Teaching Team Roger A. McEowen CALT Director mceowen@iastate.edu - PDF document

8/3/2015 1 ‐ 2 IRS Guidance on Guaranteeing LLC Debt • AM2014 ‐ 003 (Aug. 27, 2013) – Losses are deductible to extent taxpayer is “at risk” • Generally measured by amount of money and adjusted basis of other property that taxpayer contributes to activity and amount borrowed with respect to the activity • Guarantees of LLC debt are “at risk” if the member can’t be reimbursed from persons other than the LLC and the debt is bona fide and LLC’s creditors can enforce it • Guidance with respect to LLCs that hold real estate Checklist of Ideas for FLP Maintenance • File required annual filings • Memorialize all significant partnership decisions • Comply with the terms of the partnership agreement • Comply with the loan terms, if loans are made Make any distributions pro rata (and pursuant to terms of the • partnership agreement) • Refrain from the personal use of partnership assets (at least unless fair rental is paid) or using assets for the partners’ personal obligations • Refrain from having partners individually pay partnership obligations • Maintain current and accurate books and records • Review the non ‐ tax reasons for forming the partnership and follow them Pages 18 ‐ 20 of Use of Charitable Trusts Other Ways to Minimize Estate Tax? • “Charitable Lid” Planning – An estate plan is created where the testator leaves a set dollar amount of the estate to the children with the residuary estate passing to a charitable organization. • The portion passing to the charity qualifies for the estate tax charitable deduction and, thus, puts a lid on the amount of estate tax owed 8

8/3/2015 Pages 6 ‐ 9 of Practical Estate Planning Formula Allocation Clauses With Excess Passing To Charity • McCord (5th Cir. 2006) • Christiansen (8th Cir. 2009) • Petter (9th Cir. 2011) • Hendrix (Tax Court 2011) Page 20 of ATRA session “Charitable Lid” Planning • Attractive technique when combined with hard to value assets such as business interests or family partnership interests • Good way to defeat an IRS audit – If IRS challenges the valuation of assets on audit, any increase in value on audit does not increase the estate tax due – it simply passes to the charity Pages 6 ‐ 8 of Practical Estate Planning “Charitable Lid” Planning • Key case – Christiansen v. Comr., 130 T.C. No. 1 (2008) – Decedent owned cattle ranches in South Dakota with her husband. He died in 1986 and she continued to operate the ranches until her death in 2001. Her entire estate passed to her daughter, but the will said she could disclaim all or any portion of her inheritance, with the disclaimed property passing 75 percent to a CLAT and 25 percent to a private foundation 9

8/3/2015 Christiansen Case • Daughter filed a disclaimer. Largest asset in estate were FLP interests that carried out valuation discounts. – With discounts, decedent’s estate was just over $6.5 million – Daughter’s disclaimer resulted in the foundation and the CLAT receiving about $140,000 – IRS audited and increased FLP interests by about 35% ‐ but that resulted in more property passing to charity and no increase in estate tax • Daughter did not retain a continuing interest in the CLAT after the disclaimer, so no charitable deduction Christiansen Case • IRS appealed the portion of the decision allowing the enhanced deduction for the amount passing to the foundation – Attacks the disclaimer: • Any amount passing to the charity was contingent on a condition subsequent (i.e., the Service’s ultimate determination of value of the decedent’s estate) • Adjustment clause in disclaimer should be declared void on public policy grounds – discourage them from examining estate tax returns – Court disagreed with IRS (586 F.3d 1061) Page 8 of Practical Estate Planning Petter v. Comr., T.C. Memo. 2009 ‐ 290 • Court upheld a defined ‐ value gift tax clause and rejected IRS’ policy ‐ based argument – UPS stock in LLC transferred to IDGTs and charities, with split determined by formula – IRS tried to negate defined ‐ value clause based on policy reasons, but court determined that gift was of ascertainable value of stock rather than a specific number of shares or percentage interests in LLC • 9th Circuit affirmed on appeal (Aug. 4, 2011) 10

8/3/2015 Pages 8 ‐ 9 of Practical Estate Planning Hendrix v. Comr., T.C. Memo. 2011 ‐ 133 • Court approved transfers with “defined value” formula provisions to limit gift tax exposure from the transfers – Transfer of closely held stock in a gift/sale transaction to family trusts and gift to Foundation under coordinated formula provisions was at arm’s length and not contrary to public policy – Clause at issue allocated stock between family trusts and Foundation based on values as determined by IRS willing buyer/willing seller test Pages 9 ‐ 10 of Practical Estate Planning Wandry v. Comr., T.C. Memo. 2012 ‐ 88 • Facts: – Married couple gifted membership units in LLC to children and grandchildren; transfers made in accordance with dollar value of gifts and were determined by a fraction (numerator was state dollar amount and denominator was value of entire company as determined by IRS or court) – IRS claimed gifts were of fixed fractional interests in LLC and, as a result, LLC unit value understated; court determined that defined value clause reallocated LLC membership units among parties in conformance with formula in which unit value as of transfer date was "unknown constant“ – IRS lost Wandry • IRS filed notice of appeal on 8/28/12, but then filed dismissal and dropped appeal – Appeal would have been to 10th Cir. • IRS then filed non ‐ acquiescence in A.O.D. 2012 ‐ 4, I.R.B. 2012 ‐ 46 11

8/3/2015 Pages 6 ‐ 8 of Estate & Business Planning Cases Corporations • Politte – Majority shareholders liable for unpaid employment tax • Adell – Personal goodwill can reduce estate tax value of stock • Here, son’s goodwill was key to the success of the decedent’s business and had not been transferred to the decedent’s corporation 6 Estate Tax Valuation • Estate of Giustina (9th Cir. Dec. 5, 2014) – At issue was a 41.1% partnership interest in a partnership involved in forestry operations • No evidence that any sale or liquidation anticipated • Decedent couldn’t liquidate • Tax Court said there was a 25% chance that a hypothetical buyer could find another partner to agree • 9 th Circuit said it was error to assign a 25% probability of everything happening that needed to happen to liquidate. • Partnership must be valued as a going concern 6 Valuation • Estate of Kessel v. Comr., T.C. Memo. 2014 ‐ 97 – Investment account valued at $4.8 million at time of death • Estate paid FET of $1.9 million • Refund sought on basis that account was part of Madoff ponzi scheme and really had no value • Court denied s.j. for IRS because taxable asset was account itself and not the assets in the account • No s.j. for IRS on willing/buyer, willing/seller test – hypothetical buyer might have discovered the ponzi scheme • Case goes to trial – Note: Decedent made a killing on the account during life – bankruptcy trustee may be able to get hands on account funds. 12

