Estate Planning Advisor Making a Gift May Be Easy, But Is It the - - PDF document

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miller nash llp | Fall 2011

Estate Planning Advisor

inside this issue

2 Oregon’s New Estate Tax 3 California Snowbirds: Avoid an Additional Tax Burden 4 Getting Started in the Exit Planning Process

(continued on page 6) by R. Thomas Olson

tom.olson@millernash.com 206.777.7413

The current tax climate in Wash- ington, D.C., Washington, and Oregon makes gifts to children and others very attractive on their face. The federal government excludes the first $5 mil- lion of transfers from gift tax. Neither Oregon nor Washington has a gift tax. Assuming that one has made no prior taxable gifts, a gift plan would allow the transfer of up to $5 million free of all taxation, or $10 million for a husband and wife. There are a number of significant advantages to making a gift. First, any post-gift increase of the value of the gifted asset is excluded from your taxable estate. Second, post-gift income earned on the gifted asset is also ex- cluded from your taxable estate. Third, transferred assets are excluded for Oregon and Washington estate taxes. These advantages, of course, would ap- ply only to someone whose estate was larger than the applicable estate tax ex- emption ($5 million federal, $2 million Washington, and $1 million Oregon). So what is the downside of making substantial gifts? In order for a gift to be effective in removing the assets transferred from the donors’ estates, it must be a “completed gift.” This means that there can be no strings attached. For example, were I to give my home to my child, but retain the right to live in the house, it would not be a completed gift for estate tax purposes because of the retained interest in the house. (There is, however, a statutory provision that allows a grantor to make a completed gift of a house while retaining the right to live in the house through use of a “Qualified Personal Residence Trust.” “QPRTs,” as they are known, will be the subject of another article in this series.) So what’s not to like about gifts? There are at least three things to be considered before entering into an aggressive gift plan. First, under our current estate tax law, an asset that passes on death re- ceives a stepped-up basis to the asset’s fair market value as of the date of death (or six months after the date of death, if the alternative valuation method can be used). The same asset transferred by gift carries forward the lesser of fair market value or the donor’s cost basis. Thus, if you assume that the asset will be disposed of when in the hands of the recipient of the gift, you need to weigh the capital gains cost against the likelihood of estate tax payable on the donor’s estate if the asset remains in the donor’s inventory at the time of

• death. For example, had you acquired

Amazon.com at its initial public offer- ing, your cost basis would have been diluted down to next to nothing as a result of stock splits, and a sale would be nearly 100 percent capital gain, but if the stock were transferred through the donor’s estate, the new basis in the hands of the recipient would be the market value on the date of death. Second, although one can hope never to be faced with this situation, the gift of property can disqualify the donor from eligibility for need-based support such as Medicaid for as long as

Making a Gift May Be Easy, But Is It the Best Course?

2 | miller nash llp | Estate Planning Advisor

(continued on page 6)

Oregon’s New Estate Tax

In the last legislative session Or- egon extensively redrafted its woefully confusing and out-of-date inheritance tax laws. Many of the changes were technical (such as changing the name

• f the tax from an inheritance tax to

an estate tax), but some were not. The changes are effective beginning in 2012. Exemption and Rate Structure. The Oregon legislature toyed with increasing the exemption from $1 million to $1.5 million. But in order for this change to be revenue-neutral, Oregon would have had to have one of the high- est estate tax rates in the nation. Avoiding considerable political heat, the legislature left the exemption at $1 million. The federal exemption is still set at $5 million at least through 2012, after which it is scheduled to be reduced to $1 million. The legislature, however, did revise the rate structure. Previously, the rate was tied to a federal law that was repealed six years ago by the federal government! The new rates now start

• ut at 10 percent on assets valued in ex-

cess of $1 million. For estates in excess

• f $9.5 million, the tax rate tops out at

16 percent. Marital Deduction. The law con- tinues to allow a deduction for debts, assets passing to a surviving spouse, or assets passing to charity. It continues and clarifies Oregon’s special marital property provisions. This is a bit com-

• plex. But essentially, to save taxes under

federal law, many wealthy couples gave whatever remained of their $5 million federal exemption to their spouse in trust rather than outright. When the first spouse died, the $5 million passing to the trust is not taxed because of the federal $5 million exemption. When the second spouse died, the assets in the trust were not taxed because they were technically not owned by the surviving

• spouse. This planning technique can

save about $1,750,000 in federal estate tax (or perhaps more if the amount in the trust had increased at the time

