The National Underwriter Company Presents:

Advanced Markets Case Study

Beginning next month The National Underwriter Company will begin its case series for wealth managers. The case studies will be in addition to our daily articles. Check back in September to see the new content.

The case studies have expert commentary and analysis to help wealth managers with common planning issues.

Here’s a sneak peak of what is to come…

When your clients roll over a retirement account into an annuity, stay alert. They could lose significant tax benefits if they don’t document their investment in the contract.

Gains realized on surrender of an annuity are taxed as ordinary income, but the entire amount received on surrender might not be taxed, since a taxpayer is entitled to receive their investment in the contract back tax-free.

Keeping track of investment in the contract is simple enough when a person pays premiums out a checking account into the annuity—the total amount of the premiums will constitute investment in the contract. But when a rollover is made from a pre-tax retirement account like an IRA, things get more complicated, and documenting investment in the contract is essential to preserve its tax benefit.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of annuities  in Advisor’s Journal, see Annuity Respect: Earning It! (CC 11-150), IRS Streamlines Partial Exchanges of Annuities (CC 11-153), and GAO Report Touts Annuities in Uncertain Retirement Environment (CC 11-141).

For in-depth analysis of the taxation of distributions from an annuity, see Advisor’s Main Library: A—Amounts Received As An Annuity & B—Amounts NOT Received As Annuities.

A charitable freeze technique that used a complex contribution formula was considered by the Ninth Circuit Court of Appeals in Petter v. Commissioner, No. 10-71854 (2011). The charitable freeze is a technique that readjusts a simultaneous gift/charitable contribution combo if the IRS successfully challenges a valuation of the gift, shifting additional value from the gift component to the charitable contribution component to eliminate any gift taxation resulting from the challenge.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of estate planning in Advisor’s Journal, see What Next? ILITs and Estates under 5MM (CC 11-114).

For in-depth analysis of estate freeze techniques, see Advisor’s Main Library: E—Estate Planning For The Family Business.

Estates of decedents who died in 2010 finally have guidance from the IRS on how to opt out of estate tax treatment and allocate carryover basis to estate property. The guidance is long overdue, and leaves little time for estates to make decisions that could have a massive tax impact.

Under the guidance, Notice 2011-66, to opt out of the estate tax and apply the new carryover basis rules, an executor must file Form 8939, Allocation of Increase in Basis for Property Acquired From a Decedent. The due date for the form is November 15, 2011. But despite the November deadline, Form 8939 and its instructions will not be available until early this fall. The IRS has, however, released a draft version of the form.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the new estate tax in Advisor’s Journal, see What Next? ILITs and Estates under 5MM (CC 11-114), Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122), 2010 Estates: To Elect or Not to Elect (CC 10-124) & Obama Tax Agreement Passed by House (CC 10-117).

For in-depth analysis of the estate tax, see Advisor’s Main Library: Estate, Gift and GST Taxes.

Split Dollar Plans—Who’s Paying for that Life Insurance?

Why is This Topic Important to Wealth Managers? This blogticle discusses the general properties as well as taxation of the traditional split dollar plan. It is intended to provide both a review of concepts and refresher of a planning opportunity.

Split dollar insurance is an arrangement generally between an employer and an employee under which the policy benefits are split, and the costs (premiums) may be split. Split dollar plans can also be set up between corporations and shareholders (“shareholder split dollar”) or between parents and their children (“private split dollar”).

Under the traditional plan, the employer pays part of the annual premium equal to the current year’s increase in the cash surrender value of the policy and the employee pays the balance, if any, of the premium. From this basic concept, hybrid plans have evolved; for example, “employer pay all” plans under which the employer pays the entire premium, and level contribution plans under which the employee pays a level amount each year.

If the employee dies while the split dollar plan is in effect, the employer receives from the proceeds an amount equal to the cash value of the policy or at least its premium payments (under a basic plan), and the employee’s beneficiary receives the balance of the proceeds.

It is no secret to wealth managers that split-dollar life insurance arrangements can be a key feature incorporated into executive compensation packages. Beginning in 2001, transitional guidance on the valuation of split-dollar life insurance arrangements was provided in the form of notices and proposed regulations in anticipation of final regulations which were adopted in 2003.

How are the current regulations applied regarding this arrangement?

Under the final regulations issued September 17, 2003, the tax treatment turns on who owns the split-dollar policy.  If the executive owns the policy, the employer’s premium payments are treated as loans to the executive.  Consequently, unless the executive is required to pay the employer interest on the loan at or above the applicable Federal rate (AFR), the executive will be taxed on the difference between the AFR interest and the actual interest.  Verify that the rate of interest being charged is at least AFR.

If the employer is the owner of the split-dollar policy, the employer’s premium payments are treated as providing taxable economic benefits to the executive.   The economic benefits include the executive’s interest in the policy’s accessible cash value and current life insurance protection.

The final split-dollar regulations apply to any split-dollar life insurance arrangement “entered into” after September 17, 2003.  The term “entered into” is defined in 1.61-22(j)(1)(ii) of the regulations.  Under section 1.61-22(j)(2) of the regulations, an arrangement entered into on or before September 17, 2003 that is materially modified after September 17, 2003 is treated as a new arrangement entered into on the date of the modification, and is subject to the final regulations.

