Distributing Wealth (Part Three in a Three-Part Series)

For more than 82 years, our firm has helped businesses and families build, protect, and distribute wealth. In this third of a three-part series, I’ll explore several key important areas to consider when distributing wealth, especially if you own a small or medium size business.

1. See the Big Picture

Distributing your wealth, both during life and after death, presents both challenges and opportunities. However, the process cannot take place in an isolated or capricious manner. Rather, look to your overall values, family circumstances and responsibilities. Through careful planning, the proper distribution of wealth can meet responsibilities, protect your family, promote charitable causes and ultimately create a legacy.

2. Be Charitable

Gifts to charity, both during life and after death, present excellent tax, as well as intangible benefits. During life, charitable gifts are generally deductible for income tax purposes up to 50 percent of your adjusted gross income. If property other than cash, such as stock or real estate, is given to a charity, the amount of the deduction is generally equal to the fair market value of the donated property. Charitable gifts made as part of the distribution of your estate are also deductible for purposes of estate or inheritance taxes. In cases of gifts of non-cash property, the tax rules can be complex. Therefore, it’s important that you obtain professional advice before making such gifts.

3. Splitting Gifts with Charities

A charitable remainder trust (CRT) can be an excellent vehicle to accomplish both charitable and non-charitable benefits at the same time. In a typical CRT arrangement, money or other property is transferred to a privately- created trust, then the donor or a beneficiary designated by the donor receives income from the trust for a predetermined period. The trust then terminates, and the remaining assets in the trust are distributed to the charity.

Upon a lifetime transfer of the money or property to the CRT, the donor receives a partial income tax deduction. In addition, the asset is removed from the estate, reducing subsequent estate taxes. Once property is transferred to the trust, any sale of the property by the trust is exempt from income taxes. CRT’s are a great opportunity for you to convert highly appreciated assets to a predictable stream of income without paying income taxes on the sale of that asset.

4. Proactive Planning with Life Insurance

Life insurance can be a very effective tool for providing your estate and heirs with liquidity for support or to pay debts or estate taxes. However, many people are unaware that owning life insurance directly in your own name will cause the life insurance to be included in your estate for estate and inheritance tax purposes.

A common solution for this problem is to form a trust – commonly known as an irrevocable life insurance trust, or ILIT – to own the life insurance policy. “Gifts” to the ILIT are typically made on an annual basis in amounts sufficient to pay insurance premiums. At death, the proceeds of the life insurance are not included in your estate for estate tax purposes. These proceeds can then be available to the estate or its beneficiaries.

Often, the ILIT is funded with a second-to-die life insurance policy, as estate and inheritance taxes are generally payable at the death of the surviving spouse.

5. Make Lifetime Gifts Wisely

In addition to estate taxes, the Federal tax code imposes a gift tax on gifts made during your lifetime. However, the gift tax has two exemptions. The first exemption is a $1 million lifetime exemption, whereby gift tax is not payable until one’s cumulative gifts during life exceed $1 million. This exemption is on a per-person basis, meaning that a married couple can give away a total of $2 million during their lives.

The second exemption is the annual gift exclusion whereby yearly gifts up to the exclusion amount – currently $13,000 – are not subject to gift tax and also do not reduce the $1 million lifetime exemption. For example, with a $14,000 gift to a child, the first $13,000 would be exempt, but the final $1,000 would reduce the $1 million exemption amount to $999,000.

6. Gifts of Business Interests

Giving business interests to family members can present great opportunities along with complex challenges. When less than a controlling interest in a business is given, the estate and gift tax laws recognize that the transferred interests are typically valued using various valuation discounts. These discounts arise both because such interests generally have little control with respect to the operations of the business, and also because they have little resale marketability. With these discounts, larger shares of the business entity can be transferred.

However, if you choose this route, you should plan the gifting of business interests very carefully as the IRS may scrutinize the manner in which the gift value was determined. You should consider hiring a professional business appraiser to substantiate the value of the gifted interest.

7. The Estate Tax in Flux

The Federal Estate Tax is in flux. Please see the Estate Tax Abyss article by my law partner Stephen Kantor in this newsletter to learn more about this important issue.

Notwithstanding the unpredictable nature of the federal estate tax, Oregon and Washington both have state-level inheritance tax systems. Oregon has an inheritance tax exemption of $1 million per person, and Washington’s exemption is $2 million. Therefore, for some individuals, state-level tax planning may be necessary in addition to federal estate tax planning.

Building, protecting, and distributing wealth requires careful planning. This three-part series has discussed many of the key issues relating to this planning process. You can access the first two parts of this series on our firm’s website at www.SamuelsLaw.com.