Chapter 15
Basics of estate planning and asset protection

Have you ever wondered how really rich people escape estate taxes and protect their assets? It didn’t just happen. They had a plan.

To understand the importance of a plan, recognize that without one the IRS currently gets 45 percent of your estate in excess of $1.5 million and 47.9 percent for the amount in excess of $2.5 million. Basically, the IRS gets half of your estate in excess of $2.5 million.

These limits may seem high, but surprisingly few people know exactly what their potential estate will include. The fair market value of your company (net of debt) will be included, plus all of your personal assets, such as stock and bond portfolios, retirement accounts, homes, cars and even your personal belongings and collections. From the total values of these assets you may deduct your debts to arrive at your net worth, as you do on the personal financial statement you likely submit to your lenders each year.

On top of all this, add possible life insurance face values, and you can easily get into a taxable estate situation. Given this, a realistic valuation of your company by a professional valuation analyst — as well as careful monitoring of your personal financial statement values and planning for this tax — is a must. We have already discussed the value of your trucking company. Let’s turn to the estate plan itself.

A plan will coordinate various aspects of your estate, gift and asset protection needs. A proper estate, gift and asset protection plan is developed based on your wishes directing how and to whom your property will be distributed after your death. The plan becomes the tool that minimizes estate taxes, transfers assets pursuant to your wishes and desires and ensures your loved ones’ future financial security. Once the plan is developed it is continually modified as your life changes.

Creating a will or alternative
In general, one of the most important elements of an estate plan is a will, which can be as simple or complex as you like. But there are several will “substitutes” that may help reduce the overall plan administration and ownership transfer costs upon your death. Alternatives include property held jointly with rights of survivorship, living trusts, “payable on death” bank and securities accounts, annuities, and retirement accounts or individual retirement accounts.

Depending on state law these assets may not be subject to probate administration. But these substitutes can be double-edged swords. The way property is titled could circumvent your estate plan. For example, real property deeded “joint tenants with right of survivorship” will pass to the surviving joint owner irrespective of the decedent’s other wishes that may be expressed in the will. So it is extremely important that property is properly titled and that the plan incorporates the way such property is titled.

Generally, a well written plan begins with a basic will that includes two trusts – a marital trust (primarily for the spouse) and a family trust, which will maximize the estate tax exemption. Plans often become more complex, however, due to increased wealth, multiple marriages or stepchildren. In those situations, trusts such as QTIPs (qualified terminable interest trusts) may be added to the mix. These tools can be used to protect the interests of the children of a prior marriage and/or a subsequent marriage by the survivor.

Understanding estate tax limits
Each taxpayer is entitled to $1.5 million of estate tax exemption amount before reduction for lifetime gifts in excess of the annual exclusion amount in 2005. (See table below). An estate tax return must be filed only if the gross estate exceeds the applicable exclusion amount.

Applicable Exclusion Amounts

Marriage is a real plus when it comes to estate taxes as the husband and wife count as separate taxpayers. That means that $3 million in joint estate assets generally can be passed along to your heirs with no estate tax cost as each spouse in 2005 can pass to heirs $1.5 million, provided you have not used any of your lifetime exemption amount.

In addition to the $1.5 million exemption amount, taxpayers have unlimited marital deductions, meaning that the decedent spouse can leave all his or her worldly possessions to a spouse estate tax free. The estate tax problem now shifts to the surviving spouse, who theoretically could be the person who worries with the estate plan. However, a solid estate plan should leave nothing to chance and assume the possibility of a simultaneous death of both spouses.

Ensuring sufficient cash
A properly structured plan also includes provisions for liquidity. The estate tax is due nine months after death. If the estate is liquid, then having sufficient cash may not be a problem. However, liquidity is often a problem for asset rich/cash poor estates. The IRS allows for payment deferral in hardship cases at an interest rate of the federal short-term rate plus 3 percentage points. If your estate needed additional time to liquidate various assets, the interest charge for the deferral should be included in your estate plan.

Ownership of life insurance is another option. If the policy is owned by the decedent – even though a spouse, decedent or someone other than the decedent is the named beneficiary – the proceeds will be included in the estate of the decedent. Proceeds of life insurance polices are not subject to income tax, but they are subject to estate tax. The maximum estate tax rate in 2005 is 47 percent, so up to 47 percent of the policy benefits might go to the IRS, and the lack of liquidity may not have been totally resolved. The use of a properly structured trust will maximize the liquidity available to the estate and eliminate the estate tax on such benefits.

For estates of decedents dying and gifts made after 2002, the maximum rate for the estate tax and the gift tax is listed below. In 2010, there is not estate tax, however in 2011, it returns to 2003 levels in many respects.

Maximum estate and gift tax rates

One option is to purchase the life insurance policy in an irrevocable life insurance trust. The trust will own the policy and make the premium payments. The grantor/insured will generally provide the sufficient cash necessary to make the payments. Take special care to write the trust in a way that will allow the grantor to make gifts free of gift tax.

Using other tools
Other useful interfamily transfer tools available to you include self-canceling installment notes (SCINS), private annuities, interest free loans to family members, grantor-retained annuity trusts (GRATs), grantor-retained unitrusts (GRUTs) and many more. If you feel philanthropic, you can establish charitable remainder trusts or charitable remainder lead trusts. Each allows you to give away either a current value or a future value and get a current year income tax deduction. A well-versed tax attorney or tax accountant can help you decide which is best for you.

