Using Trusts for Asset Protection Without necessarily using an asset protection trust. March 17, 2011 by Daniel Rubin, JD, LLM

April 4, 2011


It has long been recognized that a “spendthrift” trust, which the Restatement (Third) of Trusts defines as “… a trust that restrains voluntary and involuntary alienation of all or any of the beneficiaries’ interests,” can be used to protect assets from a third-party beneficiary’s creditors. The seminal case in this regard is the 1875 decision in Nichols v. Eaton, in which the United States Supreme Court stated that “[w]e concede that there are limitations which public policy or general statutes impose upon all dispositions of property … We also admit that there is a just and sound policy … to protect creditors against frauds upon their rights … But the doctrine, that the owner of property … cannot so dispose of it, but that the object of his bounty … must hold it subject to the debts due his creditors … is one which we are not prepared to announce as the doctrine of this court.”

However, a “self-settled” spendthrift trust (which is a trust in which the settlor is himself a beneficiary; commonly referred to as an “asset protection” trust), is for public policy reasons generally not protected from creditors. And, although a trend is developing whereby more and more states are enacting statutes recognizing the validity of self-settled spendthrift trusts, as self-settled spendthrift trust is by no means the only or even necessarily the best, way to obtain asset protection. This is particularly true where the property to be protected is coming from someone other than the beneficiary himself.

Testamentary Trusts

A typical last will and testament for a married person of a certain net worth will provide, if the individual is survived by a spouse, for a division of the estate between a “credit shelter” trust and a marital share so as to defer estate tax until the surviving spouse’s death. The tax law generally permits the marital share to pass outright to the surviving spouse or in a special type of qualifying trust (often a QTIP (Qualified Terminable Interest Property) trust). Of course, an outright transfer will be subject to the surviving spouse’s creditors while a marital trust will not be subject to the surviving spouse’s creditors.

The surviving spouse may, however, be uncomfortable with having a significant portion of their inheritance in trust. This discomfort might be overcome by naming the surviving spouse as a co-trustee, by providing for a broad distribution standard, rather than a more restrictive distribution standard such as “health, education, welfare and maintenance” and/or by providing the surviving spouse with the ability to remove and replace their co-trustee.

Similarly, it would make sense to avoid outright distributions to descendants (which are often made through a trust providing for distributions at specified ages, such as in thirds at ages 25, 30 and 35), since the same mechanism that would give a surviving spouse comfort and control over a marital trust can be utilized to give a descendant comfort and control over their trust.

Trusts and Retirement Benefits

Coincident to its retirement planning purpose, the individual retirement account (IRA), has important asset protection planning features. Specifically, due to the fact that financial security in retirement satisfies an important public policy, the law is well settled that an IRA (to be distinguished, however, from an “inherited” IRA), is generally exempt from creditors. It remains uncertain, however, whether an inherited IRA would provide the same protection against a beneficiary’s creditors. Therefore, individuals concerned about creditor protection for their beneficiaries should consider designating a trust for the beneficiary as the IRA beneficiary in lieu of naming the beneficiary directly. The issue with using a trust, however, is that naming a trust will generally accelerate taxable distributions from the IRA and thereby accelerate income taxation. Two types of trusts, however, will not accelerate distributions from the IRA:

1. Conduit Trust. As the name suggests, acts as a conduit between the inherited IRA and the trust beneficiary with regard to the minimum required distributions from the inherited IRA. The minimum required distributions that are being paid out to the beneficiary on a current basis are not protected from the beneficiary’s creditors, but the conduit trust does serve to protect the funds remaining in the IRA from creditors.

2. Discretionary Accumulation Trust. In such cases, the trustee is not required to distribute to the beneficiary the minimum required distribution on a current basis. Therefore, both the minimum required distribution amount and the funds remaining in the IRA can continue to be protected from creditors. The issue with a discretionary accumulation trust, however, is the difficulty inherent in qualifying the trust as an appropriate owner of an IRA since, without careful drafting, the beneficiary whose life is used to measure the minimum required distributions will be unclear and distribution from the IRA may be inadvertently accelerated.

Dynasty Trusts

Trusts created during life to provide estate and generation-skipping transfer (GST) tax savings by removing the transferred assets, together with any appreciation, from the estate of the settlor, also provide significant asset protection because they divest the settlor of those assets. Such trusts are sometimes called “dynasty” trusts because they are generally structured to continue, at a minimum, for a period beyond the lifetime of the settlor’s children in order to leverage an allocation of the settlor’s GST exemption.

If the settlor’s spouse is named as a discretionary beneficiary of the trust, the settlor might indirectly benefit from the trust fund through the exercise of by the trustee of its discretion to make distributions to the settlor’s spouse. Moreover, the same mechanisms that would give a surviving spouse comfort and control over a marital trust can be utilized to give the settlor’s spouse (and, thereby, the settlor as well), comfort and control over a dynasty trust.