8/3/2015 7 Special Use Valuation ‐ Basis • Van Alen v. Comr., T.C. Memo. 2013 ‐ 255 – Special use value establishes income tax basis in the heirs’ hands – Heirs signed consent agreement agreeing to liability for any additional taxes imposed due to violation of recapture rules – Heirs even stuck with negotiated basis even though they had no part of the negotiations 43 Special Use Valuation • FCB Interest Rates for Deaths in 2014 – Ag First: 5.29% – Agribank: 4.71% – Co ‐ Bank: 4.31% – Texas: 4.82% Discussed in Practical Estate Planning Special Use Valuation • Finfrock – Real estate eligible for election must make up at least 25% of gross estate, but 25% test need not be satisfied only with the property that is subject to the election – Reg. had previously been held invalid – Still invalid under greater deferential standard • Swallows (3d Cir. 2008) applies Chevron deference to Treasury Regulations 13

8/3/2015 36 Installment Payment of FET • Estate of McNeely (D. Minn. Jun. 12, 2014) – Estate paid estimated estate tax with request for extension of time to file Form 706 • Estate also advised IRS of intent to make Sec. 6166 election – Upon filing Form 706, estate had overpaid non ‐ deferred portion by over $500,000 and sought refund • Denied, but court allowed excess to be applied to the taxes eligible for deferral as installments become due Crummey Trusts • Mikel v. Comr., T.C. Memo. 2015 ‐ 64 – Married couple set ‐ up an irrevocable family trust and put property in it worth $3.26 million • 60 beneficiaries named • Trust required notice of right to demand withdrawals within 30 days of receiving notice – Trustee to make distributions in accordance for health, education and welfare • Beneficiary would forfeit trust rights upon opposing distribution decisions of trustees • Gift tax returns showed $720,000 of gifts per spouse • IRS said not present interest gifts • Court said it’s ok – merely seeking arbitration when trustee breached fiduciary duties by refusing demand notice did not make gifts future interests and forfeiture language did not apply to mandatory withdrawal distributions Why It’s Important To File A Gift Tax 11 Return • Redstone v. Comr. (filed with Tax Court on Apr. 10, 2013) – IRS claims that, in 1972, Sumner Redstone (the chairman of Viacom/CBS) made taxable gift (stock in family company) to his children and didn’t file a gift tax return. – Gift tax being asserted 41 years after the gift • $1.1 million in taxes and penalties plus interest of about $1.4 million 14

8/3/2015 51 The Passive Loss Rules • When does a trust materially participate in a business? – A concern under the passive loss rules of I.R.C. §469 – Now, also a concern for purposes of the 3.8% NIIT of I.R.C. §1411 • The passive loss rules are used to determine if certain activities are investment income/loss for NIIT purposes The Passive Loss Rules and Trusts • IRS position – Only a trustee’s actions as trustee count in determining the trust’s material participation • But, this is only a litigating position. • The PAL regulations have reserved the section dealing with material participation by a trust • A federal district court rejected the IRS position, stating that it “defies common sense.” • The Tax Court, in 2014 also rejected the IRS position 13 Frank Aragona Trust v. Comr., 142 T.C. No. 9 (2014) • Trusts and the passive loss rules – Trusts can qualify for the real estate professional exception to the rule that rental activities are per se passive – Activities of trustees that were employees of wholly ‐ owned subsidiary of trust, acting in capacity of employees count toward material participation test – Activities of non ‐ trust employees probably also count (issue not before court) – Implications for imposition of the 3.8 percent NIIT 15

8/3/2015 Implications of Aragona • IRS position really makes no sense • A trustee’s actions as employee should count as material participation for the trust – The trustee can’t remove the fiduciary “hat” in anything that the trustee does • Until regulations are developed that set forth the IRS position, Aragona can be relied upon – It will likely be several years before any guidance is issued 13 Stable Investment Partnership v. Vilsack, (N.D. Ill. Mar. 17, 2014) • Title to land held in trust • Partnership only owned personal property interest • Partnership not eligible for farm program payment limits 17 Excluding Gain on Sale of Residence • CCM 201429022 (May 27, 2014) – In 2010, estates could elect out of FET – If election made, modified carry ‐ over basis rule applied – Under Sec. 121(d)(11), a taxpayer acquiring a residence from an estate can use the decedent’s ownership and use to determine eligibility for Sec. 121 exclusion – IRS said the provision is not repealed for 2010 deaths, but is for deaths before or after 2010. 16

8/3/2015 21 Option to Buy Farmland • Kasben v. Kasben, et al. (Mich. Ct. App. May 19, 2015) – Son deeded farmland to Dad and reserved an option to buy the land “when the grantee no longer farms the land or decides to sell it or upon his death.” • While still farming, Dad gifted the tracts to his four children equally • Court said option “ran with the land” and is valid 13% is 50% in Divorce • Kunnemann (Neb. Ct. App. Jun. 10, 2014) – Farm partnership formed with brother 8 years before divorce • Husband contributed $80,000 and brother put in $472,000 – Turns into 50% in divorce proceedings • Represented to USDA on financial documents, tax returns and USDA disclosures that it was a 50/50 partnership and they equally shared in profits, losses, income, expenses and depreciation 27 Trust Protector Can’t Challenge Trust Liquidation and Termination • Schwartz v. Wellin (D. S.C. Apr. 17, 2014) – Irrevocable trust with SD situs – Trust protector had “the power to represent the Trust with respect to any litigation brought by or against the Trust if a Trustee is a party to such litigation” and “to prosecute or defend such litigation for the protection of Trust assets” – Power not triggered when beneficiaries and trustees liquidated the trust and distributed the proceeds to themselves 17

8/3/2015 32 No Equitable Adoption in Wyoming • In re Estate of Scherer (2014) – Decedent believed to be biological father, but learned post ‐ death that he wasn’t – Claimed she was an heir based on theory of “equitable adoption” • Note – WY law does not allow stepchildren and foster kids (and their descendants) to inherit – Court refused to recognize the concept of equitable adoption 39 Assignment of Farm Rental Income as a Medicaid Strategy • Bleick v. ND DOHS (N.D. 2015) – Farmland transferred to son in 1998 with reserved life estate • Rental income was $5,332 annually for life – In 1992, son leased portion of farm to another farmer for $8,200 annually – Mom moved off farm and then later applied for Medicaid • Denied – she should be receiving a portion of the $8,200 and asset level too high • Court agreed – Not an annual gift to son because no release of life estate coupled with title transfer to son 42 Interim Changes and Adjustments • Annual exclusion – $14,000 • I.R.C. §6166(j) – 2% portion ‐ $1,470,000 • Non ‐ citizen spouse annual exclusion – $147,000 • Basic exclusion amounts – $5,430,000 18

