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Welcome
Welcome to the
September / October 2000 edition of The Riser Report. The Riser Report is a bimonthly publication covering issues and opinions
related to asset protection and estate planning. The Riser
Report is written by Attorney Christopher M. Riser, of Mayer
& Riser, PLLC (www.mayer-riser.com) in Highlands, North
Carolina and published by Axius Publishing, LLC.
The Riser Report is sent by electronic mail to subscribers of our companion
publication, The Adkisson Analysis, and vice versa. If
you aren’t already a subscriber to The Riser Report,
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The
Adkisson Analysis at www.falc.com. If you have yet to enter
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regular postal mail by writing to the address at the end of this
issue.
In this first issue, I look at a bit of the
evolving response of the offshore world to the OECD’s
blacklist of tax and money laundering havens. Next, I examine
the Delaware Series Limited Liability Company, which could be an
economical and efficient alternative to multiple entities in the
right situation. Third, I report on the recent takeover and
ongoing investigation of the First International Bank of Grenada
by government regulators. Next, I discuss the concept of growth
shifting for entrepreneurs; that is, shifting the opportunity
for vast increases in wealth to younger generations at a minimal
estate and gift tax cost. “Briefly Noted” contains a number
of short but relevant news items. Finally there is a short
review of John Huggard’s book, Living Trust Living Hell,
which fills a long-standing void in the otherwise one-sided
category of living trust publications.
I’ll be in London the last two weeks of
October preparing for and taking the exam for qualification as
an English solicitor, so the November/December issue of The
Riser Report may be a little late, but I hope to have it ready
by November 10th.
Comments and suggestions
are always welcome. Email them to comments@riserreport.com or
use the feedback form on The Riser Report Web site at www.riserreport.com/feedback.htm.
Offshore
Response to OECD
In late June, the Organization for Economic
Cooperation and Development (OECD), an organization of 29 of the
world’s most economically developed countries, issued its
report entitled Toward Global Tax Cooperation (www.oecd.org/daf/fa/harm_tax/Report_En.pdf),
which includes the so-called ‘blacklist’ of “uncooperative
tax haven” countries. The June report was a follow-up to
1998’s report entitled Harmful Tax Competition: An Emerging
Global Issue. Since when is competition harmful?
The apparent intent of the high-tax member
countries of the OECD is to create a high-income-tax cartel by
bullying the world’s low-income-tax jurisdictions into
cooperation in harmonizing tax regimes and in promoting fiscal
transparency by opening foreign financial accounts to tax
authorities from other jurisdictions.
At about the same time the OECD’s Financial
Action Task Force (FATF) on Money Laundering released its Review
to Identify Non-Cooperative Countries or Territories: Increasing
the Worldwide Effectiveness of Anti-Money Laundering Measures
(www.oecd.org/fatf/pdf/NCCT2000_en.pdf).
The FATF report also contained a ‘blacklist’ of
uncooperative offshore countries. Nine of the fifteen countries
on the FATF blacklist also appear on the tax haven blacklist. In
mid-July, the U.S. Treasury’s Financial Crimes Enforcement
Network (FINCEN) division issued Advisories notifying U.S.
financial institutions of money laundering risks when dealing
with banks in the 15 jurisdictions on the OECD blacklist.
Even before the issuance of the reports and
advisories, financial institutions in the major offshore
financial centers had begun to request more detailed information
regarding the beneficial owners of financial accounts, i.e.,
trust settlors and company owners.
Within a few days of the issuance of the
FINCEN Advisory on St. Kitts & Nevis, I had trouble with a
U.S. dollar wire from a U.S. bank account to the account of a
reputable offshore service provider at The Bank of Nevis
International, whose correspondent banking relationships with
two U.S. banks suddenly were terminated. Eventually, I was able
to make the payment through a Canadian correspondent bank.
However, it was apparent that the combination of the OECD
blacklist and the FINCEN Advisories had an immediate adverse
effect on legitimate offshore financial transactions. These were
not idle threats.
The response of the governments of the
offshore financial center jurisdictions has been to capitulate
for the most part on the issue of transparency. For example,
Belize, the Cook Islands, The Bahamas, and the Cayman Islands
have all passed emergency legislation intended to make it easier
for foreign tax authorities to gather information on foreign
financial accounts and generally to expand the scope of
international money laundering investigation capabilities of
foreign governments. Other offshore jurisdictions are expected
to follow suit in one way or another.