A dynasty trust wherein the settlor’s spouse is a discretionary beneficiary might actually provide more significant asset protection than even an “asset protection” trust because such a trust is ubiquitous as an estate planning vehicle and, therefore, much less controversial and prone to scrutiny. In addition, since the trust provides undisputed estate tax savings, it can help to counter potential claims to the effect that the funding of the trust was a fraudulent transfer made with the intent to hinder, delay or defraud the settlor’s creditors.


A self-settled spendthrift (or asset protection) trust can be a useful vehicle for generating protection from creditors, but it is only one of many different types of trusts that can provide such benefits and advisors should not lose sight of the other types of trusts that can fulfill a client’s creditor protection goals.

IRA Charitable Distributions No Panacea By Michael E. Kitces, M.Tax., CFP, ChFC APRIL 2011

April 4, 2011


The extension for 2010 and 2011 of IRA qualified charitable distributions may encourage your clients to include them in their financial planning. Yet while it is true that completing a direct contribution from an IRA is pre-tax, this is hardly unique to contributing from an IRA, and in reality other charitable contribution strategies may still be far more effective for many affluent clients.

The primary reason that direct contributions from IRAs have relatively little value is that, in fact, the charitable deduction received for a regular cash contribution to offset other income usually yields an almost identical result in terms of after-tax wealth available to the taxpayer. The difference between the two is primarily due only to the effects of higher adjusted gross income resulting from including a distribution from the IRA in taxable income, such as deduction and credit phaseouts and other thresholds, such that the charitable deduction does not quite perfectly offset the net impact of higher income.

Contrast this, though, with another popular charitable gifting strategy: donating appreciated securities. In this case, the taxpayer receives a charitable deduction to offset income, in the same manner as donating from cash or another income source. However, in addition, the individual gets to exclude the long-term capital gain attributable to the appreciation. The net result is a full pre-tax contribution and excluding capital gains from income, generating even more after-tax wealth. An example:

John, who is 74 years old, has (in addition to other wealth that he uses to maintain his standard of living) three accounts: a $100,000 IRA, a $100,000 checking account, and $100,000 of ultra-long-term appreciated stock with a near-zero cost basis. He wishes to contribute $100,000 to a charity.

Scenario A: John contributes $100,000 from his checking account. In return, he receives a $100,000 tax deduction, which can nearly offset all of the income from his IRA. The net result: Almost all of his IRA income is tax-free (we’ll assume he can spend $98,000 of it, with $2,000 owed in taxes due to a not-quite- perfect offset of the deduction), and his appreciated securities will be worth $80,000 after taxes. Final spendable wealth: $178,000.

Scenario B: John contributes $100,000 directly from his IRA to a charity, since he’s over age 70½. In return, he is able to exclude the entire $100,000 from income. He still has his $100,000 checking account available, and he still has $80,000 of after-tax value for his appreciated securities. Final spendable wealth: $180,000.

Scenario C: John contributes his $100,000 of appreciated securities to the charity, and since they’re a long-term asset, he’s able to exclude the entire amount of capital gains from income, while also still claiming a full $100,000 tax deduction. This allows John to almost fully offset his IRA income (again, we’ll assume he can spend $98,000 of it, with $2,000 owed in taxes due to the not-quite-perfect offset of the deduction), and he still has $100,000 in his checking account. Final spendable wealth: $198,000.

As the scenarios above show, there is some tax-efficiency value to completing a direct contribution from an IRA; the difference between scenarios A and B represents the benefit of having a direct exclusion of IRA income, instead of just trying to offset it with an outside charitable deduction. Nonetheless, it is still inferior to contributing appreciated securities, which results in far more final, spendable wealth.

The contribution of appreciated securities doesn’t always work out better. Charitable gifts of capital gain property, including appreciated securities, can subject the donor to lower annual deductibility ceilings (for a 50% charity, the ceiling is reduced to 30% of AGI, and for a 30% charity, it is reduced to 20%—see IRC §§ 170(b)(1)(C) and (D)); on the other hand, if the deduction is significant enough, it may still be worthwhile to contribute appreciated securities and carry forward the unused amount to a subsequent year. However, if the amount of capital gains to avoid is modest, and/or most of the charitable contribution will be carried forward (or worse, is even at risk of being carried forward until it is lost), the strategy may be less effective. If state taxation is involved and the state provides less favorable treatment of charitable deductions than the federal tax system, the direct IRA contribution may be preferable.

In the end, charitable contributions from an IRA should be viewed merely as a slightly more effective means of donating than contributing cash; contributing appreciated securities is still higher on the pyramid of tax-preferred giving.


G.E.’s Strategies Let It Avoid Taxes Altogether By DAVID KOCIENIEWSKI

April 4, 2011

The company reported worldwide profits of $14.2 billion, and said $5.1 billion of the total came from its operations in the United States.

Its American tax bill? None. In fact, G.E. claimed a tax benefit of $3.2 billion.

