By Derek M. Johnson
It’s a good idea to have your estate planning documents reviewed every 5 to 10 years or if there is a significant change to your family situation or finances, or the law. The importance of having an estate planning attorney review your current estate planning documents can the mean the difference between the smooth administration of your estate and trust when you pass away and unintended consequences such as property being left to someone you no longer intended to receive property, property being tied up in a needlessly complex estate plan or, even worse, the imposition of estate taxes. Case in point, a married couple had estate planning documents (including revocable trusts) prepared for them back in 1985 (for those of you that can’t remember back that far, that was the year the Bears went 15-1 and won the Super Bowl in 1986). Unfortunately, the husband passed away in 2016 and never had his documents changed during those 30+ years. When the family came to us to help administer his estate and trust, the husband’s estate owed $300,000 in Illinois estate taxes! To make matters worse, if the husband had his estate planning documents reviewed prior to his passing, his documents (in particular, his trust) could have been amended to avoid Illinois estate taxes entirely!
Fortunately, we were still able to help the family avoid all Illinois estates taxes through a process known as decanting. Briefly, decanting allows the trustee of a trust under limited circumstances to transfer trust assets to a new trust. In this case, the husband’s trust qualified for decanting and we drafted a new trust to which assets from the husband’s trust were transferred to avoid the Illinois estate taxes. I know. I’m just as surprised as you are, but the State of Illinois allows trusts to use the decanting process – if the trust qualifies – to avoid Illinois estate taxes.
Bear in mind, though, that decanting is allowed only under limited circumstances and should not be relied upon as a cure for outdated estate planning documents. Rather, the better and more cost-efficient option is to have your estate planning documents reviewed every 5 to 10 years or if your family situation, finances or the laws change; and, if necessary, amend your estate planning documents. No one has a crystal ball and can predict what will happen as life goes on. People go through significant changes throughout their lives and estate plans should likewise be amended to reflect those changes. An estate plan should not be viewed as something that is static and never needs to change. Rather, estate plans should be viewed as fluid and flexible – something that can and should be changed if your unique family and financial situation, or changes in the law, call for it.
By Kim Coogan
As everyone knows, a major tax reform bill was approved by Congress on December 20, 2017. It is expected to be signed into law by the President on or before January 3, 2018. The bill contains many changes to the income tax laws, as well as changes to the federal estate, gift and generation-skipping transfer (“GST”) tax law. Below is a summary of the changes to the estate, gift and GST tax laws, and a few other items included in the bill that will affect the counsel we provide to our clients in our practice. Please call us if you would like to discuss how these changes affect your plan.
Federal Estate, Gift and Generation-Skipping Transfer Tax
The current federal gift and estate tax exclusion of $5,000,000, which, with indexing for inflation, has increased to its 2017 level of $5,490,000, is increased to $10,000,000, indexed for inflation from 2011. This would make it $11,200,000 in 2018. This means each person may transfer, either during lifetime via intervivos gifts, or upon death via testamentary bequests, a total of $11,200,000 to family, friends, or other intended “objects of their bounty.”
The GST tax exclusion, which allows a donor to transfer assets, either directly to beneficiaries who are two or more generations younger, or in trust in such a manner as to avoid the estate tax on wealth transfers from children to grandchildren, is likewise increased to $10,000,000, indexed for inflation, or to $11,200,000 in 2018.
The annual gift tax exclusion, which is $14,000 in 2017, is not affected by the new law, and will increase as expected to $15,000 in 2018. The unlimited marital deduction remains unchanged. The “portability” election, made on the first of married spouses’ deaths to preserve the deceased spouse’s unused exclusion amount, also remains unchanged. Charitable bequests are still deductions offsetting the estate tax.
When considering these new transfer tax provisions, there are three issues to remember:
∙ Those of us living in Illinois still have to be mindful of the Illinois estate tax on estates over $4,000,000 (first dollars over exemption amount are taxed at 28%).
∙ After 2025, the changes to the federal estate, gift and generation-skipping transfer tax law will revert back to $5,000,000, indexed for inflation.