8/3/2015 State Legislative Developments On Estate/Inheritance Tax • Hawaii – For estates of decedents dying on or after Jan. 25, 2012, state law exemption mirrors federal exemption • Indiana – State inheritance tax repealed effective January 1, 2013 State Legislative Developments on Estate/Inheritance Tax • Illinois – Sets state law exemption at $4 million, but does not allow for portability of unused exemption at death of first spouse, and eliminates gift tax • Can make separate state QTIP election • Maine – Exemption is $2 million for decedents dying on or after Jan. 1, 2013 State Law Developments on Estate/Inheritance Tax • Ohio – State estate tax repealed effective for decedents dying on or after Jan. 1, 2013. • Oregon – State inheritance tax changed to a “stand ‐ alone” estate tax with an exemption of $1 million effective for deaths on or after Jan. 1, 2012 • Tennessee – Legislation phases out the inheritance tax over four years (gone as of Jan. 1, 2016). The exemption is $2 million for 2014 • Gift tax is repealed retroactive for gifts made on or after Jan. 1, 2012. 19

8/3/2015 Minnesota Estate and Gift Tax • Legislation signed into law (effective 6/30/13) – Gift tax rate of 10% on residents and non ‐ residents owning property in MN • Transfer of title to real estate w/o full consideration • Transfer of tangible personal property “customarily kept in MN at time of gift • Gifts of intangible assets Minnesota Estate and Gift Tax • $1 million exemption for lifetime gifts – Applicable after $14,000 present interest annual exclusion • No gift tax on the following: – Transfers to spouses – Charitable gifts – Transfers for educational or medical purposes Minnesota Estate and Gift Tax • Generally inapplicable to non ‐ residents unless gifts made within 3 years of death • Effective June 30,2013 20

8/3/2015 Minnesota Estate Tax • Applicable to estates over $1 million • Starting in 2013, both residents and non ‐ residents with property in MN must include MN taxable gifts made w/i 3 years of death in MN taxable estate • Entities disregarded for estate tax purposes – Eliminates discounting Minnesota Estate Tax • HF 1777 signed into law on Mar. 21, 2014 – Retroactively repeals the gift tax enacted in 2013 – Estate tax exemption increased to $1.2 million for 2014 • Increases in $200,000 increments and will be $2,000,000 in 2018 – Modifies computation of estate tax • First dollars taxed at 9%, and increases to 16% – Separate state QTIP election can be made – Estate tax on non ‐ residents owning an interest in pass ‐ through entity owning personal property in MN does not apply to publicly traded entities. Still applies to entities taxed as partnership or S corporation owning closely held businesses, farms and cabins 21

8/3/2015 IRS Issues Associated with Estate and Business Planning Kristy S. Maitre, Tax Specialist Center for Agricultural Law and Taxation Estate Tax Closing Letters • IRS has announced that, for estate tax returns filed on or after June 1, 2015, estate tax closing letters will be issued only upon request by the taxpayer – It has also clarified whether it will, under various circumstances, issue a closing letter with respect to estate tax returns filed before June 1, 2015 – In Rev. Proc. 2014 ‐ 18, 2014 ‐ 7 IRB 513, IRS provided procedures under which estates of decedents that died before Jan. 1, 2014, that fall below the dollar threshold for having to file an estate tax return, that failed to file Form 706, and that wanted to elect to take the estate tax portability exclusion, could get an automatic extension of time, to Dec. 31, 2014, to file Form 706 to make that election Estate Tax Closing Letter • In the past, IRS issued closing letters to estates for federal estate tax purposes, acknowledging that it has accepted the estate tax return as filed, or as adjusted pursuant to audit. This used to be an automatic process. • The IRS has now announced on its website that a closing letter will be issued only if the taxpayer requests it. – To make matters worse, the IRS asks that the request not be submitted until 4 months after the return is filed – thus ruling out making the request as part of the return filing. This makes you wonder whether the IRS no longer has the resources to do • a preliminary review of every filed Form 706, as in the past. – If that is the reason for this new policy, then perhaps it may be advantageous to NOT request a closing letter since that may generate a review of a filed return that might not otherwise have occurred. – However, in those localities where a probate court will require a closing agreement to close an estate administration, this may not be practical or possible. 22

8/3/2015 Estate Tax Closing Letters • For estate tax returns filed before June 1, 2015, IRS has continued its former instructions that: – a) personal representatives can expect a closing letter to be issued within four to six months from the date that Form 706 is filed if the return is without errors or special circumstances; and – b) letters for returns that are selected for examination or reviewed for statistical purposes will take longer. Estate Tax Closing Letters • In addition, IRS has indicated that, for estate tax returns filed after Jan. 1, 2015 and before June 1, 2015, its previous policy of issuing closing letters has been changed to reflect the portability rules • For example, no closing letter will be issued for such a return if: – a) the estate didn't meet the filing threshold and the portability election was denied due to a late filing; or – b) the return was filed pursuant to Rev Proc 2014 ‐ 18 and the portability election was denied due to failure to meet Rev Proc 2014 ‐ 18's requirements On the other hand, where such a return was filed, the estate met the filing threshold, and the portability election was denied due to a late filing, a closing letter will be issued. • It appears that the rules described in the immediately preceding paragraph are actually intended to apply to estate tax returns filed at any time before June 1, 2015. 1 Termination of a Fiduciary Relationship • Form 56 is used to notify IRS of the creation or termination of a fiduciary relationship • Form 56 revised in December 2011 • Revocation section removed from new revision • Write “TERMINATION” on the top of Form 56 23

8/3/2015 Form 56 Address Changes • Form 56 cannot be used to update the last known address of the person for whom you are acting • Must file Form 8822 or 8822 ‐ B • Change of address on Form 56 will not be processed • Form 56 needs to be filed at the campus where the person for whom you are acting is required to file. Form 56 Special Rules • Proceedings (other than bankruptcy) and assignments for the benefit of creditors. – A receiver in a receivership proceeding or similar fiduciary or – An assignee for the benefit of creditors must file with Form 56 on or within 10 days of the date of appointment with: • Advisory Group Manager – Publication 4235 • The receiver or assignee may also file a separate Form 56 with the service center where the person for whom the fiduciary is acting is required to file tax returns to provide the notice required by section 6903. 1 ‐ 2 Estate and Gift Tax Contact – Discharge of Federal Tax Lien • Form 4422 should be sent when the following applies – Form 706 has an assessed unpaid balance – Been granted a payment deferral or – Has received Letter 627, Estate Tax Closing Letter Address: Internal Revenue Service Advisory Estate Tax Group 55 South Market Street Mail Stop 5350 San Jose, CA 95113 ‐ 2324 Attention: Group Manager Applies to §2032A or §6166 and other elections 24

