Protecting Your Timberland Business & Family Wealth

Lifetime STRATEGIES

Procrastinate, that’s what many successful timberland business owners do instead of effectively planning for the future.  Now that they have accumulated sizable wealth, they become immobilized by seemingly conflicting concerns: how to retain control of their assets as they approach retirement age, retain enough income to live on after retirement, minimize their children's estate taxes and provide for their families' security after they die.  These goals need not be at odds with each other, however.  There are ways to maintain control of the family timberland business or other assets and to generate an income stream, while keeping a lid on your estate tax bill.  In the 1980s, Congress allowed everyone to pass on $600,000 transfer tax-free, 

and up to $1 million--including the $600,000--to skip a generation.  Back then, that tax exemption may have been more than enough to cover your net worth. But since that time, the exemption has remained fixed, while your family's net worth has probably climbed.  Today, a big chunk of your assets could be swallowed by federal estate tax rates that start at 37 percent (on the first dollar over $600,000) and rise to 55 per­cent (on amounts over $3 million).

If your assets already exceed $1.2 million in value---or if you expect they will someday--it makes sense to start preparing your estate plan now. You may want to consider some of the following strategies as you map out your future.

    CREDIT SHELTER TRUST

This trust serves as the core of most estate plans for married couples.  Used correctly, a credit shelter trust can double the amount free of estate taxes that you and your spouse leave to your children--from $600,000 to $1.2 million.  Suppose husband and wife each have $600,000 in assets, and each sets up a credit shelter trust.  At his death, the husband's $600,000 would go to his trust, instead of going directly to his wife.  She could draw income from her husband's credit shelter during her lifetime, and dip into the principal under certain circumstances.  Later when she dies, the trust as­sets would pass to the kids, along with her $600,000, with no estate tax liability.  Since both spouses have credit shelter trusts, the scenario would be reversed if she died first.  For this arrangement to work, however, each spouse should have at least $600,000 in his or her own name (or half the aggregate estate if that amount is less than $600,000).  That is because jointly-owned assets will not pass into the trust.  Tax Act changes in 2000 and 2001 change these dollar amounts.  See the Tax Update below.

    GENERATION-SKIPPING TRUST

While setting up a credit shelter trust, you might also want a generation-skipping trust that can provide income for your children and a big tax break later for your grandchildren.  When you die, your children's inheritance goes into this type of trust, either retaining the investment income or paying it out to your children or grandchildren.  The principal is ultimately passed to your grandchildren, and the tax laws levy no transfer taxes on these trusts up to $1 million.  In using a generation-skipping trust for your grandchildren, however, make sure you are not compromising the long-range security of your children.

   
    GIFT GIVING

A basic building block of any estate plan is making lifetime gifts of cash or other assets to your children, grandchildren or others.  By giving away assets during your lifetime, you can begin to provide for your family while shrinking the size of your estate--resulting in lower estate taxes upon your death.  Under the tax laws, lifetime gifts are added with the property that passes through your estate at death.  Aggregate amounts over $600,000--the "exemption"--are then subject to the estate and gift taxes.  Additionally, the Internal Revenue Code allows you to give away up to $10,000 ($20,000 if your spouse joins you) each year, to as many people as you desire, without denting the $600,000 exemption or paying any gift tax.  Over a five-year period, a couple making the maximum joint gifts to their four kids--$80,000 per year- could reduce their estate size by $400,000.

    FAMILY INCOME TRUST

You can help preserve the wealth you have accumulated, while gradually passing on the family timberland business to the next generation by putting family timberland ownership interests into a family income trust.  This irrevocable trust can take advantage of some of the previously discussed estate planning strategies, such as the $600,000 estate/gift tax exemption, the $ 10,000 per year, per donee gift tax exclusion 

and the generation skipping tax exemption. In addition to timberland business assets, any property with growth potential--securities or other real estate, for example--can be shifted to the trust which then pays income to your children as beneficiaries.  The children, in turn, can plow that income back into the family timberland business.

    TIMBERLAND BUSINESS GIFTS

Giving your children gifts of stock (corporation) or interest (partnership) in a family timberland business is usually advantageous for businesses that are not yet highly appreciated, but are expected to grow.  For example, if you give away your $1 million-business today, you will owe gift taxes on $400,000 (the amount over your $600,000 lifetime exemption).  If instead, you wait 10 years when its value has doubled to $2 million, you will face gift taxes on $1.4 million.  Gifts of family timberland business shares can be made into a family income trust for the next generation's benefit, or outright to your children whom you expect to eventually run the company.  As a closely-held business, you may be able to take certain valuation discounts, and save on trans­fer taxes, when making gifts of minority business interests.  The minority discount is a recognition that a minority interest may be worth less [because of the lack of control inherent in minority ownership.]  Suppose a husband-and-wife business team annually transfer shares in their business to their two children for 25 years.  By applying a 25 percent minority discount, for example, they jointly give them $53,000 of stock per year, free of gift taxes--the discounted equivalent of their joint maximum annual exemption of $40,000 to both children that grows at 7 percent yearly.  During their lifetimes, the parents would have transferred over $ I 0 million out of their estates, an estate tax savings of about $5.5 million.