∙ No tax law is permanent....
A few of the Income Tax Law Changes
Charitable income tax deductions remain unchanged, with an increase of the limit on the annual deduction from 50% of AGI to 60% of AGI.
The Qualified Charitable Rollover, whereby a taxpayer may roll his or her IRA annual required minimum distributions up to $100,000 directly to a charitable organization, remains available to taxpayers over the age of 70-1/2.
What Does the Future Hold for Your Business? Where the Rubber Meets the Road: Rolling Out the Plan You’ve Mapped Out for Your Business
by Kim Coogan
Part 5 of a 5 part series
Just like many business owners who are “too busy with their businesses” to think about planning for its succession, I am guilty of getting 80% through the process of writing this series on business succession planning, and then putting aside the task of writing the final chapter, while I was busy attending to my clients’ needs. Part 1 of this series emphasized the importance of starting the process of business succession planning well in advance of your anticipated exit date, since the transition of both ownership and management will ideally take place over an extended period of time. In Part 1 I suggested having an emergency plan in place, in the event your timeline doesn’t roll out exactly as you would have hoped. Part 2 raised the issue of identifying not only those who will own the business, but also those, who may not be the future owners, who will manage the day-to-day operations, as well as continue to develop the company’s long-term strategy and guide the future direction of the business. Part 3 discussed entering into a written buy-sell agreement among the owners, which memorializes the terms under which ownership interests may be transferred, whether by sale, upon death, or otherwise. Part 4 laid out various options for funding the buy-out of an ownership interest.
A business owner may decide that once he or she has made it through steps 1 through 4, they can put their shiny new plan on the shelf, and go back to what they would rather be doing, i.e., running the business. But it is important to pull out the business succession plan on a regular basis-perhaps annually-to determine whether changes have occurred such that the plan that made sense last year may need to be adjusted this year. You may have a clearer perspective as to how those individuals you had identified as successor owners and/or managers or directors are performing. You may have had a change in health or lifestyle that precipitates the need to accelerate your timeline for the business transition.
Using time to your advantage is a key to a successful business succession plan. If you plan to transfer ownership to family members, you want to do so in a tax efficient manner, perhaps taking advantage of annual gift tax exclusions, or your lifetime gift and estate tax exclusion. There are many options available to get a bit more “bang for your buck” from your gift tax exclusions. Transferring non-voting and/or minority business interests enables you to take a discount on the value of the transferred interest, as reported to the IRS on a gift tax return. Engaging in systematic annual gifting over many years not only gives you the opportunity to maximize use of your annual gift tax exclusions, but also gives you a chance to see whether your original plan remains in line with your intentions year after year, or if adjustments to your future gifting may be desired.
On the other hand, perhaps you’re ready to transfer a larger portion of the ownership interest. A gift to a grantor retained annuity trust might make sense if you prefer a method that uses very little or none of your gift tax exclusion. Or you may consider an installment sale of a portion or all of the business to a grantor trust for your family members, enabling you to defer, or perhaps eliminate, the capital gain you might otherwise have to recognize and take into income as a result of a sale transaction. If you’ve concluded that the best succession plan is to sell while you’re still in control of the business, then an outright sale of the business might be more appropriate. The process of hiring the right broker, and locating the right buyer, willing to pay the right price, can take considerable time and patience.
Regardless of which method of ownership and management transition of your business best fits your situation, I know one thing for sure, without even having met you yet-you need to start now, or if you’ve started, you need to continue, to develop a business succession plan. Gather your team of professional advisors, and get the ball rolling. Whether you plan to work forever, or are dreaming of days on the golf course or beach in the not-so-distant future, you’ll rest easier knowing your succession plan is in place for a smooth business transition whenever the time comes.
by Kim Coogan
The latest from Hinsdale Hospital Foundation's series on gift and estate planning topics.