8/3/2015 Estate and Gift Tax Contact – Discharge of Federal Tax Lien • If the Form 706: – has not been filed or, – is non ‐ taxable or, – the tax assessment has been paid in full, or – has been filed and the tax assessment has been paid in full and – Letter 627, Estate Tax Closing Letter, has not been issued, Submit Form 4422 and all supporting documents to: Internal Revenue Service Attn: Estate and Gift Tax Exam Group Manager Call 866 ‐ 699 ‐ 4083 2 ‐ 3 1041 Payment Voucher • In response to practitioner concerns that payments for Form 1041, US Income Tax Return for Estates and Trusts, are posting incorrectly , especially SHORT YEAR returns • IRS is considering revising Form 1041 ‐ V payment voucher to allow entry for the tax period ending date for fiscal year and short year filers • In the meantime, taxpayers who file Form 1041 using a tax period ending in a month other than December should mark out the tax year on the upper right hand corner of the Form 1041 V and write in the tax period ending date (MM/DD/YYYY) 4 Gift Tax Issues • Interfamily gifts ‐ audits • Gift Tax Return Copies – NO Form 4506 – Letter required 25

8/3/2015 Identity Theft 5 Deceased individuals • IRS can lock accounts • Proactive – Notify IRS of death – Send in death certificate – IRS will note account – Limit obit information Abatement of Dishonored Check • Evidence the account had sufficient funds • Bank error – document • Provide letter with explanation • Note IRM 20.1.1.3 5 ‐ 6 Form 1041 ‐ T • Election • Method to Allocate estimated tax payment • For the election to be valid, a trust or decedent’s estate must file Form 1041 ‐ T by the 65th day after the close of the tax year as shown at the top of the form • If the due date falls on a Saturday, Sunday, or legal holiday, file on the next business day • For a 2014 calendar year decedent’s estate or trust, that date is March 6, 2015 26

8/3/2015 6 ‐ 7 Unable to Process Conditions • Delays the processing • Generally handled through correspondence • Statute begins when reply is received and addresses the issue 7 Administrative Files • IRM 4.2.5.7 and 5.1.22.6 states that the Service will provide copies of the case file without going through the formal process of the FOIA request, unless the release would seriously impair tax administration. • Lengthy process • Files stored off site – 6 ‐ 8 weeks minimum 8 Filing Final Returns • DO NOT cross through years and write in new year • IRS cannot process a 1040 final 2015 return until 2016 • IRS cannot process any estate tax return until the forms are final • Often a duplicate file issue will occur – Months to fix – With ID Theft IRS could assume it is ID Theft 27

8/3/2015 8 ‐ 9 Form 1310 • Form 1310 is used to claim a refund on behalf of a deceased individual • IRS states that a Form 1310 is not required for a surviving spouse filing an original or amended joint return with the decedent or the person is a personal representative (executor or administrator of the decedent’s estate) filing an original return • Form 1040 series and a court certificate showing the appointment is attached to the return – Note, the court certificate is not always attached in the case of a personal representative. – IRS looks for a Form 1310 even though one may not be required. It is a good practice to always include a Form 1310, do not depend on IRS training of assistors who are involved in the processing of the final return. 9 ‐ 10 Late Established Estate • A practitioner requested information on how to prepare Form 2848, so an estate filing Form 1041 with an Employer Identification Number can get information returns filed with a Social Security number • In the practitioner’s scenario, the taxpayer died in 2011, the estate opened in 2013 and the practitioner needed information returns for 2012 • Form 2848 instructions don’t address this situation. Late Established Estate Process • The IRS will accept Form 2848 with two Taxpayer Identification Numbers, if the taxpayer is an estate and the Form 2848 includes Form 1040 issues • The Form 2848 should include both the decedent’s SSN and EIN (if estate has an EIN) • You will list both Forms 1040 and 1041, as well as the tax periods, in the tax matters field of Form 2848 • Generally, in the case of a deceased individual, enter the name and SSN (or Individual Taxpayer Identification Number) of the decedent as well as the name, title, and address of the decedent’s executor or personal representative on Form 2848 • However, in the case of an estate, enter the name of the decedent and the EIN for the estate (if assigned) as well as the name, title, and address of the decedent’s executor or personal representative on Form 2848. 28

8/3/2015 Obtaining transcripts for a deceased 10 taxpayer • Estate attorney was denied transcripts through e ‐ services because the decedent's account was assigned to the identity theft unit • The IRS response showed the taxpayer as deceased but told the authorized representative for the estate to have the taxpayer call the identity theft unit – The executor of the estate should file Form 56, Notice Concerning Fiduciary Relationship, and then call the Identity Protection Specialized Unit to get a copy of the transcript. 10 ‐ 11 Estate/Gift Tax Pre ‐ Appeals Conferences Effective January 30, 2015 • Eligibility for an IRS Appeals conference in jeopardy • The information (SBSE ‐ 04 ‐ 0115 ‐ 0015) outlines the options available if the taxpayer does not agree with the auditor’s proposed adjustments • IRS will issue the “30 day” letter with the report of proposed adjustments to the tax return along with the newly created Letter 5262 ‐ D, Additional Information Due Estate and Gift Tax • The move to the new letter hopes to increase consistency when notifying the taxpayer of the audit results • The taxpayer has 15 days to respond and provide or verify they do or do not have the information requested. • IRM sections 4.25.10 and 4.25.11 were changed due to the interim guidance. This procedure will apply through December 31, 2015. What Does This Mean? • IRS in the last few years has seen an increase in Appeals cases • The procedural change, places more responsibility on the auditor to get the information needed from the taxpayer • If new information is presented in an Appeals case, the case will generally be returned to the auditor • When the audit begins, along with the audit notice is Form 4564, an Information Document Request • This form lists the information IRS would like to view to verify the information on the tax return • Letter 5262 ‐ D will only be issued if the information is not provided or the taxpayer has not advised the auditor that no further information is available 29

8/3/2015 PRESERVE THE APPEALS CONFERENCE. • IRS requires a response from the taxpayer or representative, without a response Letter 5262 ‐ D will be issued with the final report • This will, have a direct impact on whether or not the taxpayer is eligible for an Appeals conference • IRM 1.4.40.4.11.5 Un ‐ agreed Case Procedures states the case file should not be sent to Appeals unless the information requested has been provided or there is information provided that the taxpayer does not have the information. YOU MUST RESPOND EITHER WAY TO PRESERVE THE APPEALS CONFERENCE 14 New Statute of Limitation • On September 2, 2014, the IRS Office of Appeals issued new procedures concerning the number of days that remain on the statute of limitations for assessment (270 days for non ‐ docketed estates cases and 365 days for gift tax cases) before the Office of Appeals will accept case from the examination division. New Statute of Limitation • Exception applies in estate cases where the Office of Appeals returns a case to the examination division for consideration of new information or a new issue • In these estate cases, there must be at least 180 days remaining on the statute of limitations for appeals to accept the returning case • This exception does not apply to gift tax cases • The statute of limitations cannot be extended in estate and gift tax cases. 30