• f the second spouse’s death). The

federal marital deduction tax savings is now portable and a trust need not be used, but the portability feature has not been not widely adopted because it expires in 2012 and does not save taxes on appreciation on the value of the estate between the first and second

• death. The typical trust structure was

problematic for many Oregon couples. Because Oregon’s exemption is only $1 million, using the full $5 million federal exemption when establishing a trust caused $4 million to be taxed to Oregon on the first death. The new law basically clarifies a workaround so that there is no Oregon estate tax on the first death of the $4 million as long as it is kept in a separate trust for the benefit

• f the surviving spouse and its value

is included in the surviving spouse’s Oregon taxable estate on the death of the surviving spouse. Changes in Intangible Personal

• Property. Oregon also fixed a vexing
• problem. Oregon previously attempted

to levy a tax at death on intangible per- sonal property (e.g., cash, stocks, bonds, contract rights) held by the estates of

• nonresidents. In the Internet age, it was

always a contentious issue as to where intangible property is located. Oregon now taxes intangible property only to resident decedents unless it is taxed in another jurisdiction. There is no longer an attempt to tax intangible property

• wned by nonresidents. Thus, under

the new law, Oregon computes the tax based on the value of all real property and tangible personal property located in Oregon and, for Oregon residents

• nly,

all intangible personal property unless that property is subject to an estate tax in a for- eign jurisdiction. Natural Resource Property. The Oregon law was also revised to clarify and improve the exist- ing natural resource property credit. The credit for farm, fishing, and for- est assets was revised to now include 15 percent of working capital as part

• f the personal property used in these
• businesses. The credit formula was

substantially rewritten. It continues to apply to estates whose natural re- source property comprised more than 50 percent of the estate. The new credit amount is essentially the estate taxes applicable to the first $7.5 million of natural resource assets. Gift Loophole. Oregon law regard- ing gifts is unchanged. Oregon does not add back gifts made while a person is alive in determining the estate tax. Each gift reduces the Oregon estate tax unless the gift reduces the estate below the $1 million exemption. If Jay dies holding assets of $2.5 million, and b d b h bili f h

• p

s e T t

“In the last legislative session Oregon extensively redrafted its woefully confusing and out-of-date inheritance tax laws.”

by Ronald A. Shellan

ronald.shellan@millernash.com 503.205.2541

Estate Planning Advisor | miller nash llp | 3

California Snowbirds: Avoid an Additional Tax Burden

Many Northwest residents own sec-

• nd homes in California and spend part
• f each year there. If you are one of those

fortunate people, you should know how California determines whether or not you are a resident of California and what steps you may take if you want to avoid becoming a California resident. Why would you want to avoid becoming a resident of California? The answer: state income taxes. California’s highest individual in- come tax rate of 9.3 percent is imposed

• n taxable income over $32,600, and

there is no special capital gains rate. If you are a resident of California, that state imposes tax on your worldwide

• income. If you are not a resident,

California imposes tax only on income that is derived from California, such as wages earned in that state or income produced by assets that are tied to California, such as real property. Like California, Oregon has a substantial income tax, so the difference between being a resident of either of those states may not be material. Since Washington has no state income tax, however, the difference between being a California

• r Washington resident is normally

significant. This article will examine the California residency rules relating to individuals who are not domiciled in California—that is, the rules that ap- ply if your permanent home is outside California, but you spend some time in California during a tax year. The general California rule is that if you are in California for a “temporary

• r transitory purpose,” you are not a

California resident. The determination whether a purpose is temporary or transitory is a factual one that depends in large part on how much time you spend in California and what activities you engage in while in that state. At the one extreme, if you only pass through California, stay there for a brief vacation, or go there for a particular purpose that will require only a short stay, the purpose will be temporary and you will not be a resident. The other extreme is that if you spend more than a total of nine months

• f any taxable year (in the aggregate, not

necessarily consecutive) in California, you will be presumed to be a resident. It is very rare that this presumption can be overcome. The gray area arises when you stay in California for more than a brief vacation, but less than an aggregate of nine months. Despite the nine-month presumption of residency discussed above, there is no presumption of non- residency if a person spends less than nine months in California. One California rule does offer some

• certainty. If you meet all the following

requirements during any tax year, you will be considered not to be a California resident in that year even if you own a California home, keep a bank account,

• r join local social clubs: (a) you spend

an aggregate of six months or less in California in the tax year; (b) your domicile is in another state; (c) you have a permanent home in the place of domicile; and (d) during your time in California you engage only in visitor or tourist activities (no business activities). If you fail to meet the requirements