And
it came to pass in those days that there went out a decree from
the OECD that all the world should be taxed…
It’s on the tax side of the issue that I
think things will get interesting, because that’s what this
whole issue is really about. The money laundering talk is mostly
there to make the idea of cracking down on offshore
jurisdictions seem more like “justice” and less like the
bullying that it generally is, especially given the recent
radical tax reforms in Germany lowering tax rates and similar
measures being proposed in Italy. Therefore, the continued
viability of offshore jurisdictions will depend on legislative
and economic creativity rather than tax regimes which
distinguish between resident and non-resident companies.
The Isle of Man saw the writing on the wall
and has been aggressively pursuing e-business with some success
over the past several years. As a “proving ground” for
British Telecom in partnership with the local telecommunications
company, Manx Telecom, the Island has one of the most advanced
IT infrastructures in the world. In addition, a new Electronic
Transactions Act was recently enacted.
In anticipation of the recent OECD tax
report, the Isle of Man cut its business tax to half the current
rate as part of a strategy to satisfy the OECD and the EU while
remaining economically competitive. The current standard 20% tax
rate will be reduced to 10% for companies. Some companies (those
vital to the Island’s future as a financial center, such as
shipping and insurance) will continue to enjoy tax exemption but
via a zero tax rate rather than an exemption. Furthermore, any
special tax regimes in future will be for certain types of
business rather than the distinction between resident and
non-resident.
At the same time, the Isle of Man plans to
reduce its individual income tax, which already is an attractive
personal income tax system with no capital gains tax. The
standard personal income tax rate will be fixed at 10% and 15%.
Although non-residents will pay the new 15% rate on Isle of Man
source income, they will have personal allowances which were
previously only given to residents. Also, executives on
short-term contracts of up to three years will now only be taxed
on their Isle of Man source income. These are the kinds of
comprehensive changes that signal a jurisdiction’s welcome to
“new economy” entrepreneurs and workers to both live and
establish new businesses in the jurisdiction.
The Bahamas’ immediate reaction to the
blacklists was to bristle and vow not to cave in to OECD
demands. However, it wasn’t long before The Bahamas began to
move in that direction. New money laundering legislation was
introduced quickly and Prime Minister Hubert Ingraham flew to
the U.S. and Canada to meet with government officials.
Shortly thereafter, an Act to Amend the
Evidence (Proceedings in other Jurisdictions) Act, 2000, was
enacted, which will make it easier for foreign government
investigators, including those from foreign tax authorities, to
obtain evidence on persons and entities holding bank accounts in
The Bahamas. The Act purports to restrict “fishing
expeditions” by requiring specificity in requests for
information. However, for customers of many major financial
institutions, especially for new customers, the Act doesn’t
change much. Many major institutions had already been requiring
more extensive identification from customers and some had
already been requiring customers to sign confidentiality waivers
that would apply in the event of a request for information from
a government agency.
Getting The Bahamas to loosen privacy laws in
the name of fighting drug traffickers’ money laundering
efforts is a pretty easy argument for the OECD to make.
Convincing a major offshore financial center such as The Bahamas
to “harmonize” its tax regime by converting from its current
tax regime which includes no direct taxation (although some
taxes, such as import duties, are very high) to an income tax
based regime is another matter altogether.
Delaware
Series LLC
The limited liability company (LLC) has fast
become the business entity of choice in the U.S. The LLC allows
business owners to achieve limited liability for debts of the
business while being taxed on a relatively unrestricted
passthrough basis.
The LLC also provides protection to its
owners for debts unrelated to the business in that LLC property
and LLC interests themselves generally cannot be directly seized
or attached by creditors of debtor members. Instead, such
creditors are limited to a “charging order” issued by a
court requiring the LLC to divert payments to the debtor member
to the creditor.
However, the charging order does not provide
the creditor with voting rights, such as the right to vote for a
distribution. If no distributions are made to the debtor member,
neither are distributions made to the creditor. Furthermore, in
some cases, the creditor may be taxable on the debtor member’s
share of LLC income, whether he receives a distribution or not.