That may be hard to fathom for the millions of American business owners and households now preparing their own returns, but low taxes are nothing new for G.E. The company has been cutting the percentage of its American profits paid to the Internal Revenue Service for years, resulting in a far lower rate than at most multinational companies.

Its extraordinary success is based on an aggressive strategy that mixes fierce lobbying for tax breaks and innovative accounting that enables it to concentrate its profits offshore. G.E.’s giant tax department, led by a bow-tied former Treasury official named John Samuels, is often referred to as the world’s best tax law firm. Indeed, the company’s slogan “Imagination at Work” fits this department well. The team includes former officials not just from the Treasury, but also from the I.R.S. and virtually all the tax-writing committees in Congress.

While General Electric is one of the most skilled at reducing its tax burden, many other companies have become better at this as well. Although the top corporate tax rate in the United States is 35 percent, one of the highest in the world, companies have been increasingly using a maze of shelters, tax credits and subsidies to pay far less.

In a regulatory filing just a week before the Japanese disaster put a spotlight on the company’s nuclear reactor business, G.E. reported that its tax burden was 7.4 percent of its American profits, about a third of the average reported by other American multinationals. Even those figures are overstated, because they include taxes that will be paid only if the company brings its overseas profits back to the United States. With those profits still offshore, G.E. is effectively getting money back.

Such strategies, as well as changes in tax laws that encouraged some businesses and professionals to file as individuals, have pushed down the corporate share of the nation’s tax receipts — from 30 percent of all federal revenue in the mid-1950s to 6.6 percent in 2009.

Yet many companies say the current level is so high it hobbles them in competing with foreign rivals. Even as the government faces a mounting budget deficit, the talk in Washington is about lower rates. President Obama has said he is considering an overhaul of the corporate tax system, with an eye to lowering the top rate, ending some tax subsidies and loopholes and generating the same amount of revenue. He has designated G.E.’s chief executive, Jeffrey R. Immelt, as his liaison to the business community and as the chairman of the President’s Council on Jobs and Competitiveness, and it is expected to discuss corporate taxes.

“He understands what it takes for America to compete in the global economy,” Mr. Obama said of Mr. Immelt, on his appointment in January, after touring a G.E. factory in upstate New York that makes turbines and generators for sale around the world.

A review of company filings and Congressional records shows that one of the most striking advantages of General Electric is its ability to lobby for, win and take advantage of tax breaks.

Over the last decade, G.E. has spent tens of millions of dollars to push for changes in tax law, from more generous depreciation schedules on jet engines to “green energy” credits for its wind turbines. But the most lucrative of these measures allows G.E. to operate a vast leasing and lending business abroad with profits that face little foreign taxes and no American taxes as long as the money remains overseas.

Company officials say that these measures are necessary for G.E. to compete against global rivals and that they are acting as responsible citizens. “G.E. is committed to acting with integrity in relation to our tax obligations,” said Anne Eisele, a spokeswoman. “We are committed to complying with tax rules and paying all legally obliged taxes. At the same time, we have a responsibility to our shareholders to legally minimize our costs.”

The assortment of tax breaks G.E. has won in Washington has provided a significant short-term gain for the company’s executives and shareholders. While the financial crisis led G.E. to post a loss in the United States in 2009, regulatory filings show that in the last five years, G.E. has accumulated $26 billion in American profits, and received a net tax benefit from the I.R.S. of $4.1 billion.

But critics say the use of so many shelters amounts to corporate welfare, allowing G.E. not just to avoid taxes on profitable overseas lending but also to amass tax credits and write-offs that can be used to reduce taxes on billions of dollars of profit from domestic manufacturing. They say that the assertive tax avoidance of multinationals like G.E. not only shortchanges the Treasury, but also harms the economy by discouraging investment and hiring in the United States


Once again, this shows how corporations have come to control the U.S. government and use this power to legalize criminal activities. We were warned about this over and over:

“I hope we shall … crush in its birth the aristocracy of our moneyed corporations, which dare already to challenge our government to a trial of strength and bid defiance to the laws of our country.” –Thomas Jefferson (Letter to George Logan, 1816)

“Corporations have been enthroned. An era of corruption in high places will follow … until wealth is aggregated in a few hands … and the Republic is destroyed.” –Abraham Lincoln, after the National Banking Act of 1863 was passed

“This is a government of the people, by the people and for the people no longer. It is a government of corporations, by corporations, and for corporations.” –Rutherford B. Hayes.

“The real truth of the matter is, as you and I know, that a financial element in the large centers has owned the government ever since the days of Andrew Jackson.” –President Franklin D. Roosevelt, November 21, 1933.

“In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.” –Dwight D. Eisenhower, farewell speech

One of the definitions of fascism is corporate control over the state, and we certainly have that. Behind all these corporations are the financial puppet masters, who have muscled their way to control over currency and credit, leveraging their position to profit by war and depression.