8/3/2015 §6404(a) and CCA 201520010 • Taxpayer Assistance Order request • Scenario – Taxpayer filed a late return with a balance due and tax was paid including the penalties and interest – An error was found and an amended return was filed reflecting a refund – IRS agreed the amended return was correct – IRS calculated penalties and interest based on balance due of the original return • Penalties excessive due to the amended return reflected a refund and the true liability was lower which would have resulted in lower penalties and interest §6404(a) • IRC section 6404(a)(1) authorizes the IRS to abate the unpaid portion of an assessment that is excessive in amount • While the statute specifies “unpaid” assessments, Counsel’s view is that IRC section 6404(a)(1) is permissive and that the IRS is not prohibited from abating the paid portion of assessments §6404(a) and CCA 201520010 Refund Barred has no Effect • The timing of a claim for credit or refund has no effect on the IRS’s authority to abate an assessment • Thus, although the refund of tax reported on the amended return is time ‐ barred under IRC section 6511 (the amended return was not filed within 3 years from the filing of the original return and the taxpayer full ‐ paid the liability when he filed the original return), the IRS may still abate the penalties and interest that exceed the true amount of penalties and interest the taxpayer owes • As a result of the payments of penalties and interest that the taxpayer has been making each month, the taxpayer has overpaid the penalties and interest • The amended return should be treated as a claim for refund for the penalties and interest paid in the two years prior to the date the amended return was filed, to the extent those amounts exceed what the taxpayer actually owed 31

8/3/2015 Power of Attorney Subject to FBAR 14 ‐ 15 Reporting • IRS has taken the position in their “FBAR Reference Guide” that “signature authority” includes “the authority of an individual (alone or in conjunction with another individual) to control the disposition of assets held in a foreign financial account by direct communication (whether in writing or otherwise) to the bank or other financial institution that maintains the financial account.” Example • In an example, IRS explains that this definition includes agents acting under a power of attorney (POA) • It is immaterial if the power has ever been exercised • The agent (along with the principal) is subject to the FBAR filing requirements if the POA gives the agent signature authority over a foreign account that exceeds the dollar threshold 32

8/3/2015 Estate Planners • Estate planners should immediately advise all clients where POA’s are in place of this requirement • It is standard practice to give agents authority over bank accounts of their principal • Remember, it is the agent that has liability for non ‐ filing, along with the principal. • Estate planners must take care to ensure that all agents named in POAs know that they have been named (this can be an issue with respect to durable POAs) that are not delivered to the agent until necessary • Clearly, the best practice is to have the agent sign the POA along with the principal 15 Employer Identification Number (EIN) Estates • You will be required to obtain a new EIN if any of the following statements are true: – A trust is created with funds from the estate (not simply a continuation of the estate) – You represent an estate that operates a business after the owner's death Employer Identification Number (EIN) Estates • You will not be required to obtain a new EIN if any of the following statement is true: – The administrator, personal representative, or executor changes his/her name or address 33

8/3/2015 15 Trusts and EIN • You will be required to obtain a new EIN if any of the following statements are true – One person is the grantor/maker of many trusts – A trust changes to an estate – A living or intervivos trust changes to a testamentary trust – A living trust terminates by distributing its property to a residual trust. Trusts and EIN • You will not be required to obtain a new EIN if any of the following statements are true – The trustee changes – The grantor or beneficiary changes his/her name or address. 16 Requesting an Employer Identification Number for a Trust • Practitioner's client was trustee of her living trust since its creation in 1989 • She became incapacitated in 2013, requiring a change in the trustee • Although an EIN was not required for the new trustee in this case, the practitioner applied for one using the Online EIN Assistant on IRS.gov • When prompted for the funding date of the trust, he entered 1989, the year the trust was created • This generated an IRS request for 23 years of trust returns • To eliminate confusion and minimize taxpayer burden, the practitioner suggests the Online EIN Assistant include information clarifying which date to enter when an EIN is required. 34

8/3/2015 Answer • Changes to the Online EIN Assistant are prioritized • During the next update to the Online EIN Assistant, IRS will add a help topic providing clarification on the date that should be used for the "date trust funded" question and when an EIN is required due to a change in circumstances. 16 Perfection of Returns Why is it Important? • All returns are perfected • If information, schedules documents are missing the return can be deemed invalid and not processable • This could and does extend the statute time frame depending on the importance of the document • Text provides a checklist for Estate and Gift Tax Returns 17 Estate Closing Letter • There can be some variation, but for returns that are accepted as filed and contain no other errors or special circumstances, you should expect to wait about 4 to 6 months after the return is filed to receive your closing letter • Returns that are selected for examination or reviewed for statistical purposes will take longer 35

8/3/2015 You Snooze You Lose Hot Issues • Karen Hawkins retirement • 2015 Allowed Living Expense Standards have been released – OIC • Cal Pure Pistachios, Inc v. United States • Education Credits – audits – 3.6 million received more than 5.6 million in erroneous education credits for tax year 2012 • No form 1098 ‐ T was issued • Attending ineligible institutions • Claimed credit for more than four years • Attended school less than half ‐ time More Hot Issues • Omitting information from the form 1040 can extend the statue of limitations • Electronic Confirmation Notices to Employer • Employer Notices of Address Changes • Filing deadline for 2016 = April 18, 2016 • Medicare Premium Hikes could effect your clients in 2018 – Premiums are based on 2016 data, so deferring income could have an impact on 2018 premiums 36

8/3/2015 • Tax Information with Indy 500 Speed • Kristy Maitre – CALT Tax Specialist CALT RESOURCES 37

8/3/2015 Scoop Dates for Post ‐ Filing Season • August 5, 2015 • September 23, 2015 • October 21, 2015 • October 28, 2015 CALT Website http://www.calt.iastate.edu/ Tour of the CALT Website 38

