word answer, "I don't know." After practicing law for many years, I still have a three word answer, "Well, it depends." Please, however, see my answers to Senator Salazar's and Senator Kyl's questions (below) for a laundry list of estate-planning fees.
Senator Grassley
Mr. Teitell, as you have seen from the House and Senate debate over the last few years, there is a sharp division on what our long-term estate tax policy ought to be. There is a bipartisan group who would like to, at a minimum, ensure that the estate tax does not rise above the level set in 2009. The resistance to estate tax reform resides in the Leadership of the House and Senate majorities. If the Democratic Leadership agreed that, at a minimum, the estate tax would not rise above 2009 levels, would that provide clarity to estate planners like yourself? That is, clarity for the period between now and the time long-term estate tax relief is enacted?
Conrad Teitell
Mr. Ranking Member: I am sure that taxpayers and their advisers would salute members of Congress who reach a compromise so certainty will reign for the foreseeable future.
With all due respect to members of both parties, the mood of the country on this issue -- based on what I hear at my lectures on estate planning to professional advisers and lay-people across the country and my discussions with fellow professionals at estate-planning conferences -- is that people are fed up with the Congress's inability to resolve this issue.
The present Congress can't, of course, by public statement or legislation, guarantee what a future Congress will do. But for now, passage before the summer recess of a revised estate-tax law with a $3.5 million exemption (the 2009 exemption and rates alluded to in your question) would cure the current planning paralysis. The planning techniques sanctioned under current law -- as well as the unlimited marital and charitable deductions -- should be retained.
Senator Salazar
1) Mr. Teitell, after listening to the testimony of Mr. Sukup and Mr. Rhoads, how difficult do you believe it would be for them to use planning to significantly reduce their estate tax liability?
2) How easy is it to use planning to completely eliminate one's estate tax liability? How costly is it?
3) In your view, on average, is the cost of estate tax planning overly burdensome?
Conrad Teitell
Senator Salazar, after listening to the testimony of Messrs. Sukup and Rhoads, I was impressed with the closeness of their families and their involvement with their communities. So they have riches apart from their material wealth. Regarding their riches on which Caesar might have a claim, I can't comment because I don't have information about their wishes, their beneficiaries and their assets. And if I did, I hope that you understand that it would be inappropriate for me to comment in a public record. That being said, individuals in their hard-earned and lucky shoes can significantly reduce their gift and estate taxes using current techniques sanctioned by the Internal Revenue Code.
You ask, Senator Salazar, can planning completely eliminate estate tax liability?
The estate tax payable at death is purely a function of the value of the estate and the extent to which taxpayers take advantage of the available estate tax deductions and exemptions and also avail themselves of lifetime planning that reduces the size of an estate at death. The earlier one starts, the greater can be the estate tax savings.
If a taxpayer at death leaves all his or her assets to charity, there is no estate tax. If the taxpayer leaves his or her assets to a spouse, there is no estate tax until the spouse dies. If a taxpayer's assets are less than the amount shielded from estate tax by the exemption (currently $2 million), there is no estate tax. If each of a husband and wife takes advantage of his or her respective exemptions, together they can shield from estate tax assets valued at double the exemption amount (currently $4 million), by using a "Credit Shelter Trust" for the benefit of the surviving spouse. This can be done without depriving the surviving spouse of the cash flow from the assets passing to the trust. The trust has the added benefit of making certain that the trust assets will pass to the couple's children at the surviving spouse's death. The cost of estate planning to take advantage of these exemptions and deductions is marginally more than the cost of an estate plan that does not include planning for the estate tax, but is limited to other objectives of estate planning -- e.g., making certain that property passes to the appropriate beneficiaries and that it does not pass to children until they are mature enough to spend and invest it wisely.
A taxpayer with assets valued at substantially more than the amount exempt from estate tax may make lifetime gifts to descendants or other beneficiaries in order to reduce the estate tax to some extent. The most common approach is to take advantage of the annual exclusion from gift tax that permits the transfer of a fixed amount (currently $12,000 per year) per beneficiary (double that amount for couples).
Some taxpayers go beyond annual exclusion gifts to make gifts that use up all or part of the current $1 million gift tax exemption, but those gifts are much more unusual than annual exclusion gifts and tend to be made only by clients who would be considered wealthy. Also common are "estate freeze" techniques where a taxpayer retains the current value of property plus a fixed annual return, but effectively transfers any excess appreciation over the fixed return to beneficiaries. For wealthy families, the generation-skipping tax and exemption must be taken into account.
Finally, in your third question, you ask: "In your view, on average is the cost of estate tax planning overly burdensome?"