These are the folks Dickens had in mind when he created Ebenezer Scrooge. It remains to be seen whether these people have one iota of moral sense left from which redemption would be possible, for it certainly seems, metaphorically speaking, that they are fully committed to work of the devil.


Tax Haven USA Attracts Over $3 Trillion in Foreign Dirty Money March 14, 2011 By Nicholas Shaxson

April 4, 2011


Nicholas Shaxson, the editor of TJN’s Tax Justice Focus and writer for the Tax Justice Network, is an associate fellow at Chatham House in London and the author of a book about tax havens, entitled Treasure Islands, launched in 2011.

I have found a number for the amount of dirty money that is attracted into the United States on account of the secrecy facilities it provides: US$3 trillion. Yes,  three trillion dollars . Which goes quite some way to explaining why the United States came top of the Tax Justice Network’s  Financial Secrecy Index .

The number comes from a  letter to Tim Geithner, US Treasury Secretary, sent by  every single member of the Florida Delegation to the House of Representatives. They are whinnying about new  proposed IRS regulations for the United States to be more transparent about what foreigners earn there. Currently, almost all foreigners can bank in the U.S. in complete secrecy, and evade taxes they owe their own governments. These excellent proposals would see the U.S.  co-operating with other countries to help them tax their own citizens properly.

The key section of the letter says:

“Because of the privacy laws of the United States, nonresident aliens are estimated to have deposited over $3 trillion in U.S. financial institutions . . (the United States has) refrained from taxing the interest earned by them or requiring their reporting).”

That is unequivocal. This is not a measure of non-resident deposits: it is a measure of how much money foreigners stash in the United States “because of the privacy laws of the United States.” Nearly all the money deposited in Florida banks, by the way, is drained out of Latin America.

Let’s now play with numbers here. Imagine US$3 trillion earning a conservative five percent annually: that’s $150 billion in income. Let’s say those foreigners (nearly all wealthy) ought to pay an average 35% top rate of income tax, but that tax is evaded. That’d be over $50 billion in lost taxes per year.

Which would be, on these numbers,  twice the size of total U.S. official development assistance .

Make no bones about it: this is very, very dirty tax haven business that these Congresspeople are defending. And some Latin American governments are angry about it. Take this  letter , again to Tim Geithner, by Agustín Carstens, Mexico’s Secretary of Finance, in 2009:

“We do not exchange information on interest paid by banks from one country to residents of the other country. . . . I truly believe that we should enhance our cooperation and strengthen our capacities to protect our peoples and wealth. The [automatic] exchange of information on interest paid by banks will certainly provide us with a powerful tool to detect, prevent and combat tax evasion, money laundering, terrorist financing, drug trafficking and organized crime.”

Now take this quote from Robert Goulder of TaxAnalysts, cited in  Time Magazine:

“Replace the nationalities mentioned in the letter, and you’ve replicated the UBS affair point for point,” says Robert Goulder, international editor in chief at Tax Analysts, a nonprofit publisher about taxes worldwide, which first reported on the Carstens letter. “If you are a Mexican drug lord, you can put as much money as you want into U.S. banks. We ain’t going to tax it, and the Mexicans can’t tax it because they are never going to know about it. It’s the financial equivalent of ‘Don’t ask, don’t tell.’ “

All this dovetails neatly with three main points I make in Treasure Islands.

First, there is a two-way flow going on here. U.S. taxpayers are seeing money flow out and tax revenues lost to tax havens elsewhere – but there is money flowing in the other direction: dirty money from other countries, particularly developing countries, is flowing into the U.S.

Second, the money flowing in absolutely does  not compensate for the money flowing out. These hot-money inflows are one of the big reasons why Wall Street is so powerful; the money flows in large measure into real estate, pushing up property bubbles (further inflating property bubbles) and into government bonds, worsening the macroeconomic imbalances that contributed to the global economic crisis.  This stuff not only harms developing countries – it harms the United States. So the outflows are a cost to U.S. taxpayers, while the inflows are a benefit only to Wall Street, and indirectly a cost to U.S. taxpayers too.

The third point I’d make would be to repeat  a section of the latest press release from the Center for Freedom and Prosperity (led by my old friend Dan Mitchell, whose arguments I eviscerate in the chapter  “Resistance”) that this letter was signed by

“all members of the Florida Delegation to the U.S. House of Representatives.”

That is – every single last politician from Florida defends this criminal business.

What we have here is something I describe in Treasure Islands as the Captured State syndrome. I think the best illustration of that comes in a chapter “Ratchet” where I compare two episodes, one in Delaware in 1981, and another in the Channel Island of Jersey in 1996, where I show how financial interests effectively write each jurisdiction’s laws, and find that any democratic discussion of this measure — that is, any potential opposition — is effectively neutered. The two episodes, despite being 15 years and a continent apart, were stunningly similar.

We all know of Wall Street having captured politicians in Washington. Well here we have a more granular story: the politicians of Florida captured by tax haven interests.

It’s a horrible, horrible story, and just goes to underline what’s laid out in my book.