8/3/2015 CALT Staff Roger A. McEowen CALT Director and is a Leonard Dolezal Professor in Agricultural Law Email: mceowen@iastate.edu Phone: (515) 294 ‐ 4076 Fax: (515) 294 ‐ 0700 Kristine A. Tidgren Staff Attorney E ‐ mail: ktidgren@iastate.edu Phone: (515) 294 ‐ 6365 Fax: (515) 294 ‐ 0700 CALT Staff Kristy S. Maitre Tax Specialist E ‐ mail: ksmaitre@iastate.edu Phone: (515) 296 ‐ 3810 Fax: (515) 294 ‐ 0700 Tiffany Kayser Program Administrator Email: tlkayser@iastate.edu Phone: (515) 294 ‐ 5217 Fax: (515) 294 ‐ 0700 Time For A Break! • Morning Break: – 9:45 – 10:05 a.m. 39

8/3/2015 The Impact of State ‐ Level Estate/Inheritance Tax on Farm Succession Planning Chris Hesse 1 16 States with Estate Tax • Connecticut • Minnesota • Delaware • New Jersey • DC • New York • Hawaii • Oregon • Illinois • Rhode Island • Maine • Tennessee • Maryland • Vermont • Massachusetts • Washington States with Inheritance Tax • Iowa • Tennessee calls it an inheritance tax, but it is • Kentucky really an estate tax • Maryland • Nebraska (County level) • New Jersey • Pennsylvania 40

8/3/2015 Maximum State Estate Tax Rate • 20% • 16% (continued) – Washington – New York • 16% – Oregon – Rhode Island – Delaware – Vermont – DC • 12% – Hawaii – Illinois – Connecticut – Maryland – Maine – Massachusetts • 9.5% – Minnesota – Tennesee – New Jersey 2015 State Estate Tax Threshold • $675 thousand • $2 million – New Jersey – Connecticut • $ 1 million – Maine – Washington (Indexed) – DC • $2.0625 or 3.125 – Massachusetts – Oregon – New York • $1.4 million • $2.75 million – Minnesota – Vermont • $1.5 million • $4 million – Maryland – Illinois – Rhode Island (indexed) • $5.43 million – Delaware – Hawaii How Does State Threshold Work • The threshold is usually applied to the federal gross taxable estate • Then state tax is calculated based on the federal estate • The percentage of state level assets to federal estate level is then multiplied by the federal tax • Most of the states have a pick ‐ up level tax 41

8/3/2015 1 Portability • Allowed at federal level – DSUE ported over to surviving spouse – Not allowed for GST – Not indexed to inflation • Not allowed at state level (other than Hawaii) – Wrong title of assets exposes second spouse to additional tax 1 ‐ 2 Example of Additional State Estate Tax • Ben & Maria married for over 50 years; Oregon residents; All assets titled in Ben’s name; Net worth of $10.5 million – Federal portability results in no federal estate tax – Additional Oregon tax of about $150,000 owed to no portability at Oregon level 2 AB Trust Planning • “A” trust commonly known as – “Marital Trust”, – “QTIP Trust” or – “Marital Deduction Trust” • “B” trust commonly referred to as – “Bypass Trust”, – “Credit Shelter Trust”, or – “Family Trust” 42

8/3/2015 AB Trust Reasons • Portability is not indexed to inflation • Spouses have different sets of final beneficiaries – Blended families • Federal GST is not portable 2 ‐ 3 AB Trust Structure • Appropriate AB Trust language in wills or RLT • Couple divide assets to equalize • First deceased spouse up to $5.43 million into “B” Trust • Excess goes into “A” Trust • Surviving spouse reports their assets plus value of “A” trust • Assets in “B” trust not subject to second estate tax • If “A” Trust not needed, then unused portion is ported to surviving spouse State Marital Trust Requires “C” Trust • If the state death tax threshold is less than the federal exemption amount, then a “C” trust is required to hold the difference – Normally requires state level QTIP election – DC and Vermont do not allow separate state level QTIP election 43

8/3/2015 ABC Trust Structure • “B” Trust holds assets up to state estate tax threshold • “C” Trust holds assets from that level to federal exemption level • “A” Trust holds assets above federal exemption level 4 Ben & Maria Example • Ben worth $7 million – “B” Trust is funded with $1 million – “C” Trust is funded with $4.43 million – “A” Trust is funded with $1.57 million • “A” Trust is included in Maria’s estate for both federal and state estate tax purposes • “C” Trust is only included in Maria’s Oregon estate tax filing 4 Lifetime Gifts • Most states with estate tax have no gift tax – Therefore gifts made during life will not be subject to any state level transfer tax – Care must be taken with assets to be gifted • Basis equals FMV – Best to gift • FMV much greater than basis – May want to run through estate to get step ‐ up – However, immediate state estate tax may be more costly than possible future capital gains tax 44

8/3/2015 5 Non ‐ Residents and Real Property • All states tax real property located in state for non ‐ residents • Possible planning steps – Move to another state (for personal property) – Place real property in LLE • Does not work for all states (must look to state law) • Even if allowed by statute, state may fight it if only reason is for estate tax planning purposes U.S. Income Tax Considerations When Using Foreign Guest Workers Michelle VanDellen, CPA, MS What We’ll Cover Today • U.S. Immigration and Tax Residency Status • Income Tax Return Filing • Employer Withholding and Reporting 45

8/3/2015 2 U.S. Immigration and Tax Status • Immigration Categories – In General – U.S. Citizenship • Birth • Naturalization – Immigration Visa • Those intending to immigrate permanently to the U.S. – Non ‐ Immigration Visa • Student visas • Temporary worker visas 3 U.S. Immigration and Tax Status • Tax Categories – In General – U.S. Citizen • Taxed by U.S. on worldwide income • Subject to U.S. tax regardless of residence – U.S. Resident • Taxed by U.S. on worldwide income • Eligible for foreign tax credits to reduce double taxation – Neither U.S. Citizen nor U.S. Resident • Taxed by U.S. on U.S. ‐ sourced income only Tax Classification of Common Visas Corresponding Visa Classification Tax Category U.S. Citizen N/A Permanent Resident Card (green card; LPR) Resident Alien E, H ‐ 2A , L Nonresident Alien E, H ‐ 2A , L 46

8/3/2015 4 Substantial Presence Test • Sec. 7701(b)(3)(A) • An individual was physically present in the U.S. for at least 31 days during the current (calendar) year, and • The sum of the number of days (when multiplied by a formula) on which such individual was present in the U.S. for the current and the two preceding calendar years equals or exceeds 183 days. Substantial presence test formula • 100% of current year days, plus • 1/3 rd of prior year days, plus • 1/6 th of second prior year days • equals or exceeds 183 days An individual who is present in the U.S. for 122 days during each of the three years will be considered to have met the substantial presence test. 5 Substantial presence test • Less than 183 by formula: U.S. tax non ‐ resident • 183 or more by formula (but less than 183 in current year): U.S. tax resident under the Substantial Presence Test – an exception exists for “closer connection” to another country • 183 or more in current year: U.S. tax resident – may gain non ‐ resident status under treaty 47