I'm reminded of this interchange between a client and a lawyer:
While estate planning fees paid by very wealthy clients may at times be significant, typically the fees are nominal in comparison to their net worth. Over the course of a lifetime, a typical client with $20 million is likely to spend less than $20,000 or one-tenth of 1% of net worth on estate tax planning. My recollection is that Warren Buffett, at the hearing, said that over his life he has spent under $25,000 on estate planning.
Senator Roberts
Mr. Teitell, in your testimony you discussed the costs of estate tax planning. Would you agree that the cost of estate tax compliance diverts assets that could otherwise be used to grow a business or for other economic benefit?
Conrad Teitell
Senator Roberts, not all estate planning is estate tax planning. For all but a small percentage of Americans, estate planning doesn't involve the estate tax at all. It focuses on (1) making sure that assets are given to the desired beneficiaries (rather than as dictated by the intestacy laws), (2) protecting and managing assets for young beneficiaries or beneficiaries who are not capable of managing their assets, (3) providing for health care decisions, (4) drawing living wills, and (5) providing for money management and protection during incompetency. For those whose estates are large enough to involve tax planning, as shown in my answers to questions asked by Senator Salazar (above) and Senator Kyl (below) the costs are not great.
Senator Kyl
1) Mr. Teitell, regarding estate planning strategies and costs:
a) Would the available estate planning techniques differ depending upon the amount and character of assets and the amount of income available to an individual planning his estate?
b) What are the appropriate techniques and costs of those techniques for a moderately wealthy individual or couple with assets between $2 million and $10 million? What about for larger estates?
c) I understand that it is relatively easy for someone to donate publicly-traded stock to a foundation or charitable organization, but that closely held family businesses may not have those same opportunities. What are the available techniques to maintain family ownership for a closely-held business or farm and how effective and easy are those techniques?
Conrad Teitell
Estate planning tax-saving techniques are available to everyone. Whether the technique makes sense for a particular taxpayer depends on his or her objectives, the character and value of the taxpayer's assets and the taxpayer's willingness to make gifts of property during his or her lifetime.
Planning for the estate and gift tax is only a part of the estate planning process. Estate planning involves many other objectives that may, in fact, be more important to a client, such as: (1) planning for the management of the client's assets after the client is no longer able to manage them; (2) restricting the use of the assets by the beneficiary to avoid unproductive uses and providing incentives to the beneficiary to pursue a worthwhile and fulfilling career; and (3) protecting the assets from creditors of a beneficiary, including a divorcing spouse.
Estate tax planning for a moderately wealthy couple with assets between $2 million and $10 million is usually limited to: (1) planning for the establishment of a Credit Shelter Trust upon the death of the first of them to die; and (2) making annual gifts to take advantage of the annual exclusion from gift tax ($12,000 per donee). The cost of estate planning for those clients will fall within a range of $1,000 to $5,000 and would not be appreciably less even if the federal estate tax were eliminated and none of the states had estate taxes.
Clients with more than $10 million may engage in more complex
estate planning because they are willing to give away more than the
annual exclusion gifts noted above. Those clients may engage in one or
more of the following techniques:
2. Gifts to Section 529 Plans or Uniform Gifts or Transfers to Minors Accounts for grandchildren (no legal expense).
3. Gifts to trust(s) for grandchildren (cost -- $2,500).
4. Qualified Personal Residence Trusts (cost -- $5,000).
5. Grantor Retained Annuity Trusts (cost -- $5,000).
6. Sales of assets to descendants or trust(s) for descendants (cost -- $5,000 to $10,000).
7. Charitable Trusts (cost -- $2,500 to $5,000).
The techniques available to maintain family ownership of a closely-held business or farm are essentially the same as the techniques available for making gifts of other assets. When the transferred asset is an interest in a closely held business or a farm, implementation of the technique may be modestly more expensive and complex because of the need to value the business or farm and/or retain control of the transferred interest.
Senator Kyl
2) Mr. Teitell, regarding special use valuation:
a) How difficult or easy is it for a decedent's estate to qualify for special use valuation? Do estates need to maintain the special use for any particular time? I have heard that the special use valuation is of little benefit to many estates. Is that your experience?
b) What are the additional costs to an individual or his or her estate to make sure that a family farm or business will qualify for special use valuation?
Conrad Teitell
Senator Kyl, with hedges the primary crop in our part of Connecticut, our law firm's clients are rarely involved with special-use valuation.
