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The Train is Leaving the Station Estate Planning in 2012 October 10, 2012 William L. Montague Frost Brown Todd LLC wmo

The Train is Leaving the Station Estate Planning in 2012 October 10, 2012 William L. Montague Frost Brown Todd LLC wmontague@fbtlaw.com. 3300 Great American Tower 301 East Fourth Street Cincinnati, Ohio 45202 (513) 651-6920. 7310 Turfway Road Suite 210 Florence, Kentucky 41042

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The Train is Leaving the Station Estate Planning in 2012 October 10, 2012 William L. Montague Frost Brown Todd LLC wmo

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  1. The Train is Leaving the Station Estate Planning in 2012 October 10, 2012 William L. Montague Frost Brown Todd LLC wmontague@fbtlaw.com 3300 Great American Tower 301 East Fourth Street Cincinnati, Ohio 45202 (513) 651-6920 7310 Turfway Road Suite 210 Florence, Kentucky 41042 (859) 517-5920

  2. William L. Montague is a member of the Cincinnati and Northern Kentucky law firm of Frost Brown Todd LLC, where his practice is concentrated in estate, business and estate planning, charitable giving and estate administration. He received his B.A. degree, magna cum laude, from Wittenberg University and his J.D. degree from the University of Cincinnati College of Law. Mr. Montague has co-authored several articles and is a frequent speaker on the topics of estate planning, estate administration and taxation. He has been repeatedly recognized as a Best Lawyer in America and Ohio Super Lawyer.

  3. Historic Time PeriodNext 3 Months • Gift Tax Exemption- $5,120,000 sheltered from gift tax ($10,240,000 for a married couple) for gifts in 2012 • Depressed Asset Values – The values of many assets, including marketable securities, business interests and real estate, remain low in many cases • Historically low interest rates • For loans, the interest rate for a 9 year loan in October 2012 is .93% • For other transactions such as GRATs and CLATs, the interest rate for October 2012 is 1.2%

  4. Take Advantage of Larger Gift Tax ExemptionNext 3 Months • Direct Gifts to Children – simple, but not as much protection for the children • Direct Gift to Irrevocable Trust for Children– Protects the gifted assets from estate taxation at the children’s deaths, from the children’s creditors, and from the divorce of a child. Can also provide asset management, if needed • Direct Gift by One Spouse to Irrevocable Trust for Other Spouse and Children – Provides same protections for children, but provides the additional benefit of making assets available to the other spouse if living needs require in the future

  5. Take Advantage of Larger Gift Tax ExemptionNext 3 Months • Leveraged Gift to Irrevocable Trust for Children– Protects the gifted assets from estate taxation at the children’s deaths, from the children’s creditors, and from the divorce of a child. Can also provide asset management, if needed • Leveraged Gift by One Spouse to Irrevocable Trust for Other Spouse and Children – Provides same protections for children, but provides the additional benefit of making assets available to the other spouse if living needs require in the future

  6. Take Advantage of Low Interest RatesNext 3 Months • Direct Loan to Children – simple, but not as much protection for the children • Direct Loan to Irrevocable Trust for Children– Protects the gifted assets from estate taxation at the children’s deaths, from the children’s creditors, and from the divorce of a child. Can also provide asset management, if needed • Direct Loan by One Spouse to Irrevocable Trust for Other Spouse and Children – Provides same protections for children, but provides the additional benefit of making assets available to the other spouse if living needs require in the future

  7. Loan to Lifetime Trust

  8. Loan to Lifetime TrustStep 1: Set up Irrevocable Trustand Fund it with Cash Irrevocable Trust Husband & Wife $100,000 cash

  9. Loan to Lifetime TrustStep 2: Apply Generation Skipping Exemption on Gift Tax Return Irrevocable Trust Husband & Wife $100,000 GST Exemption

  10. Loan to Lifetime TrustStep 3: Loan Money to Irrevocable Trust Irrevocable Trust Husband & Wife $900,000 loan (9 years at .93% interest)

  11. Loan to Lifetime TrustStep 4: Pay Loan Back at End of 9 Years Irrevocable Trust Original assets $1,000,000 Growth* $740,000 Loan payoff in year 9 ($900,000) Value of Trust in Year 9 $840,000 Husband & Wife Payoff of loan $900,000 *Assumes 7% annual total return on investment and annual interest payments of .93%