Originally published on the Treasure Islands blog

Anti-Money Laundering: Progress Made And Gaps In Swiss Measures March 15, 2011

April 4, 2011


By Daniel Thelesklaf

Daniel Thelesklaf is a board member of Transparency International Switzerland and executive director of the Basel Institute on Governance. The article represents the author’s personal opinions.


Switzerland has made distinct progress in its combat against money laundering . Yet there are still significant gaps. Switzerland was the trailblazer in the fight against money laundering in the 1990s, but it is now following in midfield. Implementation is still at a high level, but when it comes to the non-banking sector and the reporting of suspect cases, the Swiss Anti-Money Laundering Act (AMLA) still has considerable shortcomings. The standard is higher in the banking sector precisely because the internationally active banks must conform to more than just the Swiss AMLA.

The international anti-money laundering standard is laid out in the 40 Recommendations of the Financial Action Task Force on Money Laundering (FATF). These FATF Recommendations list the persons and entities that should be subject to money laundering legislation. In addition to banks and insurance companies, these include a range of other players such as accountants, tax advisers, notaries, lawyers, trust and company service providers, real estate brokers, traders (if substantial cash payments are involved) and casinos.

In Switzerland, dealers in valuable items (e.g. art dealers), real estate agents, tax consultants, as well as investment consultants, trustees, lawyers and notaries  only become subject of the law when they are involved in financial transactions – they escape from the scope when they are in an advisory role only.

Because all major financial centres have adopted a broader scope of application than Switzerland, there is the risk that such players may gravitate towards Switzerland on account of these gaps. This regulatory arbitrage is the booby trap that could mean damaged reputations in the future. It is interesting that the former pariah Liechtenstein has prudently brought the activities of trust companies comprehensively within the scope of anti-money laundering legislation.

This shortcoming in the AMLA is all the more regrettable because Switzerland has made considerable headway in other areas in the fight against money laundering, for example as regards establishing the identity of beneficial owners . Identifying a beneficial owner is a core element of any modern anti-money laundering legislation. The FATF Recommendations require that not only the customer must be identified, but also the person who ultimately owns or controls a customer and/or the person on whose behalf a transaction is being conducted. In the case of legal entities, this verification must include measures to understand the ownership and control structures of the contracting partner. It is not enough in this process merely to rely on customer-supplied information. Such information must also be verified. This conception raises big challenges for contracting parties because they generally have no direct contractual link with the beneficial owner. They depend on the customer (the contracting partner) to provide information on the identity of the determining person who in fact controls the customer.

Switzerland has also been a path-breaker in another aspect of international regulation, namely the “risk-based approach,” which aims to ensure a more targeted and efficient application of anti-money laundering regulations. The higher the risk that the assets involved may have money laundering connections, the more steps the financial intermediary must take to limit that risk. Switzerland introduced the risk-based approach in 2002 for banks, describing in detail the measures that must be taken in high-risk areas. Yet there are still gaps in the non-banking sector in this respect.

The biggest shortcoming in Switzerland’s anti-money laundering strategy is that the reporting requirement in the event of suspected money laundering is not sufficiently fleshed out. The reporting requirement has long been controversial in Switzerland. It was introduced in 1998, ultimately under pressure from the FATF. Yet the Parliament decided to attach unnecessarily high prerequisites to the reporting requirement. The basic principle remains that the transmission of customer data is fundamentally a breach of banking secrecy, and a waiver is only possible when “reasonable suspicion” exists. The reporting threshold in Switzerland is considerably higher than in other centres. This accounts for the rather small number of reported suspected cases, and the FATF criticized Switzerland on that score in its latest country review

Education tax credits comparison table

April 4, 2011

If you’ve looked in the upper right corned of the ol’ blog, you’ve seen that Today’s Tax Tip deals with education tax credits.

In connection with that tip, I thought it would be helpful to put the high points of the American Opportunity and Lifetime Learning credits in a table format.

American Opportunity Lifetime Learning
Up to $2,500 credit per student; 40 percent of credit may be refundable (limited to $1,000). Prior Hope Credit claims must be taken into account when figuring eligible expenses. Up to $2,000 credit per tax return.
Covers course-related books, supplies and equipment for first four years of a student’s undergraduate studies. Available for all years of postsecondary education, both undergraduate and graduate, as well as for courses to acquire or improve job skills. A degree or certification is not required.
To claim, student must be enrolled at least half-time in a program that will lead to a degree, certificate or other recognized education credential at a an eligible institution. Available for one or more courses, with no long-term enrollment conditions.
Credit is phased out for modified adjusted gross incomes between $80,000 and $90,000 for single filers, $160,000 and $180,000 for joint returns. Credit is phased out for modified adjusted gross incomes between $50,000 and $60,000 for single filers, $100,000 and $120,000 for joint returns.
Is not available if student has a felony drug conviction on his or her record. Is available even if student has a felony drug conviction on his or her record.