Top Ten Ways to Simplify Your Estate Plan
Things change. Your circumstances and those of your family may have changed over the past several years. And estate tax laws have certainly changed. Our Planned Giving Council's Kimberly Coogan, Esq., offers the following suggestions to help you keep up with these changes and, most importantly, make things easier for your surviving spouse or family members. Here's her "Top Ten List" of opportunities to simplify your estate plan:
Quick and Easy
10. Update your Executor and Trustee appointments. Things do change. Avoid unnecessary cost and wasted time later by making sure these parties are you're the parties you'd choose today.
9. Review your Powers of Attorney. Perhaps your children are now old enough to be named to make financial and health care decisions for you if you become unable to act for yourself.
8. Confirm your IRA beneficiaries. If your children were younger the last time you signed IRA beneficiary designation forms, or if you named your trust as the beneficiary of your IRA, you may need to change the wording so your beneficiaries can take advantage of the inherited IRA rules with the fewest number of "hoops" to jump through to achieve the most income tax advantage.
7. Revisit your asset titling to ensure your assets pass as simply as possible to your beneficiaries. If you have a trust, make sure your after-tax accounts and real estate are titled in the trust. If you don't have a trust, you might consider ways to keep your estate out of probate. This will save time and money for your beneficiaries.
A Little More Detailed
6. Learn about the new estate tax laws, and how they affect your estate plan. If your estate is $4.0M or less, the tax formulas used in your old documents may result in unnecessary complication after your death. (Look at these changes over past 14 years: The federal estate tax exclusion amount was $675,000 in 2001; it is $5.34 million in 2014. Illinois passed its own estate tax in 2003; currently it applies to estates over $4.0 million.)
5. Would a TODI work for you? A "Transfer on Death Instrument" is a document that names a beneficiary to whom your primary residence will pass upon your death. This is a new Illinois law, providing an alternative for keeping your residence out of probate.
4. Consider using disclaimers to keep it simple. Providing for everything to pass to your surviving spouse unless he or she signs a "disclaimer" after your death, is one way to build flexibility into your estate plan and yet keep things simple for the surviving spouse. Your Will or trust agreement would provide that the disclaimed portion be held for the surviving spouse's benefit, but the disclaimed portion will not be subject to estate tax on the second death.
3. Does portability help in your situation? Portability, a provision of the 2010 federal tax act, allows the surviving spouse to file an election to retain any unused estate tax exclusion amount from the predeceased spouse's estate. Consult an attorney before relying on portability, since it does not apply to the Illinois estate tax, and presents certain other potential pitfalls.
2. Does generation-skipping transfer tax ("GST" tax) planning still make sense for you? If your old plan includes GST exemption planning, you may want to revisit it. The GST exclusion was much lower years ago, so avoiding estate tax in your children's estates may not be a priority now.
Easiest of All: Doing Good
1. Consider lifetime gifts to charity if your estate is potentially subject to estate tax. You'll make a difference for the charity of your choice and might be able to get the value of your estate below the estate tax exclusion amount. That means not only avoiding the tax, but saving your beneficiaries from having to file your estate tax return. If your age is over 70 ½ , you may roll your annual IRA required minimum distribution over to a charity, thereby avoiding paying any income tax on your IRA RMD.
These are just a few suggestions for ways in which the new estate tax laws, and other new developments in the law, afford you the opportunity to simplify your estate plan. Please contact your attorney for more detailed information as it applies to your personal situation.
by Kim Coogan
Part 4 of a 5 Part Series
You know you need to establish a succession plan for your business; you've identified and continue to develop individuals to whom the management, executive decision-making, and ownership of your business will pass. You recognize the importance of documenting your intentions for the future ownership of your business using a "buy-sell agreement."
Now you have to ask yourself the not-so-simple question, "If I pass away or retire and my interest is sold, how will I, or my family, be paid?" Or, "If my partner dies or wants out, how will I pay him or her, or his or her family, if I have to buy out his or her interest?" The answers to these questions will be different if the buyout occurs during lifetime as opposed to upon the death of an owner.