Section 1.61-22(j)(2)(ii) of the regulations provides a non-exclusive list of changes that are NOT considered material modifications.

See Tax Facts Q 3793 What is reverse split dollar and how is it taxed? for a discussion of reverse split dollar plans.

Tomorrow’s blogticle will discuss issues surrounding year-end planning preparation.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

The 37th Annual Notre Dame Tax and Estate Planning Institute will take place on September 15-16, 2011, in South Bend, Indiana at the Century Center. If you have an interest in estate planning including issues regarding federal estate and gift taxes this conference is for you. Hosted by one of the foremost expert attorneys in the area, Institute Director, Professor Jerome M. Hesch, has invited a number of distinguished guests who will discuss relevant estate planning issues surrounding the practice today.

The program  includes highlights in 2011 that are new to the format this year:

With increased exemptions, the need for estate planning for the moderately wealthy will decrease. Recognizing this trend, the 2011 Institute will add topics that go beyond gift and estate tax savings. It is intended that these add-ons will introduce topics that can create new planning opportunities and thus new business for your practice. These special features will include income tax planning ideas that estate planning professionals can introduce to their individual clients and using variations of traditional estate planning techniques for income tax planning for corporations. The Institute will also address the tax and state law issues relating to early termination of trusts, interpretation of ambiguous trust language and amending trust terms by reformation or decanting. Another focus will be communicating charitable planning techniques to encourage charitable giving that will also accomplish the individual’s other objectives. As part of the communication focus, sessions will cover the mathematics of estate planning and using financial projections as part of the evaluation and communication process. [1]

For those attendees desiring certification of attendance at the program, the Institute will issue certificates of attendance. The program will afford up to 17.00 actual hours of continuing education, including 1.00 hour of ethics. Each continuing education accrediting agency determines the number of hours it will accept for accreditation.

Wealth managers are welcome to attend. There is a fee for registration. For additional information on the event please visit click here. If you have any other questions about the Institute, please contact Dawn Boulac at (574) 631-2616 or dboulac@nd.edu.

“Founded in 1869, the Notre Dame Law School is the oldest Roman Catholic law school in the nation. Embracing equally the wealth of its heritage and a calling to address the needs of the contemporary world, Notre Dame Law School brings together centuries of Catholic intellectual and moral tradition, the historic methods and principles of the common law, and a thorough engagement with the reality of today’s legislative, regulatory, and global legal environment. At Notre Dame Law School, students and faculty of diverse backgrounds, experiences, and commitments are encouraged to cultivate both the life of the mind and the wisdom of the heart, to pursue their studies with a passion for the truth, and to dedicate their professional and personal lives to serve the good of all the human family.” [2]

[2] Notre Dame.  See About the Law School. http://law.nd.edu/about/. Last Accessed 8/07/2011.

The IRS has released guidance [Rev. Proc. 2011-38] that substantially liberalizes the rules for partial exchanges of annuity contracts.

Section 1035 allows a tax-free exchange of an annuity contract for another annuity contract. Congress introduced the tax-free exchange because it recognized that the needs of life insurance and annuity owners change over time and that it would be unfair to tax them when they switched policies to better meet their needs.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For in-depth analysis of Section 1035 exchanges, see Advisor’s Main Library: E – Non-Taxable 1035 Exchange of Contracts. See also, Advisorfyi.com, Income Tax: Partial Annuity Exchanges Under Section 1035

Author: Jesse Mackey

The saying goes that “the best way to gain money is to avoid losing it.” It is also said that “nothing is certain in life except death and taxes.” If there is truth to either of the above kernels of wisdom, a logical conclusion is that the most assured way to avoid losing money is to minimize, defer, and eliminate taxation to the greatest extent possible. This article begins a 3-part article series that will briefly outline some of the most common and effective means of limiting the over-taxation of the individual investor’s portfolio. The techniques described here will be most beneficially applied if diligently overseen and executed through a competent financial planner and portfolio manager.

Tax Deduction and Deferral – The IRS allows for tax deductions of contributions made to certain types of accounts in the year in which they are made. Most of these accounts are commonly known as “Qualified” plans or assets. Some examples are the 401(k), Traditional IRA, Defined Benefit Pension Plan, SEP IRA, etc. Non-qualified deferred annuities may also be used for the purposes of tax deferral (though not necessarily for tax deductions). Once money is invested under the provisions of one of these plans, the growth in value of the assets over time is free from taxation until the time at which it is distributed from the plan (which is typically not allowed until age 59 ½ without a 10% federal tax penalty). The money may be invested in virtually any series of marketable securities that the investor wishes, as long as it is contained within the plan wrapper (although this may be subject to any limitations imposed by a plan provider). This results in more money working for the investor over a longer time period than would be possible in a currently taxable account, ultimately resulting in a greater future income or lump sum to be received.  This most basic technique of investment planning is usually appropriate only for assets that are earmarked for use in retirement.