If you, or a child, is in college or you’re continuing your own education, check out these tax credits that could help you pay some of the high costs of higher education. Your tax homework could pay off on your 1040, as well as on your college transcript.

Estate Tax Tips for Married Couples

April 4, 2011

Put another way, you and your spouse can together leave up to $10 million to relatives and loved ones without any federal estate tax hit if you (both) die in 2011 or 2012. If you leave more, there will be a federal estate tax bill to pay. But the taxable value of your estate is reduced by donations that the executor of your estate is directed to make to IRS-approved charities. Of course, increasing charitable donations to avoid the estate tax means leaving less to relatives and loved ones.

Key Point: Gifts in excess of the annual exclusion amount ($13,000 for 2011) reduce your $5 million federal gift tax exemption and your $5 million federal estate tax exemption dollar-for-dollar. But that is OK if you are giving away appreciating assets–because the future appreciation will be kept out of your taxable estate

Make Annual Gifts to Relatives and Loved Ones

Thanks to the annual federal gift tax exclusion ($13,000 for 2011 and probably the same for 2012), making annual gifts up to the exclusion amount will reduce the taxable value of your estate without reducing your lifetime $5 million federal gift tax exemption or your $5 million federal estate tax exemption. The same holds true for gifts by your spouse.

With two adult children and four grandchildren, for example, you and your spouse could give them each $13,000 in 2011 for a total of $156,000 (6 x $13,000 x 2). Then, do the same thing in 2012. Over the two years, your taxable estates would be reduced by $312,000 (2 x $156,000) with no adverse federal gift or estate tax effects.

Give Away Appreciating Assets to Relatives and Loved Ones While You Are Still Alive

Thanks to the federal gift tax exemption for 2011 and 2012, you can give away up to $5 million worth of appreciating assets (stocks, real estate, etc.) without triggering any federal gift tax hit. So can your spouse. This can be on top of cash gifts to relatives and loved ones that take advantage of the annual exclusion and on top of cash gifts to directly pay college tuition or medical expenses for relatives and loved ones.

Key Point: Gifts in excess of the annual exclusion amount ($13,000 for 2011) reduce your $5 million federal gift tax exemption and your $5 million federal estate tax exemption dollar-for-dollar. But that is OK if you are giving away appreciating assets–because the future appreciation will be kept out of your taxable estate.

If you and your spouse each give stock worth $100,000 to your favorite relative in 2011, for example, the gift uses up $87,000 of both of your $5 million federal gift tax exemption ($100,000 – $13,000 annual exclusion) and $87,000 of both of your $5 million federal estate tax exemption. Utilizing your exemptions like this makes sense if you are giving away appreciating assets–because the future appreciation will be kept out of your taxable estate.

Set Up Irrevocable Life Insurance Trust

As you may know, life insurance death benefit proceeds are usually federal-income-tax-free. However, the proceeds from any policy on your own life are included in your estate for federal estate tax purposes if you have any incidents of ownership in the policy. It makes no difference if all the insurance money goes straight to your beloved Aunt Myrtle.

It does not take much to have incidents of ownership. If you have the power to change beneficiaries, borrow against the policy, cancel it, or select payment options, you have incidents of ownership. (The preceding is not a complete list of things that count as incidents of ownership.)

This unfavorable life insurance ownership rule can cause federal estate tax exposure for people who believe they have none.

Key Point: The life insurance ownership rule is more likely to adversely affect unmarried people. Why? Because death benefit proceeds from a policy on the life of a married person can be left to the surviving spouse without any immediate federal estate tax hit, thanks to the unlimited martial deduction privilege (assuming the surviving spouse is a U.S citizen). However, all the insurance money going into your surviving spouse’s coffers could cause his or her estate to eventually exceed the federal estate tax exemption.

The estate-tax-saving solution is to set up an irrevocable life insurance trust to own the policies on your life. Since the trust, rather than you, owns the policies, the death benefit proceeds are not counted as part of your estate (unless the estate is named as the policy beneficiary which would defeat the purpose). You are still able to direct who gets the insurance money because you get to name the beneficiaries of the irrevocable life insurance trust (typically your children and/or grandchildren).

There may be some complications. When you move existing policies into the trust, you must live for at least three years. Otherwise, the death benefit proceeds will be included in your estate, just as if you still owned the policies at the time of death. Also, when existing whole life policies are transferred into the trust, their cash values are treated as gifts to the trust beneficiaries. Finally, you may have to jump through some hoops to get the cash needed to pay the annual insurance premiums into the trust without adverse gift tax consequences. All these issues can usually be finessed with the help of an estate planning professional.

When you have a large estate that will inevitably owe some federal estate tax, you can set up an irrevocable life insurance trust to buy coverage on your life. The death benefit proceeds can then be used to cover all or part of the estate tax bill after you die. This is accomplished by authorizing the trustee of the life insurance trust to purchase assets from your estate or make loans to the estate. The extra liquidity is then used to cover the estate tax bill. When the irrevocable life insurance trust is eventually liquidated by distributing its assets to the trust beneficiaries (usually your children and/or grandchildren), the beneficiaries will wind up with the assets purchased from your estate or with liabilities owed to themselves. Bottom line: the federal estate tax bill gets paid with dollars that are not themselves subject to the federal estate tax.