8/3/2015 Closer connection exception • Sec. 7701(b)(3)(B) • Individual is present in the U.S. less than 183 days in current year, and – maintains a tax home in a foreign country, and – has a closer connection to such foreign country. • Individual must File IRS Form 8840 with individual income tax return to make a claim for a closer connection to a foreign country. How this impacts foreign guest 6 workers with h ‐ 2a visas • Treated as a tax nonresident, unless s/he meets the substantial presence test. • If the substantial presence test is met, the worker may still be treated as a tax nonresident if s/he has a closer connection to another country. • If the worker is in the U.S. for 183+ days in the current year, s/he is a U.S. tax resident unless a treaty exception applies. Special rules applicable to foreign agricultural workers with h ‐ 2a visas • Exempt from U.S. Social Security and Medicare taxes on wages paid in connection with the H ‐ 2A visa, – Regardless of whether the worker is a resident or nonresident alien. • Wages paid in connection with the H ‐ 2A visa are not subject to FIT withholding (unless backup withholding applies). – Worker and employer should consider voluntary FIT withholding if worker may owe U.S. income tax. – State withholding rules may differ. 48

8/3/2015 7 Requirement to File a U.S. Income Tax Return ‐ nonresidents • Nonresident must file a U.S. income tax return (Form 1040NR) if s/he has U.S. source income. Reg. 1.6012 ‐ 1(b)(1) • Exception for nonresident who earns U.S. sourced wages, who would be required to file a U.S. income tax return solely because of those wages, if those wages are less than the personal exemption amount ($4,000 for 2015). Notice 2005 ‐ 77 Form 1040NR • May also need to file: – Form 8840 – Closer Connection Exception Statement, or – Form 8833 – Treaty ‐ Based Return Position Disclosure • Due date for filing (Reg. 1.6072 ‐ 1) – Nonresident alien individual – June 15 (generally) – Nonresident alien who has wages subject to withholding – April 15. • IRS: “compensation paid to H ‐ 2A agricultural workers for services performed in connection with the H ‐ 2A visa is not considered to be “wages” for purposes of federal income tax withholding . . .” 8 Dependency exemptions • Entitled to one personal exemption. • Residents of Canada and Mexico may claim additional exemptions: – for his/her spouse (if s/he has no gross income and is not the dependent of another taxpayer), – for other dependents using the same rules as for U.S. citizens. Sec. 873(b)(3) and 151(b) 49

8/3/2015 Qualifying child • Child (including step and foster), sibling (including half and step), or a descendant of any of them. • Under age 19 (age 24 if a student) and younger than the taxpayer, or any age if permanently and totally disabled. • Lived with the taxpayer for more than half the year • Must not have provided more than half of his/her own support. • Not filing a joint return for the year. 9 Qualifying relative • Not Qualifying Child • Either live with the taxpayer all year as a member of the taxpayer’s household or be related to the taxpayer: descendants, siblings, ancestors, nieces and nephews, most in ‐ laws. • Gross income must be less than the personal exemption amount ($4,000 for 2015). • Taxpayer must provide more than half of the person’s total support during the calendar year . Individual taxpayer identification numbers (itins) • In order to be claimed as a dependent, qualifying individuals must have an ITIN or SSN. • Complete Form W ‐ 7 or W ‐ 7(SP) to obtain ITIN. – File with tax return for the first year the ITIN is needed. – Original (or certified copies) of documents that support the information provided on Form W ‐ 7. – Original documents are returned to the mailing address shown on the W ‐ 7. 50

8/3/2015 Requirement to file a U.S. income tax 10 return – residents For individuals who trigger the substantial presence test: • File Form 1040 reporting worldwide income. • Credits: – Earned income credit: qualifying child must live with the parent in the U.S. Both the parent and the child must have SSNs to claim the credit. – Child tax credit: qualifying child must be a U.S. citizen, U.S. national, or a resident alien. Form W ‐ 2 REPORTING • Wages paid in connection with H ‐ 2A visas must be reported on Form W ‐ 2 if $600 or more. • Complete: – Box 1: Wages, tips, and other compensation – Box 2: Federal income tax withheld if the employee elected voluntary FIT withholding • Do not complete: – Box 3: Social Security wages – Box 5: Medicare wages 11 Form W ‐ 2 REPORTING 51

8/3/2015 FORM 943 REPORTING • Complete: – Line 1 – Number of agricultural employees – Line 8 – Federal income tax withheld if the worker elected voluntary FIT withholding • Do not complete: – Lines 2, 4, and 6: total wages subject to social security and Medicare taxes 12 Form 943 reporting FUTA tax • Wages paid to workers on H ‐ 2A visas are not subject to the FUTA tax. • However, their wages must be counted in determining the FUTA threshold of: – $20,000 wages per quarter, – 10 or more workers per day for 20 weeks. 52

8/3/2015 13 Form 940 reporting • Include workers’ wages on Line 3: Total payments to all employees • Subtract these wages on Line 4: Payments exempt from FUTA tax • Check Box 4e: Other Form 940 Questions? Michelle VanDellen, CPA, MS Michelle.vandellen@mossadams.com 360 ‐ 685 ‐ 2205 53

8/3/2015 Long Term Care Planning Strategies Roger McEowen Page 16 of Planning Techniques Planning for Long-Term Health Care • Deficit Reduction Act of 2005 – Signed by President on Feb. 8, 2006 • Among other things, makes Medicaid asset- preservation planning more difficult 161 Page 16 ‐ 17 of Planning Techniques Deficit Reduction Act • Look-back period extended to five years for all transfers – Can no longer transfer assets and wait three years for Medicaid eligibility – Planning options: • Set aside enough funds to pay for 5 years of care and transfer the balance to the kids; or • Transfer all assets to the kids and let the children pay for parent’s nursing home care for 5 years – A child can then claim parent as a medical dependent on tax return 162 54

8/3/2015 Extended Look-back Period • Planning options: – Use grantor trusts instead of transferring assets to the children • Less risky • Retain I.R.C. §121 exclusion • Step-up basis available for appreciated assets • Income taxed to grantor 163 Extended Look-back Period • Planning options: – Buy long-term care insurance for a period of five years • If care needed in the future, transfer assets and wait-out the 5-year look-back period via use of the long-term care insurance 164 Deficit Reduction Act • Change in beginning date for computation of ineligibility period for transferred assets – Later of: • Date transfer made or date individual would – be eligible for medical assistance; – otherwise be receiving institutional care based on an approved application for such care, but for the application of the penalty period (whichever is later); and – which does not occur during any other period of ineligibility 165 55