• f the preceding paragraph, your state of

residency will be determined by balanc- ing your connections with California against your connections with the other state in which you spend time. Some of the connections and factors that will be considered, listed roughly in the order

• f importance, are:
• The amount of time you spend in

each state;

• The location of your family;
• Where your children attend school;
• The size and characteristics of

the home you own in each state (whether one is more obviously a vacation home);

• Where you conduct your business;
• The location of your real property

and investments;

• Where your driver’s license was

issued;

• Where your vehicles are registered;
• Where you maintain your profes-

sional licenses;

• The location of your doctors, den-

tists, accountants, and attorneys;

• Where you vote; and

by Adrienne P. Jeffrey

adrienne.jeffrey@millernash.com 206.777.7512

(continued on page 5)

4 | miller nash llp | Estate Planning Advisor

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(continued on page 5)

Nora Chapman’s story was typical

• f most business owners who have

made the tough decision to leave their

• companies. At age 54, she was confi-

dent in finding a meaningful second act and was ready to leave her 25-em- ployee advertising business. Nora was thinking of selling to one or two of her key employees. Nora approached her at- torney and asked, “Is this the right exit choice?” Many of you might find yourself in the same predicament. You are able to envision your life beyond business own- ership, but you don’t have a clear picture

• f how best to “leave your business.” So

what do you and the Nora Chapmans of the world do? First, understand that leaving your company is a process. Realizing that life after your business exit can be as fulfill- ing as your life as a successful owner is simply the first step. The next step is to figure out a way to approach your exit in a methodical, logical, rational man-

• ner. Most owners do not put enough

thought and planning into their exits, because they don’t know how to begin, that a proven process is available to them, or exactly what issues to consider and analyze. If that describes your situation, you are not alone. Most owners, and many advisors, don’t realize that planning and implementing their exit process can be methodical, rational, and tailored to their unique exit goals. The process begins by setting your exit objectives and understanding the value of your business. Based on what you want and what you have, you can then examine and choose a proper path for you—be it a sale to a third party, a transfer to children, a sale to an Em- ployee Share Option Plan, a sale to a co-

• wner, or an orderly liquidation. As part
• f the process, you must also consider

what would happen to the business and to your family if your death or disability precedes your planned exit. Simply knowing the process and proceeding down the exit planning path, however, is insufficient. Accord- ing to the Small Business Administra- tion, most business owners who begin the planning process fail because they fail to plan. To succeed, you need a writ- ten plan that:

• Identifies your exit, financial, and
• ther objectives that must be con-

sidered; and

• Documents how you are going to

achieve those objectives. Along with this written plan, you should have a checklist that:

• Assigns responsibility for each task

to be completed throughout the exit planning process;

• Sets dates for each task to be com-

pleted; and

• Designates the person responsible

for completing each task. How do you begin? As skilled and as successful as most business owners are, they cannot, working alone, create and execute their exit plans. Rarely have owners made a career of exiting businesses. Those

• wners who do attempt to craft their
• wn exit plans frequently fail, or at

best, they leave a lot on the table: a lot

• f money, time, or their own happiness.

And as skilled as is your attorney, CPA, or financial and insurance repre- sentative, acting alone, each is unable to craft a successful exit plan. This is because successful exit planning is a multidisciplinary effort that requires you and your advisors to work together. No one profession possesses the breadth

• f knowledge necessary to advise a busi-

ness owner on the wide variety of exit planning issues. For your exit plan to succeed, you will likely need legal expertise, financial advice, tax planning, financial advisory input, and, often, consulting ideas. If you decide to sell to a third party, you may require the services of a business broker or investment banker. No one advisor can be an expert in all aspects

• f exiting a business.

Getting Started in the Exit Planning Process

by William S. Manne

bill.manne@millernash.com 503.205.2584

“Let us, therefore, decide upon the goal and upon the way and not fail to fi nd some experienced guide who has explored the region towards which we are advancing; for the conditions of this journey are different from those most travel.” — Seneca, “On the Happy Life” (A.D. 58)

5 | miller nash llp | Estate Planning Advisor Exit Planning . . . | Continued from page 4 California Snowbirds . . . | Continued from page 3 5 So what does it take to create an exit plan?

• Understand that there is a proven

exit planning process. Learn as much as you can before you make final decisions.

• Commit

to see the process through—holding yourself and

• thers accountable.
• Document your decisions and cre-

ate a written plan.