Capital Gains Tax (CGT) and Divorce Posted by admin on Monday, March 28, 2011 · Leave a Comment

April 4, 2011


Where there is a breakdown in a personal relationship, and the ownership of an asset changes, there is a CGT relief measure that applies.

Q. I am in the process of a divorce settlement. Together with my former spouse we own two investment houses and a business. We have decided to split 50-50, with her taking the investment houses and I keep the business, which she has not being involved in. She is taking the CGT into account for the houses and I’m not sure of the legalities of the CGT for the business and rental houses. All were purchased after 1993.

A. It interesting when you do a search on capital gains tax and divorce there is very little listed as being produced by the ATO. One of the few things that the ATO does offer is a list of assets that are CGT exempt. These include:

  • an asset acquired before September 20, 1985
  • cars, motorcycles and similar vehicles
  • compensation received for personal injury
  • disposing of a main residence
  • a collectable – for example antiques or jewellery costing $500 or less
  • a personal use asset acquired for $10,000 or less – for example, items such as boats, furniture, electrical goods and household items used or kept mainly for personal use or enjoyment. Land and buildings are not personal use assets
  • disposing of an asset to which the small business 15-year exemption applies
  • the exchange of shares and units owned in a company or trust that is taken over, if certain conditions are met, and
  • shares in a company or interests in a trust where there has been a demerger and certain conditions have been met.

Although not strictly an exemption, there is capital gains tax relief that applies where the ownership of an asset changes as a result of divorce. The relief is in fact not optional and must be applied where a legally binding agreement has been entered into. This could be an agreement imposed by the family court or one mutually agreed between the parties to the divorce.

Under the rollover relief that must be applied in the case of a divorce agreement there are no capital gains tax implications for the person disposing of an asset. The person who receives the asset as a result of the divorce agreement takes over all of the CGT history related to the asset.

In relation to the divorce settlement with your wife this will mean the rental properties being transferred to her will be regarded as being purchased by her when you purchased them as a couple. There is no capital gains implication for you but she will pay CGT when she sells them if the net sale proceeds exceed the cost paid by you as a couple.

With regard to the business that you will be retaining, there is no capital gain payable by your wife. When the business is sold you may be able to take advantage of the various small business capital gains tax concessions. These include the 15 year asset exemption, the 50 per cent active asset exemption, and the retirement exemption. To be eligible for these concessions you must either have a turnover of less than $2 million or meet the other criteria.

(Source: CGT is as certain as death and taxes, Max Newnham, 28/3/11, SMH Money)

Mar 17 Foreign Bank Account Reporting – 2011 Offshore Voluntary Disclosure Initiative By John Williams · Trackback URL

April 4, 2011

Does the date June 30, 2011, mean anything to you?

It should – especially if you’re a “U.S. person” (US citizen, Green Card holder and/or a non-resident alien if you are physically present in the US over a prescribed number of days and hold foreign assets with an aggregate value of $10,000 or more.

June 30th is the deadline for filing  “Form TD F 90-22.1″ for 2010;  this  “foreign bank account report” (FBAR) gives the Treasury a look at your  foreign “bank, brokerage, or ‘other’ financial accounts” you held during 2010 .  If you have a financial interest in, or signature or other authority over foreign bank, securities or “other” financial accounts with an aggregate value exceeding $10,000, you must file the FBAR. That’s true even if the account contains only precious metals or other non-cash assets, or generates no income.

The FBAR is not the only reporting obligation for your offshore investments.  Additionally, you must also report your foreign accounts each year on Schedule B of your Form 1040, federal income tax return. Moreover, the IRS has created a special reporting regime for Americans with more than $50,000 in non-U.S. assets.

FUBAR – ‘Fouled Up Beyond All Recognition’

The FBAR offshore reporting regime truly is FUBAR. The tax penalties for failing to file FBAR forms are draconian. You could end up paying a $10,000 fine per unreported account for each year you neglect to file the FBAR. Far worse, if you “willfully” fail to file the form, you face a fine up to $500,000, five years imprisonment . . . or both.  In addition, if you own more than 50% of the shares of a corporation (by value, U.S. or foreign) with a foreign account, the corporation must file a FBAR. You must also file a separate FBAR in your own name acknowledging the same account.  Similar rules apply to partnerships. Even a single-member LLC, taxed as a “disregarded entity,” is a “U.S. person” for FBAR purposes.