Thus the charging order is not a particularly attractive remedy
for a creditor. For more about LLCs in general, see the articles
at the Mayer & Riser, PLLC Web site at www.mayer-riser.com
and the articles at the Adkisson Analysis Web site at www.falc.com.
Segregating “dangerous” assets and
businesses into separate entities away from other assets,
especially “safe” assets, is always a good idea from an
asset protection point of view. For example, an individual who
owns a gas station and a rental home shouldn’t own both within
the same entity. Neither should an individual with a large
amount of liquid assets (cash, securities, etc.) to protect hold
the cash in the same entity as a business.
Best practices would dictate that every
distinct business or major business asset be segregated into a
different limited liability entity. In an ideal situation,
someone with 25 rental properties would have 25 separate LLCs,
one for each property. However, this isn’t always practical
because of administrative costs and government fees that must be
paid for each LLC. What can such a business owner do to protect
his assets from liabilities unrelated to those assets in a
cost-effective way?
Enter the Delaware series LLC. The Delaware
LLC Act provides for the creation of separate “series”
within an LLC whose debts and other liabilities are enforceable
against that series alone. The Act also provides that classes or
groups of members can be established, having whatever rights the
LLC agreement says they have. The combination of the two
provisions allows a series to be treated in many ways as a
separate LLC. Thus, the series provisions in the Delaware LLC
Act allow for the creation of separate protected “cells”
within one limited liability “container” without the need to
create separate entities, thus avoiding the inefficiencies
associated with multiple related entities. The concept is
similar in function to the segregated portfolio companies and
protected cell companies designed for the mutual fund and
captive insurance industries in Bermuda, Guernsey, the Cayman
Islands, Mauritius and Belize.
The Act allows an LLC agreement to designate
series of members, managers or LLC interests that have separate
rights and duties with respect to specific LLC property or
obligations. So, each series can be tied to specific assets and
can also have different members and managers. If the various
series within an LLC have different members or different
membership rights, each series may be treated as a separate LLC
for income tax purposes, eliminating some of the administrative
advantage of the series LLC.
Each series can have its own separate
business purposes. A series can be terminated without affecting
the other series of the LLC. A series can make distributions to
its own members without regard to the financial condition of the
other series.
Most importantly, the Act provides that
debts, liabilities and obligations incurred, contracted for or
otherwise existing with respect to a particular series are
enforceable against that series only, and not against the assets
of the LLC generally or any other series of the LLC. However, to
obtain this protection, each series must be treated separately.
Books and records must be kept for each series and the assets of
each series must be held and accounted for separately. Finally,
in order that the public knows that it is dealing with a series
LLC, it must be put on notice by the inclusion of the series
limitations in the LLC’s Certificate of Formation filed with
the Delaware Secretary of State.
Practical Uses of the
Series LLC
The most obvious use for the series LLC is to
hold multiple parcels of real property in liability-segregated
cells. Consider Bob and Nancy, who own ten small rental
properties, each worth between $50,000 and $100,000. Forming and
maintaining ten separate LLCs would cost several thousand
dollars in the year of formation and several thousand dollars
each subsequent year. Instead, Bob and Nancy might form a
Delaware series LLC and transfer each property by deed to a
separate series. They would achieve their goal of segregating
the properties for asset protection purposes while saving
several thousand dollars in startup costs and another several
thousand dollars a year in ongoing administrative costs.
Another use for the series LLC might be to
facilitate an equity compensation program in a business with
multiple divisions. If each division were segregated into a
separate series, the LLC could give the key employees of each
series some sort of equity interest tied to that series only
rather than equity interests in the entity as a whole. That
rewards employees at productive divisions and protects them from
the potential downside of another division.
Yet another use for the series LLC might be
to make a de facto transfer that avoids gain that would
otherwise be recognized on a transfer from one LLC to another
LLC. Consider the following example: Dan & Ed contribute
adjacent tracts of land to D&E, LLC and develops most of the
land. A few years later, they want to sell the remaining
undeveloped land, worth $1 million, to Fred for a shopping
center. Dan & Ed want D&E, LLC to get some cash out of
the deal, but they also want a piece of the shopping center
action. If D&E, LLC contributes the property to a new LLC
formed with Fred, DEF, LLC, in exchange for DEF, LLC interests
and cash, the cash distribution would be taxable to Dan & Ed
under Section 707(a)(2)(B) of the Internal Revenue Code as a
taxable exchange of appreciated property for cash.