• Hire an experienced team of

professionals—attorney, CPA, and financial or insurance representa- tive (at a minimum)—to help guide you through this process. These professionals should more than pay for themselves by putting money in your pocket. If they cannot, you have the wrong team. If you are to exit successfully, there

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The Miller Nash Trusts & Estates Practice Team assists our clients in achieving their goals for the disposition of their estates. In this process we consider first a client’s goals and then exam- ine a variety of strategies to achieve those goals, including the relative tax efficiencies of the various strategies. Our team has assisted clients with appropriate and efficient estate plans for estates ranging in size from $100,000 to $100,000,000. We are well acquainted with bank trust departments and trust companies throughout our region. Estate planning may include consideration of transitioning a family business to the next gen- eration, the preservation of ownership of significant family property, and the achievement of philanthropic objectives.

W W W . M I L L E R N A S H . C O M learn more about our trusts & estates team at

Practice Leader:

• R. Thomas Olson

tom.olson@millernash.com

• The location of the church, profes-

sional associations, or social and country clubs of which you are a member. The Franchise Tax Board (the “FTB”), California’s taxing agency, has historically been aggressive in seeking

• ut individuals who may be California

residents but do not file returns as

• such. Therefore, if you spend time in

California other than a short vacation, you should be prepared to prove that you were in that state for a temporary

• purpose. Some of the steps we suggest

are the following:

• If you keep a permanent home in

the Northwest and do not conduct business in California, try to keep your time in California during any tax year to less than six months.

• If you must spend more than six

months in California, keep your is much to do. We can help by provid- ing more detailed information on exit planning in general, and by giving you a sense of the time and resources that this planning and implementation process will take. Bill Manne chairs the fi rm’s tax and business-owner exit practice teams and is also a certifi ed public accountant. This ar- ticle was previously published by Business Enterprise Institute in The Exit Planning Review™. time in the state to less than nine months.

• Maintain detailed records on when

you were in California and where you were when you were not there.

• Maintain records of your activities

in California so that, if necessary, you can establish that you engaged

• nly in tourist or vacation activities.
• Prepare a list of individuals who

can attest to where you spent your time.

• Keep all credit-card bills, including

gas credit cards. These can sub- stantiate where you were and are

• ften obtained by the FTB during

an audit.

• Do not claim the annual California

homeowner’s exemption on your California real estate. This exemp- tion is allowed only for your prima- ry residence and, if claimed, may be used as evidence of residency.

• Never inadvertently list California

as your place of residence or your California property as your primary residence.

• Do not vote in California.
• Do not obtain a California driver’s

license.

• Do not use your California address
• n any income tax return.

Although keeping these records may seem like a burden, it will help you adjust the time you spend in California if you are at risk of inadvertently be- coming a resident and will enable you to prove that you are not a resident if the FTB wrongly asserts that you are. With your recordkeeping well maintained, you can relax and enjoy the California sunshine.

3400 U.S. Bancorp Tower 111 S.W. Fifth Avenue Portland, Oregon 97204

Estate Planning Advisor™ is published by Miller Nash LLP. This newsletter should not be construed as legal opinion on any spe- cific facts or circumstances. The articles are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and any specific legal questions you may have. To be added to any of our newsletter or event mailing lists or to submit feedback, questions, address changes, and article ideas, contact Client Services at 503.205.2608 or at clientservices@millernash.com.

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Oregon’s New Estate Tax | Continued from page 2 he has no other deductions, his estate will pay an Oregon estate tax of about $152,000. But if Jay had given away $1.5 million before his death, his estate tax would have been zero. Jay would probably have been happy to know that he was able to save his family some money by making a gift to them while he was alive. But note that gift property does not adjust its basis to the date-of- death value. It has a carryover basis, and it is possible that the tax on ultimate sale of the asset could be greater than the estate tax savings. Most Oregon families will never pay a federal estate tax. But quite a few will have to pay the Oregon estate tax. With its relatively low exemption of $1 million, many families will feel its

• sting. For those families who plan for

this eventuality, the sting can often be soothed or even avoided with proper estate planning. 60 months. The gift program must be consistent with the donor’s long-term financial situation. Third, as discussed above, for a gift to be an effective part of estate planning, it must be a completed gift. It would not be a case of first impression to say that the attitude of the recipient of the gift toward the donor might well change when the recipient realizes that the gift is his or hers alone without obligation to the person making the gift. In summary, before engaging in a significant gift plan, meet with your lawyer and accountant and carefully review the implications of making a large gift. Making a Gift . . . | Continued from page 1