Tax Elimination – Within the tax code, there are limited instances in which investors may choose to pay their taxes now, and never pay taxes on the same set of assets again. Two of the most widely used accounts of this type are the Roth IRA and the 529 College Savings Plan. Although the contributions that one may make to these accounts may be limited by the income level of the investor and the amount that may be invested each year, if the assets are earmarked for specific purposes (Retirement for a Roth IRA and qualified educational expenses for the 529 Plan), the assets will grow tax free and may be withdrawn tax free at the permitted time. This technique is especially useful for investors that are currently in a lower tax bracket than they expect to be at the time of withdrawal of the assets. A similar methodology may be utilized when accumulating assets through the cash value of a dividend paying life insurance policy, such as Whole Life. While not considered an “investment” from a regulatory standpoint, a portion of premiums contributed to a whole life insurance policy can produce dividends* over time and will grow on a tax deferred basis. The policy owner may take “policy loans”** from the cash value to be used for any purpose, and the loans will remain tax free provided that the policy remains in-force. However, if the policy lapses or is discontinued, the portion of cash value attributed to gains becomes taxable as ordinary income.

To be continued tomorrow…

*Dividends are not guaranteed, any may be declared annually by a company’s Board of Directors.

**Policy benefits are reduced by a loan, loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest.

Jesse Mackey is a partner and Investment Officer of 4Thought Financial Group Inc. 4Thought was created with the base vision of advancing individual freedoms and the human quality of life through economic means. This vision is pursued by applying the firm’s four specialties – Economic Theory and Research; Multi-Contingency Investment Management; Financial Planning for Business Owners and Individuals; and Support for Partner Firms and Advisors.

Contact:

Jesse Mackey

4Thought Financial Group Inc.

www.4TFG.com

jmackey@4TFG.com

Trusts offer your clients asset protection and tax benefits, giving them the power to say how and when their cash and property are distributed. They also offer a mechanism for putting the decision-making process in the hands of someone other than the grantor—the power of appointment (POA).

But for all their flexibility, powers of appointment also have the tendency to throw estate plans off track, resulting in unplanned-for tax liability and unforeseen results.

Although a person who has a general power of appointment over property isn’t said to own the property, if they die holding the POA, their gross estate can include the value of that property. And that’s where the dispute in Estate of Chancellor v. Comm’r, T.C. Memo 2011-172 (2011) begins.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the estate tax in Advisor’s Journal, see More States Moving to Estate Tax Repeal (CC 11-121) & Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122).

For in-depth analysis of the estate tax, see Advisor’s Main Library: A—Federal Estate Tax General.

Why is This Topic Important to Wealth Managers? This blogticle discusses the Value Added Tax or VAT. As our debt limit debate continues, we examine one avenue the government may consider to close the deficit.

General dissatisfaction with the federal tax system by the taxpayers  has contributed to a debate about U.S. tax reform, including proposals for a national consumption tax. One type of proposed consumption tax is a value added tax (VAT), widely used around the world.

A VAT is levied on the difference between a business’s sales and its purchases of goods and services. Typically, a business calculates the tax due on its sales, subtracts a credit for taxes paid on its purchases, and remits the difference to the government.  VAT liability is typically calculated in industrialized countries using what is known as the credit invoice method. Under this method, businesses apply the VAT rate to their sales but claim a credit for VAT paid on purchases of inputs from other businesses (shown on purchase invoices). The difference between the VAT collected on sales and the credit for VAT paid on input purchases is remitted to the government.

Example: VAT with a 10 percent rate. A lumber company cuts and mills trees and has sales of $50 to a furniture maker. Assuming no input purchases from other businesses, to keep the illustration simple, the company adds the tax to the price of the goods sold and remits $5 in tax to the government. The purchase invoice received by the furniture maker would list $50 in purchases plus $5 in VAT paid.

If the furniture maker has sales of $120 to a retail store, $12 of VAT would be added to the sales price but the furniture maker could subtract a credit for the $5 VAT paid on purchases and remit $7 to the government. The retailer would receive an invoice showing purchases of $120 and $12 of VAT. Similarly, if the retailer then has sales of $150, $15 of VAT would be added but the retailer could subtract a credit for the $12 paid on purchases and remit $3 to the government.

Yes, there is revenue for the government in the VAT tax, but what will the costs of administration be?  A VAT, like any tax system, will require government resources to administer. The drivers of administrative costs in many tax systems  include the number of taxpayers (businesses, individuals, or both) subject to the tax, how often they file returns, and the percentage of taxpayers audited. In the case of a VAT, administration requires the government to process tax returns and provide certain services to businesses.

Even a simple VAT warrants education and assistance services, in part to address compliance risks. Tax administrators also need to spend significant resources on audit and enforcement activities.

Some available data from the Government Accountability Office indicate a VAT may be less expensive and easier to administer than an income tax. In 2006, the tax administration agency in the United Kingdom measured administrative costs for the VAT to be approximately half a percent of revenue collected compared to over one and a quarter percent for the income tax.

Tomorrow’s blogticle will discuss issues related to regulation.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.