    FAMILY LIMITED PARTNERSHIP

A family limited partnership can help you gradually shift ownership of your timberland business (or other assets) to your children yet allowing you to retain control until your retirement.  By properly designing the parents' partnership interest, it is possible to pass a large portion of the business' growth in value to the next generation.  Family limited partnerships can help reduce your estate tax bill.  By transferring limited partnership interests in tire business to your children over time, you may also utilize your annual gift tax exclusion.  The partnership can be structured so that you can shift income among family members, while ensuring that you and your spouse continue to receive income in the form of salary.

    GRANTOR RETAINED ANNUITY TRUST

This kind of trust, also known as a GRAT, lets you remove assets from your estate without giving up the income they generate. When you set up a GRAT, you keep the annuity interest--the right to receive the trust property's income for a specified time. You could place income-producing investments and timberland into the trust.  When the trust period ends, the property passes to your heirs.  Since they are annuities, GRATs pay you a fixed dollar amount each year, for instance, the trust could pay you $4,000 annually.  Be cautious, however; if you take more income from the trust than you can use during your lifetime, you will ultimately put that unspent money back into your taxable estate and possibly pay estate taxes on it.  Your gift tax is based on the present value of the remainder interest going to your heirs.  Therefore, you will be transferring the assets at a discounted rate, which means a lower gift tax bill for you.  Since GRATs are irrevocable, you cannot take the assets back later should you need them.  So be sure you can afford to lose control of those assets before placing them in the trust.

    GRANTOR RETAINED UNITRUST

The Grantor Retained Unitrust (GRUT) is a cousin of the GRAT.  It too holds income-producing assets that pay income to the trust's grantor for a set period, at the end of which the assets pass to the beneficiaries.  A GRUT, however, pays a fixed percentage of the trust's value each year instead of a set dollar amount.

    CHARITABLE REMAINDER TRUST

If you have highly appreciated assets--such as a closely-held timberland business, a stock portfolio or real estate--and a charitable inclination, you might consider transferring them to a charitable remainder trust.  This trust is similar to a GRAT or GRUT, but a charity is the beneficiary instead of your children.  You get a lifetime annuity or unitrust interest from the trust assets--either a set dollar figure each year or a fixed percentage of the assets not less than 5 percent.  At your death, the assets go to the charity you named when you set up the trust.  If the trust is properly drafted, you can take a charitable income tax deduction when the assets are first placed in the trust.  You can not deduct the full value however, because the charity will not receive the principal for years.  Another tax advantage: the potential for the trust to sell the stock or other trust assets without paying the 28 percent capital gains tax.  If you sold it outright instead of giving it to the trust, you would be writing the IRS a check for 28 percent of your profit upon sale.  One way you can replace the donated assets and provide for your children is to purchase life insurance with the income stream produced by the trust.

    PERSONAL RESIDENCE TRUST

Suppose you want to pass your home, currently worth $500,000, to your children.  You also plan to retire in l0 years and move out of state.  Rather than giving them the house when you retire and incurring hefty gift taxes on its appreciated value, you can, ill effect, give it to them now.  By placing your home into a qualified personal residence trust, you remove it from your estate-thereby avoiding future estate taxation.  You live in the house during the l0 years, then ownership passes to your children. Since your kids must wait a decade to receive the property, the IRS discounts the value of the gift they are getting. Thus, the $500,000 house is transferred at a lower gift tax cost.  If the house appreciates during the decade, the trust will produce bigger savings since it freezes the value of the children's interest.  These trusts do have their drawbacks; if you die before the trust expires, the house is kicked back into your taxable estate at its full value, if you move or sell the house before the end of the trust term, you may also lose the tax advantages if the house is not replaced.

Used correctly, these various techniques may help you meet your goals of:

(1) reducing the size of your taxable estate,

(2) retaining income and, in some instances,

(3) keeping control of your assets.

Contact an estate planning professional to get a better idea of how you may help pre­serve your family's assets as they continue to grow.

W. Alex Shumate of CIGNA Financial Advisors, Inc., 5605 Seventy-Seven Center Dr., Ste. 290, Charlotte, NC 28217. Supervising Branch Office: Two Parkway Ctr., 1800 Parkway Pl., Ste. 900, Marietta, GA 30067.

TAX UPDATE 2002

Economic Growth and Tax Relief Reconciliation Act of 2001-
Estate, Gift and Generation-Skipping Provisions

President Bush has signed the "Economic Growth and Tax Relief Reconciliation Act of 2001" (the "Relief Act") into law. Among the most significant of the provisions contained in that law, signed on June 7^th, are sweeping changes in the federal estate, gift and generation-skipping taxes that will be phased in over the next eight years, culminating in the complete repeal of the federal estate and generation-skipping taxes (but not the federal gift tax) in year 2010. Even though the law contains a sunset provision which will restore these taxes as the law exists in 2001, it is likely that Congress will act before then to modify the effect of that return to existing law.