The buy-sell agreement should set forth the terms of payment of the purchase price, which will be determined in accordance with the valuation provisions of the agreement. In the event of the departure, retirement, disability or other lifetime buyout event of an owner, typically the agreement will allow for a promissory note evidencing the obligation to pay the purchase price over time. The term of the note may be principal and interest payments over 5, 10, or more years. The interest rate will be set at the time of the buyout, based on an index, e.g. prime rate, or the applicable federal rate, as published by a specific source. The note will most likely be secured by the pledge of the business interests being purchased.
Upon the death of an owner, the buyout may be funded either in the same manner as a lifetime buyout, or more commonly, with the proceeds from a life insurance policy on the life of the deceased owner. If the buy-sell agreement is a redemption agreement, whereby the business entity buys out the interest of the deceased owner, then the business entity will own the life insurance policies on the lives of the business owners. Upon the death of an owner, the business entity will pay out the agreed purchase price to the business owner's estate, or trust, depending on how the business interests were owned. The business interests will be transferred by the deceased owner's successor in interest to the business entity.
If the buyout is a cross purchase, then the surviving business owners will pay the agreed purchase price to the deceased owner's successor in interest. If there are two owners, then each would own a life insurance policy on the life of the other. In the case of a business with multiple owners, insurance can become more complicated. For example, with three owners, each would have to buy life insurance on two other owners. In total, there would be six life insurance policies. This can become somewhat cumbersome. An alternative might be a trusteed buy-sell agreement, whereby one life insurance policy on each of the owners is owned by an escrow agent (or "trustee"). Upon the death of an owner, the trustee collects and pays out the insurance proceeds to the deceased owner's successor in interest in exchange for the shares in the business. The escrow agent then allocates the shares among the surviving owners.
Congratulations! You've consulted with your professional advisors; you've done the hard work of considering who will carry on your vision for your business after you step away from it; you've laid the groundwork for management, leadership and ownership succession; and you've documented all of this in a well-written buy-sell agreement. You've obtained the proper life insurance or other mechanism to fund a potential buyout. You are doing great! But your work isn't done. It's a work in progress. You should revisit your business succession plan annually, and re-evaluate your management and leadership to ensure your plan is on track, and make any necessary adjustments. Your attorney, accountant, and insurance professional should work together with you to make sure your plan is the best it can be for you and your business.
by Kim Coogan
Part 3 of a 5 Part Series
In Part 1, we recognized the need to establish a succession plan for your business; and we discussed the importance of identifying and developing individuals to whom the management, executive decision-making, and ownership of your business will pass. Whether you determine that the business should pass to family members, key employees, or will be sold to a third party, it is critical that you document your intentions in a document often referred to as a "buy-sell agreement."
A buy-sell agreement is an agreement among the owners of a business, or between the sole owner and certain key employees, which sets forth the conditions under which ownership interests in the business may be transferred. One of the goals of such an agreement is to prevent the entity ownership from landing in the hands of the spouse of a deceased owner, the ex-spouse of an owner, or children who are not involved in the business. The agreement lists certain events, e.g. death, disability, departure or retirement of a business owner, the desire to sell to a third party, or the entry of a divorce or bankruptcy court order, which would trigger a buyout by the remaining owner(s) or key employee(s).
The agreement may be in the form of a redemption agreement, under which the business entity itself buys the business interest from the transferring owner. Alternatively, it may be a cross-purchase agreement, under which the remaining owner(s) buy the interests of the transferring owner; or it may be a hybrid agreement, which allows either the entity or individual owners to buy the interest. The agreement may provide for rights of first refusal, or a mandatory buyout by one party of the other party's interests in the business. There may be put and call options, giving an owner the right to require the other owner(s) to buy his or her interest, or sell their interests to the calling owner. The buy-sell agreement should also address the conditions under which an owner may transfer his or her interests by gift or sale to his or her descendants, or to a trust for their benefit, without triggering a buyout by the other party to the agreement.