Instead, D&E, LLC creates a new series
within D&E, LLC, the Shopping Center Series, issues the
Shopping Center Series interests 10% each to Dan and Ed, and 80%
to Fred, and transfers the land to the Shopping Center Series.
Fred contributes $2 million to D&E, LLC, of which $1.5
million is designated for the Shopping Center Series. If
D&E, LLC is respected as a single tax partnership (i.e., the
Shopping Center Series is not treated as a separate partnership
for tax purposes), the current income tax gain to Dan & Ed
on the cash portion of the land exchange that otherwise would
have been triggered in a transfer to a new LLC will have been
avoided. In addition, since the transfer of the land was
entirely inside the LLC, depending on local law, there may be no
real estate transfer tax on the transfer whereas there may have
been tax on the transfer of the land to a new LLC. This is
cutting edge planning with no guarantees, but the possibilities
are exciting.
Mayer & Riser, PLLC has considerable
experience in using Delaware series LLCs to achieve the asset
protection goals of its clients, particularly in the area of
real estate investment. If we can help you or your clients, give
us a call at 828-526-3731 or send me an e-mail message at criser@mayer-riser.com.
Grenada
Finally Acts Against FIBG
Readers of The Adkisson Analysis (www.falc.com),
Matt Blackman’s Goldhaven (www.goldhaven.com),
and David Marchant’s Offshore Alert (www.offshorebusiness.com)
are familiar with the First International Bank of Grenada (FIBG).
FIBG is an offshore bank, initially capitalized with a single
alleged gemstone, that promised investors returns of up to 250%
on certificates of deposit. FINALLY, the government of Grenada
has taken over FIBG’s operations as of August 17th. The story
here is not that the government acted, but rather — what
took so long? FIBG’s first auditors, Wilson & Co.,
warned the Prime Minister in March of 1999 that FIBG’s assets
were “bogus and fictitious” and that the entire Grenadian
offshore sector needed a serious overhaul.
Grenada’s former Accountant General Garvey
Louison has been appointed to investigate the bank and assume
control over bank operations. Finance Minister Anthony
Boatswain, who appointed Louison, said he knew the bank was
experiencing a “shortage of funds,” but he did not say how
it would affect investors. Well, maybe it will affect them in
that most of them will never see their principal, much less
their promised interest?
FIBG depositors can view a “Proof of Loss
& Claims Form” at the Web site of the International
Deposit Indemnity Corporation (www.idic-ec.org),
the supposed insurer of FIBG deposits, which was last year was
kicked out of Nevis and turned away by Dominica (neither of
which countries even have insurance legislation) and now simply
calls itself a “West Indian corporation.” Of course, IDIC is
not accepting any of these claims forms, but the reason is not,
the IDIC says, “that IDIC is a scam,” but rather that
“IDIC was never intended to be a quick fix, but rather
would/will have to liquidate bank assets in the event of
failure. This is a process that takes time and one that for
practical reasons can only be used as a last and final
solution.” What would IDIC and any interested parties likely
receive upon liquidation of FIBG? A ruby and accompanying
appraiser’s certificate if they’re lucky.
Louison’s letter of August 22nd to the
present and former directors of FIBG (available for viewing at www.offshorebusiness.com
along with other documents relating to FIBG) claims that “many
millions of dollars” of depositors’ monies have been
transferred to four bank directors, including Brink, directly or
through IBCs and other entities set up for that purpose. Louison
also notes that CDs for “many millions of dollars” have been
issued “without any proper assets being in place which are
immediately available to meet such claims.” Further,
apparently many millions of dollars have been diverted to
Uganda.
A Grenadian government spokesperson said that
the government was continuing to investigate the bank in
coordination with the FBI. The investigation reportedly includes
the possibility of money laundering. Surprise.