To answer your question, however, Section 2032A and its regulations detail a number of hoops to jump through to qualify a farm for special-use valuation. It can be a hard row to hoe. If you successfully get through the hoops, the decedent's estate may elect to value the farm or other qualifying real property at its farm or business-use value rather than its fair market value. For example, if a farm is worth $500,000 at its current use of growing crops, but would be worth $900,000 as a site for a housing development, the decedent's estate -- if numerous tests are met -- can value the property on the estate tax return at $500,000. The total value of the property valued under Section 2032A may not be decreased from fair market value by more than $960,000 for decedents dying in 2008. This amount is indexed annually for inflation.
The preliminary hoop to jump through is spelled out in the instructions to Form 706 (the federal estate tax return):
"b. At least 25% of the adjusted value of the gross estate must consist of the adjusted value of qualified farm or closely held business property."
[The Code, the regulations and the instructions to Form 706 define -- in great detail -- all the above terms.]
Senator Kyl, you ask: "Do estates need to maintain the special use for any particular time?" Yes -- and my answer tells the consequences of failing to keep them down on the farm.
Any estate taxes saved by special-use valuation are recaptured by the IRS if within 10 years of the decedent's death, the qualified heir disposes of the property or ceases to use the property for a qualified use. The qualified heir, however, can avoid the 10-year-recapture rule if he ceases to use the farm during the period because of his death.
Among the many other requirements to qualify for special-use valuation are that the election must be properly made on the return, and an agreement signed by the qualified heirs must be annexed to the Estate Tax Return. Qualified heirs are personally liable for any recaptured taxes. Then there is the matter of estate tax liens.
Although the rules are many, it shouldn't be costly to make the determination whether an estate qualifies for special-use valuation, and if it does qualify whether that election should be made. The actual making of the election and the other Form 706 requirements shouldn't be expensive.
See Section E.I.E.I.O. for additional rules for farm property. Just kidding.
Senator Kyl
3) Mr. Teitell, regarding Section 6166 election (installment payments):
a) How easy is it for a family with a closely held business to use the Section 6166 estate tax deferral and installment payments treatment?
b) Can you explain how the bond that an estate must give or the lien that must be placed on the closely held stock under Section 6166 works? Does this deter some estates from making the Section 6166 election?
c) How much does it cost an individual to make and implement this election?
Conrad Teitell
Senator Kyl, first let's do the numbers: To qualify for installment payments under the Section 6166 election, the value of the closely held business that is included in the gross estate must be more than 35% of the adjusted gross estate.
Special rules define a closely held business -- and when there is more than one business and when businesses are in individual, partnership or corporate ownership. Other rules deal with holding company stock and the business's ownership of passive assets (that could keep the estate from satisfying the 35% requirement). I have just scratched the surface. Additional rules abound.
Lifetime planning may be required to meet the 35% requirement. Generally, gifts made before death are not included in the gross estate and hence the adjusted gross estate. However, for purposes of meeting the 35%-of-the-adjusted-gross-estate requirement, any gifts made in the three-year period ending on the date of death are includable (but not taxed) in the adjusted gross estate.
Note that the maximum amount that can be paid in installments is that part of the estate tax that bears the same ratio to the total estate tax that the value of the closely held business bears to the adjusted gross estate.
Senator Kyl, you also ask about bonds and liens -- and your question is most timely because of some recent developments.
The instructions to Form 706 lay out the rules:
"If you elect the lien provisions, Section 6324A requires that the lien be placed on property having a value equal to the total deferred tax plus four years of interest. The property must be expected to survive the deferral period."
In a recent Internal Revenue Service Legal Memorandum (ILM 200747019, 10/11/07), the Service comments on nine questions on its acceptance of stock in a closely held corporation as collateral in Section 6166 lien situations.
Now for the latest development: The IRS announced on November 13, 2007 (Notice 2007-90, IRB 2007-46), that in light of the Tax Court's Roski decision (above), the bond/lien security issue will be determined on a case-by-case basis. Standards for making that determination are now being formulated by the Treasury and the IRS. Thus for more on this continuing tax saga, look down the road for proposed regulations, a hearing and then final regulations.
The lien/bond provisions and monitoring by the IRS can be onerous. Rarely do our clients' estates elect installment payments. If paying the estate tax is expected to be a problem, most clients provide for the payment of those taxes by purchasing life insurance -- and often second-to-die life insurance for spouses.
Senator Kyl, to answer your last question, the cost of making the election is minimal -- but implementing the election can be burdensome.
Senator Kyl
4) Mr. Teitell, regarding redemptions of closely held stock. How easy is it to plan under the rules in Sections 302 and 303 of the Internal Revenue Code to make sure that a redemption of closely held stock from an estate qualifies for capital gain treatment and not ordinary income treatment?