Offshore Voluntary Disclosure Initiative

If for whatever reason you failed to satisfy the FBAR requirements anytime during the past eight years – now is your chance!  A  new IRS initiative allows certain taxpayers to voluntarily disclose hidden offshore accounts (accounts outside of the US) without the risk of criminal prosecution and also provides for reduced civil penalties for prior noncompliance with offshore account reporting requirements. The initiative, known as the 2011 Offshore Voluntary Disclosure Initiative (OVDI), was announced by the IRS on February 8, 2011. Taxpayers participating in the 2011 OVDI must file all original and amended tax returns and include payment for taxes, interest and accuracy-related penalties by August 31, 2011.

Penalty Framework

The 2011 OVDI provides the following penalty framework during the eight-year look-back period:

  • an “off-shore” penalty of 25% on the highest annual aggregate balance in the unreported accounts;
  • an “accuracy-related” penalty of 20% for unpaid taxes; and
  • late filing and/or late payment penalties in certain cases.

A taxpayer with offshore accounts or assets that, in the aggregate, did not exceed $75,000 in any calendar year during the look-back period will qualify for a reduced 12.5% rate instead of the standard 25% rate. A 5% rate (instead of the standard 25% rate) will apply in certain limited circumstances (e.g., in the case of foreign residents who were unaware that they were U.S. citizens).

Under the 2011 OVDI, taxpayers will not be required to pay a penalty greater than what they would otherwise be liable for under the maximum penalties imposed under existing statutes. The 2011 OVDI also offers a modified mark-to-market election for taxpayers with interests in passive foreign investment companies (e.g., foreign mutual funds) to determine the income from such investments.


Taxpayers, including entities such as corporations, trusts and partnerships, who have undisclosed offshore accounts or assets are eligible to apply for the 2011 OVDI. However, taxpayers under criminal or civil investigation by the IRS or who participated in the 2009 Offshore Voluntary Disclosure Program (predecessor to the 2011 OVDI) are ineligible.


There is a fairly simple process to make a voluntary disclosure under the 2011 OVDI. A taxpayer may either submit basic personal information by fax letter to the IRS or submit a more detailed disclosure letter from the outset. Either way, a detailed package of information must ultimately be provided to the IRS to secure acceptance into the program. Mark Bailey & Co. has taken several clients through this process and can assist you.


The IRS has launched a new webpage that includes the full terms and conditions of the 2011 OVDI, as well as the necessary forms and documents for making a disclosure.  Additionally, the webpage contains information regarding the procedure for making a voluntary disclosure and a comprehensive FAQ. For more information regarding the 2011 OVDI, click here

Small Business Jobs Act of 2010 By John Williams · Trackback URL

April 4, 2011


On September 23, the House passed the Small Business Jobs Act of 2010 (H.R. 5297) and signed into law by President Obama on September 27, 2010.

The following are some of the key provisions of the 2010 Act:

  • Section 179 Expense Election expanded: For tax years beginning in 2010 and 2011, expense limit is increased to $500,000 and phase-out threshold increased to $2 million;
  • Section 179 for (some) real estate: For tax years beginning in 2010 and 2011, taxpayers can elect to treat certain real estate as Section 179-eligible. Qualifying real estate includes:
    • Qualified leasehold improvements;
    • Qualified restaurant property; and
    • Qualified retail improvement property.
  • Bonus depreciation extended: Available for property purchased through December 31, 2010;
  • Luxury auto depreciation increased: As a result of the extension of bonus depreciation, first-year depreciation of automobiles is bumped up $8,000;
  • Deduction for start-up expenditures increased: Under Section 195, increased from $5,000 to $10,000 for taxable years beginning in 2010 (only);
  • Exclusion for small business stock: For purchases made after the date of enactment and before January 1, 2011, the exclusion for small business stock under Section 1202 is increased to 100%;
  • Five-year carryback for general business credits: Effective for credits determined in the taxpayer’s first taxable year beginning after December 31, 2009 (one year only), the carryback period for an “eligible small business” is increased from one to five years. In addition, the credit is not subject to the AMT limitation;
  • Built-in gain period shortened to five years: For taxable years beginning in 2011 (only), the recognition period for the BIG tax is shortened to five years;
  • Deduction for health insurance for SECA purposes: For 2010 (only), the deduction for self-employed health insurance is also a deduction for purposes of the SE tax;
  • Cell phones removed from listed property: Permanent and effective for tax years ending after 2009;
  • Information reporting required for rental property: Effective for payments made after December 31, 2010, rental real estate is treated as a trade or business for information reporting purposes. IRS to prescribe de minimis exceptions;
  • Higher information return penalties: Penalties under Section 6721 are substantially increased beginning in 2011;
  • Section 457 plans can include Roth accounts: For tax years beginning after December 31, 2010; and
  • Rollovers from elective deferral plans to in-plan Roth accounts allowed: Effective on the date of enactment. Will allow a two-year deferral (2011 and 2012) for rollovers done in 2010.

If you would like to know how these new provisions may specifically impact your 2010 taxes, please contact us at Mark Bailey & Co.  The IRS has included the provisions of the 2010 Act on its website. To view, click here.