Bank owner Van A. Brink resigned from his
bank directorship in 1999 and reportedly has been spending much
of his time in Uganda. Before embarking on his career as a
Grenadian banker, Brink lived in Oregon as Gilbert Allen Ziegler
until he declared bankruptcy in 1994, bought a Grenadian
passport and changed his name. Brink’s response to Louison’s
letter (“alleged letter” Brink calls it) was posted to the
IDIC Web site on August 28th.
Brink obtained FIBG’s banking license in
1998. Apparently not interested in lying low — pun fully
intended — FIBG reported gross income last year of $26
billion, about the same as the revenue reported by Bank One
Corp., of Chicago, the fifth-largest bank in the U.S. According
to Louison’s letter, on the last available balance sheet, FIBG
claimed to have $62 billion in assets! So, either there’s
going to be a 62 billion dollar fire sale to pay depositors’
principal and interest, or FIBG will end up in the Quatloos!
Cyber-Museum of Scams and Traps. My guess is the latter.
IRS
Issues New Foreign Trust Tax Regs
The IRS recently issued new proposed
regulations (“Prop Regs”) governing the recognition of gain
on transfers to foreign trusts under Section 684 of the Internal
Revenue Code. The IRS also issued new proposed regulations
governing the general income tax treatment of foreign trusts
with one or more U.S. beneficiaries under Section 679 of the
Code.
The former 35% excise tax on transfers of
appreciated property to foreign trusts was eliminated in 1997
and replaced with the new gain recognition provisions of Section
684, which gave the IRS the authority to make exceptions to the
general gain recognition rule. As expected, the Prop Regs would
require immediate gain recognition upon the transfer of
appreciated property to a foreign trust, including upon the
trust’s change from a domestic trust to a foreign trust, even
though there is no actual transfer. However, the Regs would
disallow loss recognition on such transfers, including
disallowing losses in some transferred property to offset gains
in other transferred property.
Most importantly, the 684 Prop Regs would
except from gain recognition those transfers to foreign trusts
made at death. This had been an area of uncertainty for the last
few years. The concern was that instead of a step-up in basis at
death under Section 1014, there would be recognition of gain
inherent in transferred assets at the moment of death under
Section 684. Generally, under the 684 Prop Regs, if the assets
transferred to the foreign trust at death are includible in the
decedent’s estate, the basis in the assets will be stepped-up
and the basis in the hands of the foreign trustee will be the
value for estate tax purposes.
The 684 Prop Regs also provide for relief for
trusts that inadvertently change from domestic to foreign, e.g.,
when a individual non-citizen sole trustee moves from the U.S.
and becomes a nonresident alien.
Section 679 of the Internal Revenue Code
deals with the income tax treatment of transferors to foreign
trusts of which there are one or more U.S. beneficiaries.
Generally, the income of such trusts is taxed to the transferor.
The 679 Prop Regs make it clear that having U.S. beneficiaries
of a foreign trust is all that it takes to make a transferor to
such a trust taxable on the income of the trust attributable to
the transfer. The 679 Prop Regs also provide that if another
person holds a Section 678 general power of appointment that
would otherwise make that person taxable, 679 overrides 678.
The 679 Prop Regs also make it clear that the
IRS will look beyond the terms of the trust to see who the real
beneficiaries are, including looking to letters of wishes and
investigating any oral agreements and understandings.
Furthermore, if the trust can be amended to benefit a U.S.
person, then all potential benefits that could be provided to a
U.S. person in accordance with such an amendment will be taken
into account. Thus, in order to ensure that a trust will not be
taxed to a U.S. grantor, there must be no possibility of adding
a U.S. person as beneficiary during the grantor’s lifetime.
The 679 Prop Regs also cover the situation
where U.S. persons are indirect trust beneficiaries via
controlled foreign corporations, partnerships, other trusts, or
estates; such trusts will also be taxed to the transferor. Using
a foreign “straw man” to make the transfer to the foreign
trust won’t work either. The 679 Prop Regs provide that
indirect transfers will be transfers for 679 purposes if it can
be shown that avoidance of U.S. tax was one of the principal
reasons for the transfer to the foreign transferor. The Prop
Regs contain rules which will deem such reasons to exist.
You can read the 684 Prop Regs online at ftp.fedworld.gov/pub/irs-regs/10852200.pdf
and the 679 Prop Regs at ftp.fedworld.gov/pub/irs-regs/20903889.pdf.