Conrad Teitell
Senator Kyl, it is difficult for an estate to have the redemption of all its stock in a family-owned corporation qualify for capital gains treatment. To qualify for capital gains treatment, the estate must waive family attribution. The family attribution waiver rules can be applied only to stock that the beneficiary of the estate owns constructively by attribution from a member of the beneficiary's family. The waiver of family attribution doesn't apply to stock that the beneficiary (1) owns directly, (2) is considered as owning by attribution from another entity, or (3) can acquire under an option to purchase.
If the family attribution rules are applicable, then two conditions must be met; namely, (1) both the estate itself and each related person must satisfy the normal requirements for a waiver (no post-redemption interest in the corporation, no acquisition of an interest within 10 years from the date of the redemption, and filing of the notification agreement) and (2) each related person must agree to be liable along with the estate for any deficiency (including interest and additions to tax) resulting from a tainted acquisition of an interest during the ten-year period.
"Related person" is specially defined for these purposes as any person to whom stock is attributable under Section 318(a)(1) at the time of the distribution if the stock would be further attributable to the estate under Section 318(a)(3).
It is difficult for the estate to be able to use Section 303 and, therefore, receive capital gains treatment upon a redemption of all or part of its stock. Section 303 requires that: (1) an actual redemption must occur, (2) the redeemed stock must be included in determining the value of the decedent's gross estate for federal estate tax purposes, or the stock must be subject to the generation-skipping transfer tax at death, (3) the distributing corporation's stock included in the gross estate must exceed 35% of the excess of the gross estate over the amounts allowable as deductions for funeral and administration expenses, claims, taxes, losses and so forth, and (4) the benefits of Section 303 cannot exceed the lesser of the (A) sum of (1) the state and federal (and foreign, if any) death taxes imposed because of a decedent's death, and (2) the funeral and administration expenses allowable as deductions for federal estate tax purposes, or (B) the amount by which the death taxes and expenses actually reduced the interest of the person whose stock is redeemed. For example, if a decedent left the stock to her spouse, the stock will be included in the gross estate and, thus, will be potentially subject to Code Section 303; but, if, as is generally the case, the decedent's will frees the marital share from any responsibility for death taxes and expenses, which normally fall on the residue, that provision has the ancillary effect of preventing application of Code Section 303 to the redemption of the stock.
So you see, Senator Kyl -- it's hardly a piece of cake.
Senator Kyl
5) Mr. Teitell, regarding life insurance:
a) How important is the purchase of "Key-man" life insurance and other high-premium insurance products in providing liquidity to an estate?
b) Our family business witnesses are understandably reluctant to reveal how much they pay in life insurance premiums and other estate planning. For a business valued at $5 million, how much would key-man life insurance cost? How about for a business valued at $35 million?
c) It is my understanding, and I believe you touched on this in your written testimony, that families need to use irrevocable life insurance trusts to prevent the inclusion of insurance proceeds in an insured's estate. Can you explain how those trusts are structured? What are the costs to an individual of setting up an irrevocable life insurance trust and administering the trust?
Conrad Teitell
Senator Kyl, your question about insurance comes just when I am reading Walter Isaacson's biography of Albert Einstein. Young Einstein, having great difficulty in landing a job, promised his bride-to-be that he would marry her as soon as he found work -- and said that he was going to call the director of the local insurance company. I'm no Einstein, but let me answer your questions.
"Key-man" life insurance is a term typically used to describe life insurance payable to a business to assist it in withstanding the economic impact resulting from the death of a person whose participation in the business is essential -- key -- to its success. It is more a business preservation technique than an estate tax planning technique.
If a taxpayer's estate consists primarily of illiquid assets such as a privately owned business or farm, a common estate planning technique is the purchase of life insurance to provide liquidity to the estate to pay estate tax and thereby avoid the need to raise the required cash either through extensions of time to pay estate tax, borrowing from a financial institution or selling the business.
The cost of life insurance depends on the type of insurance, the amount of coverage and the age and health of the insured. If you give that information to a CLU, I'm sure that you can get a quote quicker than you can wink an eye.
The most common use of a life insurance trust is to implement an annual exclusion gift program. If an individual with significant wealth wants to take advantage of all or part of his annual giving exclusion by making gifts to children and grandchildren ($12,000 per donee), but the beneficiaries have no current need for additional cash, the donor may want to make the gifts to a trust so that a trustee can invest the gifted funds for growth over time. In those situations, it is not unusual to invest the gifted funds in a life insurance policy as a conservative way to guarantee growth. Owning the gifted funds in an irrevocable trust reduces estate tax since the funds will not be taxable in the estate of the donor because the donor no longer owns them.