Your estate plan should incorporate lifetime gifts, thus escaping the need to be included in the will. Your properly structured plan should maximize the wealth transferred to your heirs by gifting assets during your lifetime.

One of the more powerful tools that is sometimes overlooked is the annual exclusion amount. In 2005, the annual exclusion amount is $11,000 per donee per donor. Thus, a husband and wife each can give $11,000 annually to any number designated beneficiaries. For example, suppose that a husband and wife have a son and a daughter-in-law. The husband can give $11,000 to his son and $11,000 to his daughter-in-law. Meanwhile, the wife can also give $11,000 to her son and $11,000 to her daughter-in-law. In this scenario, the family has transferred $44,000 in wealth tax free. Assuming a 47 percent estate tax rate, this reduces the estate tax liability by more than $21,000 each year the gifts are made. And the more donees a couple has the more wealth that can be transferred tax free.

Finally, gifts do not have to be in cash. Some taxpayers have established limited liability companies (LLCs) to protect certain property and achieve certain business control aspects. (LLCs will be discussed in greater detail later.) A gift can take the form of interests in LLCs. The advantage is that a minority interest in an LLC may qualify for certain discounts for lack of marketability and control, thus reducing the tax value. But the IRS will demand documentation of the value, so gifts of this nature require a business valuation.

Minority interests in closely held stock may also achieve discounts that would lower the gift tax liability. However, be alert to the structure of the corporation so that you do not trigger any unwanted corporate changes. For example, a small business corporation (i.e., an S corporation) is generally not allowed to have a regular corporation as a shareholder.

Protecting your assets
The IRS isn’t the only entity that might reduce your estate when you are living or after your death. As you well know, trucking is an inherently risky business from both a financial and a liability perspective. Creditors are a real worry, but the scariest scenario is exposure to litigation. The recent insurance crisis forced many trucking companies to reduce or even eliminate their umbrella coverages. Meanwhile, jury verdicts in trucking accidents keep rising. Several in 2004 and 2005 involving large carriers have run into the tens of millions of dollars.

Separate from but closely tied to estate planning is asset protection. Given the risks, it’s critical that business owners take steps to structure the legal form of business to increase the protection afforded both company and personal assets. At least two asset protection strategies are emerging for increased use by fleet owners and allied industries.

Entity planning. Increasingly, savvy fleet owners are setting up multiple LLCs or corporations to hold various parts of their businesses, separating the risks, and managing the insurance costs in the riskiest entities. The resulting legal protection can build legal hurdles that frustrate plaintiffs attorneys and would-be creditors in lawsuits. This practice is common throughout corporate America but is finally catching on in trucking in response to increased insurance costs.

Generally, one LLC would hold title to the equipment and take on the debt related to it. Another would hold the operating authority, rights to operate the equipment and deal with customers, holding the accounts receivable financed by lines of credit. This one would pay lease payments to the holding company. Should the overall business have considerable investments or cash accumulated, yet a third LLC would be set up to be the “Cash Company” that might loan funds to the other two.

Applying this model to trucking, the operating company would bear almost all the major risk. Should a catastrophic accident and resulting trial verdict cause this one entity to go bankrupt, the other companies’ assets potentially would be protected, and you could then attempt to set up another operating company.

Some fleet owners adopting this model have reported hundreds of thousands of dollars in annual insurance cost savings. Yes, there is complexity to the accounting, legal structure and requirements to be met in terms of “dotting the Is and crossing the Ts,” but the potential annual savings in insurance costs are worth the efforts. And don’t discount the owner’s peace of mind afforded from the extra legal protection.

Welfare Benefit Trusts. An alternative and promising tool is the welfare benefit trust, which can offer enhanced asset protection especially for larger companies. WBTs allow companies to set up special benefit plans and place company assets in these plans for the benefit of key employees and the employers. Once there, these assets are protected from many creditors. But be very careful. State laws vary, so before you spend too much money or time, be sure a WBT is permitted in your state.

In addition to asset protection, WBTs can bring significant tax benefits. A WBT can help company owners provide benefits to key employees, including company owners, that otherwise might be limited in tax deductibility, or not deductible at all, or limited by retirement plan contribution caps. One example is life insurance, which, under ordinary circumstances, is not tax deductible. But life insurance can be deductible inside a WBT, if structured properly. And, the death benefit can still be tax free to the beneficiary’s family – definitely a “cake and eat it too” scenario.

Beware. These asset protection strategies are not cheap and not for amateurs to implement. They demand calculated risks and diligence. Careful and experienced tax, accounting, legal and professional documentation and assistance is an absolute necessity.

Plan, plan, plan
The key to a successful estate, gift and asset protection plan is proper planning. Once drafted, the plan must be properly implemented. The benefits of a great plan without follow through or proper implementation is seriously impaired. Retain trained and experienced tax professionals to be sure the plan is properly implemented.
Your heirs will appreciate you all the more for a well-conceived succession plan. The next chapter outlines some guidelines and suggestions on structuring your succession plan.