Growth
Shifting: Estate Planning for Entrepreneurs
It’s hard enough for many successful
entrepreneurs to comprehend their present financial largesse.
It’s often even more difficult for them to think about estate
planning for the future. Planning now instead of later can allow
an entrepreneur to pass on business wealth to his family at a
minimal transfer tax (i.e., estate tax, gift tax and generation
skipping transfer tax) cost compared to waiting until later.
Let’s take a look at some of the tools that can be used to
accomplish these savings. Keep in mind that the following tools
can be used alone or in combination with one another.
Outright Gifts of Stock
Outright gifts of stock to children,
custodians or children’s trusts are the simplest tools for
transferring entrepreneurial wealth and often make a lot of
sense at a company’s formation stage. Well-documented
appraisals are key in order to prevent the IRS from challenging
the value of such gifts in the future.
GST Exempt Dynasty Trust
An individual with a net worth of over $2
million should consider using her generation-skipping transfer (GST)
tax exemption amount ($1.03 million in 2000, and adjusted for
inflation as time goes on) to transfer assets to generations
below her children’s generation (even if she has no children
yet) in order to skip the estate tax at the children’s
generation (for a little more GST tax information, visit the
Mayer & Riser, PLLC Estate Planning Basics page at
www.mayer-riser.com). It used to be difficult to skip transfer
taxes for more than 90 years or so because of an arcane rule of
common law, the “rule against perpetuities,” which prevents
trusts from lasting much longer than that.
However, a number of states, including South
Dakota, Delaware, Alaska and others, have abolished the rule
against perpetuities and allow trusts to last forever. Such
trusts are often called “dynasty trusts.” Establishing a GST
exempt dynasty trust for his family allows an entrepreneur to
make gifts of stock, at a low startup value, to a trust which
will be exempt from estate and GST tax forever.
Preferred Equity Freeze
It may occur to a financially-minded
entrepreneur to simply recapitalize his company and give common
interests — the growth stock — to his children and keep
preferred interests for himself. Congress thought of that too.
In 1989, they enacted special valuation rules in Chapter 14 of
the Internal Revenue Code to prevent abuses of such
recapitalizations. For such a recapitalization to work, the
preferred interests must receive a certain minimum payment or
liquidation preference that usually works out to be around 10
percent. The rest of the growth potential can be shifted to the
common interests. A recapitalization prior to a successful IPO
can produce astounding transfer tax savings.
Family Limited Partnership
(“FLP”) / Family Limited Liability Company (“FLLC”)
Using FLPs and FLLCs to make “discounted”
gifts of equity interests is becoming more common. What makes
the gifts discounted is that it is not the equity interest
itself that is gifted, but rather an interest in a FLP or FLLC
that owns the equity interest. Because the FLP or FLLC interest
is a non-marketable minority interest, it is worth less than a
pro rata share of the value of the assets in the FLP or FLLC.
Discounts generally range from 25% to 50% or more. Expert
appraisals are key to using this technique. For more information
on FLPs and FLLCs, visit the Mayer & Riser, PLLC FLP/FLLC
page at www.mayer-riser.com.
Charitable Remainder Trust
A charitable remainder trust is a trust to which a grantor
transfers assets and in which someone, often the grantor and the
grantor’s spouse, has an income interest for a term of years
or for life. When the income interest ends, a charity of the
grantor’s choosing receives what is left in the trust. The
grantor of the CRT receives an income tax deduction for the
actuarial value of the charity’s remainder interest. In order
to qualify for CRT treatment, the actuarial value of the
remainder interest must equal at least 10% of the value of the
assets transferred to the CRT. The income interest is either a
fixed annuity amount or a “unitrust” amount, which is a
fixed percentage of the assets of the CRT as valued each year.
Charitable remainder unitrusts (“CRUTs”) are more prevalent
than charitable remainder annuity trusts since the income
interest of a CRUT can keep up with inflation by growing with
the principal. There are two variations on the CRUT theme—the
net income with makeup CRUT (NIMCRUT), which allows CRUT
payments to “build up” even if there is not current income
to pay them (which can be useful for creating a retirement
income stream). There is also the “flip CRUT,” which is a
NIMCRUT that switches to a regular CRUT upon the happening of
some specific event, such as the sale of specific assets
contributed to the trust.
