Note: The following article appeared in the July, 2000 edition of Contra Costa Lawyer.
Keith Schiller, 2000.

ANTI-TAXIDENTS_¹ AND ESTATE PLANNING--
PRESCRIPTION FOR A HEALTHY ESTATE PLAN

Had King Lear preferred Anti-taxidents_ to the fawning of false-faced children, he could have preserved his kingdom and dignity. Anti-taxidents_ provide a prescription for the healthy estate plan... giving priority to non-tax wishes while achieving effective tax savings.

The largest estate tax arise when the decedent is the sole owner of property or the assets are held in joint tenancy. Property held in sole ownership, particularly real estate or sole ownership of a business, lose valuation discounts that may apply to fractional or minority interests. Fractional interest discounts are denied to joint tenancy property. Estate of Young v. Comr. 110 TC 24 (1998). Consider the following unplanned estate for a married couple:

By blending tax and non-tax considerations with an Anti-taxident_ approach this couple can save over $4 million in estate tax without giving up control as part of a healthy estate plan. Our Anti-taxident medicine chest includes Vitamin E (Exemptions), Vitamin T (Title), Vitamin G (Gifts), Vitamin D (Discounts), Vitamin C (Charitable deductions), and Vitamin I (Insurance).

1. Vitamin E... Exemptions: Federal tax law offers Vitamin E in two forms - the gift and estate tax exemption AND the Generation Skipping Transfer Tax (GST) exemption.

   The estate and gift tax exemption allows greater wealth up to the "tax-free" amount ($675,000 in 2000 increasing to $1 million in 2006) to pass without estate tax on the death of the decedent or his spouse. This benefit is available with a "Credit Shelter Trust" or "By-Pass Trust" even for a surviving spouse receiving an extensive menu of benefits and powers. The GST exemption ($1,030,000 and increases with cost of living) saves taxes when property is left in trust for children or on direct gifts to grandchildren.

2. Vitamin T... Title to assets. Title to assets, including real and personal property, can have a significant affect on estate tax as well as ownership and right to property. Funding a living trust avoids probate, exploits the non-tax and tax planning embodied in the trust, and coordinates distribution to avoid disputes within the family. .

   Major court decisions encourage the use of trusts as opposed to outright bequests to the surviving spouse in order to save estate tax on the death of the surviving spouse. Estate of Mellinger v. Comr. 112 T.C. No. 4 (1999); and, Estate of Nowell v. Comr. T.C. Memo. 1999-15. These cases hold that on the death of the surviving spouse, the interest of the surviving spouse held in a QTIP Trust cannot be blended with the interest owned outright by the surviving spouse. As a result, fractional and minority discounts can be applied to each of these interests rather than incurring aggregation of ownership in the gross estate.

3. Vitamin G... Gifts. Lifetime transfers receives the greatest tax benefit under all forms of federal transfer tax. Annual exclusion gifts ($10,000 per year with cost of living increases) provide the easiest means to transfer-tax free savings because they are on a per-donor/donee basis. Health care and tuition costs paid directly to the provider are not also tax free.

4. Vitamin D... Discounts. Perhaps the greatest estate tax savings opportunity for the wealthy investor or business owner rests with valuation discounts. Value and ownership drive the estate tax system. "Vitamin Discounts" can be obtained without giving up control.

   Family limited partnerships, closely-held corporations and limited liability companies can all be structured to provide tax savings consistent while meeting control needs.

   While discounts must be established by appraisal, minority and marketability discounts of 35-50% are frequently opined with discounts of 40% reflecting a reasonable range for planning. See, Schiller, Hot Topics of the Federal Estate Tax Return. CPA Foundation Text, 2000.

   These savings can be enhanced through time-value discounts, based on the principle that property received in the future is worth less than property received today. If the donee is a family member, these discounts are obtained through the Grantor Retained Annuity Trust (GRAT) among other approaches.

   GRATs provide an attractive strategy to moving great wealth to children at very low values through a trust approved by Code 2702. Provided the underlying asset achieves income and growth that is greater than the 7520 rate, the GRAT will achieve overall transfer tax savings.

   With gifts of minority interests in family limited partnerships (FLPS) or closely-held corporations, the net return from the GRAT can achieve tremendously leveraged yields. Property in a GRAT receives a starting value NET of any minority interest, lack of marketability, fractional interest and other discounts that enter into the value of the entity, property or interest (apart from time-value discount of the trust). However, economic return for the interest (i.e., the capitalization rate) is based on pre-discount returns. The following example illustrates the potential cash-flow with a GRAT owing a minority interest in an S Corporation valued at six times earnings (and assuming the Corporation can distribute its net income):

   Example: S Corp. has a value of $10 million with a net operating income of $1.6 million. H (age 65) donates a 10% interest to a GRAT, which receives a 40% minority interest discount ($600,000). The net operating income on the 10% interest is $16,000, or 26.667% of the discounted value (16,000/60,000). Applying the 7520 rate (8% for April, 2000) in this example, an annual payout of $13,737 (22.895% annuity rate) leaves a gift tax remainder value of only $3,104 (IRS measure or 0 in a more aggressive approach) to include on the gift tax return.

   If the grantor dies within the retained period, the GRAT is brought back into the grantor's gross estate for estate tax purposes. Code 2036.

5. Vitamin C... Charitable deduction. Charitable planning has its own non-tax rewards and benefits for the betterment of society, support of worthwhile causes, and support the family mission. Income and estate tax incentives through the "Vitamin C deduction" arise through a variety of approaches:

   • High value, low basis assets contributed to a charitable remainder trust (if the donor wants income) or charitable lead trust (possible greater income tax savings if the donor does not need the income).

   • Husband and wife with a large IRA or qualified retirement plan can leave a rollover to benefit the other spouse with the remainder to charity, including to a charitable foundation on the death of the surviving spouse. This approach protects the security of the widow(er) while avoiding the over 70% combined income and estate tax that will arise on the death of the surviving spouse from these zero-basis assets.

6. Vitamin I... Life Insurance. Life insurance is the only asset that can avoid estate tax on the death of both the husband and wife. IRC 2042. The "Vitamin I" prescription bulks up the estate without estate tax by using an Irrevocable Life Insurance Trust (ILIT) or other third-party owner and beneficiary over the policy, thereby keeping the wealth provided by the insurance benefits within the family but without estate tax.

   Vitamin I blends well with the Vitamin C charitable deduction by replacing the wealth through non-taxed life insurance for the later generations that is lost to the family from the donation of outright or remainder gifts to charity. In our example, the $1 million of life insurance would be placed in to an ILIT, providing that amount tax-free to the children, with the remainder in of the IRA and qualified funds going to the family foundation on the death of the surviving spouse. Only the IRS receives less from this blending of Vitamins I and C.

The "vitamin enriched" estate plan achieves estate tax savings consistent with the client's desires, personality, desires for control, and the unique qualities of the family. As we return to our opening vitamin-deficient example, the $5,395,000 estate tax can be reduced to $1,330,000, or less, through the vitamin enriching strategies discussed in this article without loss of effective control by the client of his or her estate and future. If a GRAT is used, the tax savings will be even greater.

The following highlights the strategies and reduction to the taxable estate owned solely by one person or by a married couple in joint tenancy:

^1. Anti-taxidents_ is registered service mark of Schofield & Schiller, a Professional Law Corporation.
Keith Schiller, Esq. May, 2000. Mr. Schiller is a shareholder with Schofield & Schiller of Walnut Creek, CA. He is a certified specialist in Taxation Law and Estate Planning, Probate and Trust Law by the California State Bar.