The estate tax benefit could also be achieved by having the policy owned directly by the beneficiaries and by giving to the beneficiaries the cash needed each year to pay the premiums. Estate planners discourage clients from that approach, however, for the following reasons: (1) individual ownership of the insurance policy may lead to a problem if the beneficiary's marriage is dissolved or the policy is attached by the beneficiary's creditors; (2) it is administratively more difficult to have each of multiple beneficiaries own a share of a life insurance policy than it is to own that policy in a trust; (3) the insured may prefer that the death benefit be held in trust for the beneficiaries rather than be distributed outright to them, particularly if they are young; and (4) many times the beneficiaries of the trust will be minors.
The typical cost of establishing a life insurance trust would be in the range of $2,000 to $3,000. Those trusts are usually administered by family members, thereby eliminating any administration cost during the insured's lifetime. After the proceeds are collected upon the insured's death, income tax returns will be required if the proceeds remain in a trust.
Senator Snowe
Mr. Teitell, thank you so much for your reference in your written testimony to the Public Good IRA Rollover Act of 2007 (S. 819) that I introduced with Senator Byron Dorgan earlier this year. I agree with you that it is a critical incentive for both donors and charities.
Mr. Teitell, focusing on the planned-giving component of this legislation through which an individual could donate to a charity and receive life income that is taxable, could you please comment on how this provision would promote charitable donations while simultaneously reducing individuals' present-law estate tax liabilities and addressing Congress' concern that individuals do not outlive their retirement savings?
Conrad Teitell
Senator Snowe, many individuals would like to give part or all of their IRAs outright to charity, but they need the retirement income from their IRAs. Allowing them to roll over their IRAs at age 59 1/2 or older to a life-income plan that would pay the individual (and a spouse, if desired) income for life (through a charitable gift annuity, charitable remainder unitrust or annuity trust, pooled income fund gift) would enable them to provide retirement income for life and make a charitable commitment. The charities could plan on receiving the gift after the life interest terminates.
A life-income rollover is truly an All-American IRA/Charitable Rollover. It would encourage philanthropy by all Americans -- not just those who can afford to part with their assets now and not just those who itemize their deductions on their tax returns.
The ability to roll over an IRA to charity directly -- or for a life-income plan -- gives charitable tax incentives to the approximately two-thirds of taxpayers who take the standard deduction. Not being taxed on income that would otherwise be taxed (withdrawal from an IRA) is the equivalent of a charitable deduction.
The IRA assets rolled over for a life-income plan would not be included in the taxpayer's estate at death. However, the vast majority of the rollover gifts would come from individuals who have no estate tax concerns.
The life-income rollover shouldn't cost the government anything because the payments received from the life-income plans would be fully taxable -- just as if the payments were received from the original IRA custodian or administrator. The big difference is that the nation's charities and the people they serve will be greatly benefitted.
Rolling over an IRA for a charity's life-income plan is not giving away the assets in the plan. The individual continues to receive income for life -- just as if she or he had kept the IRA assets with the current custodian or administrator.
Senator Snowe, as you know the IRA/charitable rollover law that allowed tax-free rollovers for direct (outright) rollovers to charity for 2006 and 2007 wasn't in an extenders' bill at the end of 2007. When the Senate this year (soon, I hope) considers extending the just-expired IRA/charitable rollover provision, I hope that it will add the life-income component of the Public Good IRA Rollover Act of 2007 (S. 819).
As volunteer legal counsel to the American Council on Gift Annuities (an organization of over 1200 charities receiving support through life-income plans), I convey ACGA's thanks for your being an initial co-sponsor of S. 819 with Senator Byron Dorgan -- not only in this Congress, but also several years ago in an earlier Congress.
The bill that you and Senator Dorgan initiated now has wide bipartisan co-sponsorship in both the Senate and the House -- including many members of the Finance and Ways and Means Committees.
To sum up: The IRA/charitable life-income rollover is not a revenue drainer and it doesn't decrease retirement savings -- just puts an IRA in a different container. I hope that Congress agrees that passage should be a no-brainer.
Conrad Teitell's Conclusion.
A fable by the late Ambrose Bierce, American journalist and satirist, may be instructive:
An Associate Justice of the Supreme Court was beside a river bank when a Traveler approached him and said:
"It will," was the reply; "it is my boat."
The Traveler thanked him and, pushing the boat into the water, embarked and rowed away. But the boat sank and he was drowned.
"Heartless man!" said an Indignant Spectator. "Why did you not tell him that your boat had a hole in it?"
"The matter of the boat's condition," said the great jurist, "was not brought before me."
Now that the matter has been brought to the Congress's attention by myriad taxpayers and their advisers, it is time to enact corrective legislation -- and soon.