CRTs work well for low-basis assets, such as
post-IPO stock. This is because the CRT is a charitable entity
and does not pay income tax. So, it can sell the low-basis stock
and reinvest the entire sales proceeds to pay the income
interest. The income interest is not tax-free to the recipient,
but the tax hit is spread out over a longer period of time than
if the entrepreneur had sold the stock himself.
Charitable Lead Trust (“CLT”)
A charitable lead trust is sort of like a CRT
in reverse. A trust is established, assets are transferred, and
a charity receives an income interest for a term of years, after
which time the family receives what’s left in the trust. The
donor gets an immediate income tax deduction for the actuarial
value of the charity’s interest (although in the second and
later years, the grantor is taxed on the CLT’s income). Like a
CRT, the income interest of a CLT can be either an annuity
amount or a unitrust amount. The annuity trust (a “CLAT”) is
almost always chosen because the goal is to maximize the amount
passing to the family later. If a CLAT is funded with pre-IPO
stock and the remainder is post-IPO stock, the transfer tax
savings can be huge.
Grantor Retained Annuity
Trust (“GRAT”)
The GRAT is another tool for transferring
future appreciation to children. The entrepreneur funds a trust
with rapidly appreciating (e.g., pre-IPO) stock and retains the
right to a fixed annuity payment for a term of years, usually 2
to 5 years. What’s left in the trust after the term passes to
the remainder beneficiaries of the trust, e.g., the children or
a children’s trust. IRS tables set the minimum annuity payout
for GRATs to prevent abuse of the technique. Also, the grantor
of a GRAT must survive the annuity payment term for the assets
in the GRAT to be excluded from his estate for estate tax
purposes. As with the CLAT, if the GRAT is funded with pre-IPO
stock and the remainder to the kids is post-IPO stock, the
transfer tax savings can be substantial.
Installment Sale to an
Irrevocable Grantor Trust
All of the techniques described above require
the entrepreneur to use some or all of his or her lifetime
estate and gift tax exemption amount ($675,000 this year,
increasing to $1 million by 2006). To avoid using the exemption
or to avoid paying gift tax after having used the exemption for
prior gifts, an entrepreneur might consider selling his equity
interests to a “grantor trust” (a/k/a “defective trust”
- misleadingly poor nomenclature, in my opinion), i.e., a trust
that is income-taxable to the grantor, for an interest-bearing
installment note. Because the sale is to a grantor trust, it is
essentially a sale to himself for income tax purposes, and
therefore not a sale at all; thus there will be no capital gains
tax to pay. The interest rate on the note must meet a minimum
standard, the equity interests must be carefully valued for
purposes of the sale, and the trust must be “seeded” with a
gift of cash (usually 10% of the purchase price), but in effect,
the technique can work somewhat like a GRAT to save substantial
amounts of transfer tax.
|
Growth-Shifting
Tools and Stages for Best Use |
|
Tool |
Formation |
Pre-IPO |
Post-IPO |
|
Outright
Gift |
● |
|
|
|
GST Exempt
Dynasty Trust |
● |
|
|
|
Preferred
Freeze |
● |
● |
|
|
FLP/FLLC |
|
● |
● |
|
CRUT |
|
|
● |
|
CLAT |
|
● |
|
|
GRAT |
|
● |
|
|
Installment
Sale to Grantor Trust |
|
● |
|
Briefly
Noted
U.S.
Know-Your-Customer Law Gains Momentum Again
Strong public opposition killed
“Know-Your-Customer” laws for U.S. banks two years ago. Now,
with the OECD leaning on member states and others, the House
Banking and Finance Committee is trying once again to persuade
Congress to pass legislation, H.R. 3886, which would require
U.S. banks to gather information about depositors and sources of
funds and expanding reporting of so-called “suspicious
transactions.” The bill was passed in committee 18 to 1 and
sent to Congress for consideration this fall.
In addition to the information gathering and
reporting rules, the bill would give the Treasury Department the
power to implement additional rules, prohibit entire classes of
international banking transactions, prohibit international
banking transactions with designated institutions, and prohibit
international banking transactions with designated countries.