A critical component of the buy-sell agreement is the valuation mechanism used to determine the purchase price for the business interest. There may be a specific formula included, or a provision that a valuation will be obtained from a professional valuation expert. Different methods of valuation may be applied, depending on the circumstances of the buyout. For example, book value might be used in a divorce or bankruptcy situation, and fair market value might be used for a death or disability situation. There might be a discount on the buyout price for a "put" and a premium on a "call." The parties should review the valuation provisions annually to ensure they remain appropriate, given changes in the industry, the market, and the business' financial condition.
Another critical question that must be considered is how the buyout will be funded. We will address funding in the next installment of this series on business succession planning. Note, however, that the method of funding and the design of the buy-sell agreement must be coordinated, so it is important to consider these issues concurrently.
by Carrie Buddingh
Crisis averted! Well, for the time being at least. As you probably know, on January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (“ATRA-2012"), which prevented our nation from going over the “fiscal cliff.” You may now be thinking, “What does this new law mean to me and my estate?” “Has anything changed at the state level?” Or even, “I thought the gift and estate tax law just changed in 2010. What changed this time?” You are in luck! Below please find a concise description of the current changes in the law that took effect January 1, 2013:
What Does the Future Hold for Your Business? Management Succession - Perhaps the Most Critical Piece of the Puzzle
by Kim Coogan
Part 2 of a 5 part series
So you’ve taken a moment to step back to survey the successful business enterprise you’ve built, and you realize you need to create a plan for the succession of your business. At some point you’ll want to retire, or you’ll pass on, as all of us eventually will. What would be your number one concern if suddenly you were unable to run the business? If you plan for your business to provide value to you in your retirement, or to continue to provide value to your family after you’re gone, likely your biggest concern is management succession. Who will provide leadership in your absence? Who will manage your employees? Who will maintain your customer and vendor relationships? If, like many business owners, you are the one filling all of these critical roles, you will need to consider developing people to fill your shoes when you step away.
The best place to start this process is to break your business down into components and evaluate who the key employees in each area are. What are their skills; what critical functions do they serve? Do they have the experience and skills to successfully lead the company? Are they respected by the other employees, and do they have the characteristics necessary to be an effective leader? If this examination reveals certain areas of the business operations that rely solely on you for leadership and direction, you will need to consider developing a layer of support. Are there individuals who are already part of your organization, who have the ability and aptitude needed to make the kinds of analyses and decisions you make? Do they have the depth of understanding of the industry, and the foresight needed to guide the company in the future?
One issue that commonly arises in closely-held business situations is the involvement of family members in the succession plan. It may be difficult to communicate to a family member that he or she is not entitled to take over running the business based on ancestry alone. It is critical, if a family member is to succeed to the business, that he or she is qualified and committed to continuing your vision in the best interests of the business and its employees.
Day-to-day operations are important, but long-term business strategy will determine the ongoing success of the business. If you don’t have a board of directors, or a board of managers if you are an LLC, you may want to think about forming a board. Ideally, a board of directors or managers is comprised of individuals with knowledge of your industry and your business. Think of individuals who would be helpful in creating a business plan for the company, as market conditions, technology and the economy change over time. The board members may not have any involvement with the day-to-day operation of the business, but would keep tabs on its financial health, and make decisions outside of the ordinary course of the business. Building a reliable board while you are still around to share your ideas will help to ensure that your vision for the future of your business will be carried forward.
While the directors’ or managers’ role is to make high level decisions and to keep the business moving in the right direction, the officers’ role is to govern the day-to-day operations. The officers have more hands-on responsibility for ensuring that the strategies and decisions laid out by the directors are being implemented. If you are the President, you may consider naming one or more Vice-Presidents, and grooming your replacement by involving him or her in some of the higher level operational decisions.
Your professional advisors, i.e., your attorney, accountant, and banker can be valuable resources who may guide you in developing a management succession plan. Additionally, there are small business consultants available who may help you to work through some of the more emotional aspects of formulating a plan. These can be very difficult decisions, which may take a considerable amount of time and mental and emotional energy to discern and to implement. It is important to start this process long before a management succession plan becomes necessary, to maximize the potential for a seamless transition of your business.