  12. Leveraged Gift to Lifetime Trust

  13. Installment Sale to Grantor Trust Original Scenario Steve 100 shares 100% ownership XYZ Manufacturing $15,000,000 $1,200,000 annual distribution

  14. Installment Sale to Grantor Trust Creation and Funding of Irrevocable Trust Steve 2 Gift of $600,000 cash Irrevocable Trust Sale of 50 nonvoting shares ($5,250,000) with 30% discount) 3 $500,000 in cash and $4,750,000 promissory note 5 voting shares ($750,000) 95 nonvoting shares ($14,250,000) 1 XYZ Manufacturing

  15. Installment Sale to Grantor Trust Cash Flow(Year 1) Steve Irrevocable Trust Taxes ($526,000) IRS $600,000 note payment 50% of profit distributions ($600,000) premium payments 50% of profit distributions ($600,000) Life Insurance XYZ Manufacturing

  16. Installment Sale to Grantor Trust Step Four: Sale of XYZ Manufacturing in 2017 for $30,000,000 Steve $882,000 promissory note balance Irrevocable Trust management control 50 nonvoting shares XYZ Manufacturing Cash $30,000,000 Buyer assets Buyer Cash $30,000,000

  17. Installment Sale to Grantor Trust Step Five: Distribution of Sale Proceeds Steve Irrevocable Trust Cash $15,000,000 $882,000 promissory note $15,000,000 cash distribution $15,000,000 cash distribution 50 voting and nonvoting shares management control 50 nonvoting shares XYZ Manufacturing Cash $30,000,000

  18. Installment Sale to Grantor Trust After Sale of XYZ ManufacturingOption 1: No Reimbursement for Income Taxes Irrevocable Trust Sales proceeds $15,000,000 Payoff of Note ($882,000) Net proceeds $14,118,000 IRS $7,500,000 tax payment $882,000 promissory note payoff Steve Sales proceeds $15,000,000 Note payment $882,000 Income taxes ($7,500,000) Net proceeds $8,382,000

  19. Installment Sale to Grantor Trust After Sale of XYZ ManufacturingOption 2: Reimbursement for Income Taxes Irrevocable Trust Sales proceeds $15,000,000 Tax reimbursement ($3,750,000) Payoff of Note ($882,000) Net proceeds $10,368,000 IRS $3,750,000 tax reimbursement $7,500,000 tax payment Steve Sales proceeds $15,000,000 Tax reimbursement $3,750,000 Note payment $882,000 Income taxes ($7,500,000) Net proceeds $12,132,000 $882,000 promissory note payoff

  20. Installment Sale to Grantor Trust Bottom Line $14,118,000* is sheltered from estate tax inside the Irrevocable Trust at a gift tax cost of $600,000, which is leverage of more than 23 to 1! *Assumes Steve will not request reimbursement for income taxes paid on behalf of Irrevocable Trust.

  21. Installment Sale to Grantor Trust • Step One: Recapitalize company into voting and nonvoting shares • Step Two: Seed the irrevocable trust with gifted assets so that the purchaser of nonvoting stock will be a “creditworthy” purchaser • Step Three: Steve sells nonvoting stock to the Irrevocable Trust, free of capital gain taxes, in exchange for an installment promissory note • Step Four: Make note payments back to Steve with cash flow generated by corporate distributions paid to the Irrevocable Trust

  22. Installment Sale to Grantor Trust • Issue #1: The only taxable gift is the gift of the seed money. The sale portion of the transaction is an arms length transfer, and is not subject to gift tax or generation skipping tax. • Issue #2: Be sure that the term of the note is not excessive, or the IRS could argue that the transfer is with a retained life interest. If the note is paid off prior to death, nothing gets reported on an estate tax return • Issue #3: As is the case with all large gifts, valuation is critical!!

  23. Installment Sale to Grantor Trust • Advantages • No gain recognized by grantor on sale • Payment of income taxes by grantor rather than by irrevocable trust (reducing the size of grantor’s estate) • Favorable interest rates • Payment flexibility / refinancing • Protected from estate taxation in multiple generations • Partial disclosure on gift tax return / no disclosure on income tax return

  24. Installment Sale to Grantor Trust • IRS attack in Karamazin • It is preferable to have the trust own assets other than interests in the entity being sold • If personal guarantees would be required by a commercial lender, they should be used here • There should be sufficient entity income to assure repayment of the note

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