Read H.R. 3886 online at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=106_cong_bills&docid=f:h3886rh.txt.pdf.
Brunei
Enters the Offshore Financial World
The sultanate of Brunei, a tiny country on
the west coast of the Malaysian island of Borneo, has enacted
several new laws intended to make Brunei an offshore
international financial center and to reduce the economy’s
dependence on oil and natural gas exports. The new laws cover
trusts, partnerships, licensing, and money laundering prevention
measures.
Brunei is responding to the 1997 Asian
economic crisis and the recent long period of low oil prices.
Brunei was particularly hard hit because during the same period
of the recent economic difficulty, Prince Jefri Bolkiah, brother
of Sultan Hassanal Bolkiah, depleted the state treasury of about
$16,000,000,000 while mismanaging the country’s investments.
Bankruptcy
Reform Pushed in Congress
Fueled by credit card industry lobbyists, the
push for bankruptcy reform continues in Congress. The House (H.
836) includes limits on the ability of consumers to eliminate
credit card debt by forcing many debtors into a Chapter 13
repayment plan and disallowing the use of Chapter 7 to obtain a
discharge of debt.
Popular opinion seems to be that maxed-out
credit cards are the primary reason for personal bankruptcy
filings. In fact, the most common reason for personal bankruptcy
filings is medical expense debt.
Other potential changes involve the homestead
exemption and the exemption for IRAs and qualified retirement
plans. The Senate’s bill contains a $100,000 cap on the
bankruptcy homestead exemption in order to curb what it
perceives as an abuse of the homestead exemption.
Two key players in the Senate bankruptcy bill
debate, Sen. Jeff Sessions (R-AL) and Sen. Chuck Grassley
(R-IA), proposed in May to cap the exemption for IRAs and
qualified plans at $1 million. The proposal has not made its way
into a bill yet, but it is an indication of the sense of
Congress on bankruptcy reform.
It appears that no bankruptcy reform bill
will be passed in this session of Congress. Whether or not
bankruptcy reform will happen in the next few years probably
depends largely on the outcome of the November elections.
New
Online Offshore Financial Services Directories Launched
Focus Information Systems Limited, a Jersey
company affiliated with the Jersey law firm of Crills Advocates,
has launched three new online offshore financial services
directories: FocusIOM.Com,
FocusJersey.Com, and FocusGuernsey.Com.
Future sites will cover Anguilla, The Bahamas, Bermuda, BVI,
Caymans, Curacao and Gibraltar.
Book
Review: Living Trust Living Hell
It’s not new (published in 1998), but Living
Trust Living Hell by Raleigh, North Carolina attorney
John Huggard should be on your reading list (and your lending
and giving list—we’ve lent or given away several copies at
Mayer & Riser, PLLC). If you are as irritated by living
trust hucksters as I am or if you find yourself actually wanting
to believe some of the over-hyped claims of living trust
salespeople, you’ll find the book a great resource.
The book’s style (right down to the cheesy
flaming cover) is a little over-the-top, but my guess is
that’s by design. Fight fire with fire, fight cheese with
better cheese. Compared to the Cheez Whiz squirted at the public
by many living trust hucksters, Huggard is serving up Camembert.
The book debunks numerous myths and exposes
traps related to poor or ignorant planning with living trusts.
The short, easy- to-read chapters contain plenty of examples
showing how living trusts can actually increase rather than
decrease taxes, expenses and administration time, as well as
unnecessarily expose assets to claims of creditors.
Order Living Trust Living Hell from
The Riser Report online store at www.riserreport.com/store.
© 2000 Axius Publishing, LLC.
All rights reserved. Limited permission is
granted to readers to reproduce and forward this newsletter in
electronic form for noncommercial purposes to individuals whom
the reader reasonably believes have an interest in the content
hereof.
View or download The
Riser Report September / October 2000 issue in Adobe Acrobat
Format
Author/Editor:
Christopher M.
Riser, M.A., J.D., LL.M.
Mayer & Riser, PLLC
Attorneys at Law
511 Smallwood Avenue
Post Office Box 750
Highlands, NC 28741 USA
Tel. (828) 526-3731
Fax (828) 526-3734
criser@mayer-riser.com
www.mayer-riser.com
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