This memorandum describes some of the most important features of the federal estate, gift and generation-skipping tax changes. The implications of these changes for the estate plans of many individuals will be such that they will be well-advised to seek the advice of counsel for their own situations. Because the effects will vary from individual to individual, this summary is not intended to be and should not be understood to constitute advice for your personal estate planning situation.

For purposes of this memorandum estate tax refers to the tax imposed by the federal government on gifts and bequests that occur at the time a person dies, which in the language of politics is commonly called the death tax. Gift tax refers to the tax imposed by the federal government on gifts made by a person during his or her life. Generation-skipping tax refers to the special, additional tax that the federal government imposes on gifts, either at death or during life, to beneficiaries more than one generation lower than the person making the gift. Thus, a gift by a grandparent to his or her grandchild is a generation-skipping transfer subject to generation- skipping tax.

Current law under which the maximum estate tax rate is 55% remains in effect through December 31, 2001. There also is a 5% "surtax" on that portion of estates in excess of $10,000,000 up to $17,184,000 under current law. The practical effect of this surtax is to eliminate the benefits of the lower bracket rates, that is those of less than 55%. The current rate for federal generation-skipping tax is, by definition, a flat rate equal to the highest estate tax rate—in other words, a flat 55%.

The Relief Act reduces the maximum estate tax rate as follows:

Because after 2003 the federal generation-skipping tax is tied to the maximum estate tax rate, the rate of that tax will decrease at the same times and at the same rates.

Under current law the first $675,000 in value of an estate is shielded from federal estate tax by an arbitrary credit—the so-called "unified credit." The amount thus exempted from tax is called the "unified credit exemption amount," or, in tax law shorthand, the "credit shelter" or "credit shelter amount." Before the passage of the Relief Act, the credit shelter amount was scheduled to increase as follows:

Under the Relief Act, this phase-in of higher credit shelter amounts will change to the following:

Under the new law, starting in 2004 the federal generation-skipping tax exemption increases with the amount of the unified credit exemption amount. Until then, the generation-skipping tax exemption remains at $1,000,000 indexed for inflation. The federal generation-skipping tax is also repealed in 2010.

Under current law, each estate is given a credit for estate and inheritance taxes paid to a state. The amount of the credit is based upon a graduated rate schedule so that the larger the value of the estate, the higher the state death tax credit. Many states, including Illinois, have enacted as their only estate or inheritance tax a tax exactly equal to the state death tax credit under the Internal Revenue Code.

The Relief Act reduces and then eliminates the state death tax credit as follows:

This phase-out and ultimate elimination of the state death tax credit does not increase the federal estate tax. However, the implication of this change for states is potentially great: for states like Illinois all of the Illinois estate tax revenues will disappear unless the State Legislature enacts some kind of replacement tax. It is likely that many states will enact new taxes at death.

The Relief Act DOES NOT repeal the federal gift tax. It does, however, make significant changes to that tax.

Under current rules when a person inherits property from a decedent, the heir takes as his or her income tax basis the value of the property on the date of the decedent’s death, or, if the estate was eligible to make the alternate valuation election and does so, the value on the six month anniversary of the date of the decedent’s death. Starting in 2010, The Relief Act reintroduces carryover basis, an idea which had a limited life once before in the federal estate tax. The Relief Act version provides for certain limited adjustments and exceptions. Carryover basis becomes effective with the repeal of the estate tax.

Carryover basis means that the person who inherits property from a decedent will also inherit the decedent’s income tax basis in that property. The inheriting person would take the date of death value as his or her basis only if the date of death value were lower than the decedent’s basis. By way of example, if a person were to inherit stock from a decedent whose basis in that stock was $100 and which had a date of death value of $1,000:

The Relief Act does allow an increase in basis at date of death of up to $1,300,000 per decedent and not per inheriting person, subject to certain special rules and limitations. It also allows a basis increase for property passing to a surviving spouse of up to $3,000,000. Assuming that estate tax repeal in its present form becomes permanent, there are likely to be significant planning implications in these new carryover basis rules, as well as significant implications for executors as they are required to allocate the partial step-up in basis among a decedent’s heirs and legatees.

The Relief Act of 2001 is much more—and much less—than a simple repeal of the death tax. There are many ways in which it will make wealth transfer planning more, rather than less complex. It is likely to present highly beneficial planning opportunities as well as to lay hidden tax traps for those who fail to attend to some of the built-in pitfalls. Because of the phase-in of many of its most significant features few of those with significant wealth can safely ignore its implications and assume that their present estate plans will be adequate to achieve the best results.