8/3/2015 Change in Ineligibility Period • Planning options (step by step): – Parent transfers assets and applies for Medicaid – Application denied – Child then re-transfers roughly half of the assets to the parent – Parent reapplies and is rejected – Parent pays for care during period of ineligibility 166 Deficit Reduction Act • Home equity – Medicaid ineligibility if applicant has home equity in excess of $500,000 (or $750,000 at state’s option) • Exceptions apply is home occupied by: – Spouse – Child under age 21 – Child who is blind or permanently and totally disabled 167 Home Equity Rule • No impact on planning if applicant is single • For married applicants, have the community spouse buy a more expensive home as a means of sheltering assets 168 56

8/3/2015 Deficit Reduction Act • Mandates partial month penalties for asset transfers – Can no longer transfer small sums (lower than the state’s divisor) and not be penalized – No longer possible to transfer assets and then make additional transfers within the look-back period that are structured in a manner that the penalty for the subsequent transfers did not extend beyond the original look-back period 169 Deficit Reduction Act • Accumulation of multiple transfers – Fractional transfers of assets in more than one month are accumulated – Transfers during all months within the 5-yr look-back period are treated as one transfer • All transfers within the 5-yr look-back period are penalized 170 Title XIX and Saving the Family Business • General comments: – Obtain nursing home insurance at age 60 ‐ 65 (not beyond age 70) • Get what you need and no more (can get a rider to increase policy benefits as time passes) • Determine what income is from Soc. Sec., rents, dividends, etc. • Set up such that no benefits paid during first 6 months • Get lifetime coverage 171 57

8/3/2015 Title XIX and Saving the Family Business • What if person is too old to get insurance? – Sell 20 acres at a time to family members on installment basis • Make sure contract provides that upon death the contract is cancelled and conveyance to buyer of only the fractional part of the contract that has been paid for – Have family members make a loan to the person in the nursing home • Document carefully and obtain a mortgage and make copies of checks 172 Title XIX and Saving the Family Business • What if one spouse is in the nursing home and the other isn’t – Exempt assets should be turned over to spouse not in nursing home – Division of non ‐ exempt assets • First $24,000 goes to spouse at home • Next $24,000 goes to spouse in nursing home • 50/50 split thereafter up to $90,660 (each) • Balance goes to spouse in nursing home 173 Long Term Care Planning • Estate Recovery – Any money spent by Medicaid for a person’s care can be recovered from assets owned by the person at the time of death 174 58

8/3/2015 Long Term Care Planning • Strategies – Plan to pay for your own care out of your income and assets – Purchase long term care insurance – Purchase long term care insurance to cover the 5 year period – Transfer assets before the 5 year period 175 Long Term Care Expenses  Average annual cost of nursing home around $65,000 (not including incidentals)  What if income is also needed for the community spouse? 176 Long Term Care Risk • Business Assets $800,000 • Non Business Assets $100,000 • Total Assets $900,000 • Income Social Security $15,000 • Rent $30,000 • 3 children • One child in the business Question: Are the Business Assets and the son’s vocation at RISK? 177 59

8/3/2015 8 ‐ 13 More Thoughts on Long Term Care Planning LTC Demand • Need may be rising • Demand for policies dropping • Anybody who can afford it doesn’t need it; • Anybody who needs it can’t afford it! LTC and the Insurance Companies • Losing on LTC policies for years • New policies with much more conservative assumptions • Options include return of unused premium ‐ costly 60

8/3/2015 LTC Options • Self ‐ Insure • Annuity Hybrids – Include LTC benefits riders – Single payment • Traditional income annuity • Life Insurance – current or exchange – Include LTC benefits riders – Withdrawals/policy loans LTC Options • Reverse Mortgages • Potential changes: – LT Disability plan reverting to LTC – Term life version of LTC policy • Higher premium during earning years • Eliminates concern for increases – ????? Time for Lunch! • Session Resumes at 1:00 p.m. 61

8/3/2015 Planning Techniques Designed to Aid Farm Operational and Succession Planning Roger McEowen and Chris Hesse Reasons Why Businesses Don’t Have Succession Plans • Successor doesn’t believe that the predecessor will ever retire – Arthur Andersen survey • Between 25% and 33% of leaders of family businesses don’t intend to retire or plan to remain involved throughout their lives • 30 ‐ 40% of family businesses have no plan in place • Taboo subject – Relationships and emotions involved – Business may be founder’s self ‐ identification – Animosity toward younger generation • Primogeniture 1 OBJECTIVES OF SUCCESSION PLANNING • Objectives must drive the process and must be clearly articulated 186 62

8/3/2015 1 Objectives of Succession Planning • Successfully bringing the next generation into the business • Providing vocation for next generation • Establishing a base for a financially successful business into future • Providing a plan for the older generation • Providing an estate plan that is fair to business and non ‐ business heirs • Tax minimization 187 Thread Through Other Efforts Estate Planning Succession Business Planning Planning 188 Steps to Successful Succession Planning • Determine business owner’s long ‐ term goals and objectives • Determine financial needs of business owner and spouse and develop plan assuring financial security • Determine who will manage the business and develop the management plan • Determine who will own the business and how to transfer owner’s interest • Minimize transfer taxes and establish estate plan 63

8/3/2015 Step One • Family business assessment • One ‐ on ‐ one interviews with all family members • “To do” list for family and business – Must have family chemistry • Advisory board meetings • Life insurance requirements – Buy out? – Trust as beneficiary set up in business’ name? – Payout stays in the business? Step Two • Financial needs – Can business support owner and spouse after succession? – Can business support children? – Should business be sold to third party? Step Three • Who will manage the business? – Management and ownership may not be the same thing • Multiple entities? • Ownership could stay in the family, but management could be outside the family • Plan on 3 ‐ 5 years to select, mentor and train new management team 64

8/3/2015 Retaining Key Employees • Employee agreement • Non ‐ qualified deferred compensation plan – Business promises to pay key employee upon loss of founder in return for continued employment through specified term provided in contract • No reporting of any payment until made Ensuring Viability • Sell business to active children – Valuation by outside appraisers – Use of voting and non ‐ voting shares – Gifts of non ‐ business assets to inactive children – Equality does not equal fairness – Retaining voting shares – Buy ‐ sell agreement 1 INVOLVING CHILDREN IN THE BUSINESS 195 65

8/3/2015 1 Child Coming into the Business • Long ‐ term acquisition with supplemental income – Child establishes own vocation and gradually acquires interest in family business, but is never involved full time while parents are alive 196 1 ‐ 2 Sharing of Labor and Capital • Parents loan funds to child so child can acquire an interest in the business. Over time, there may be a sharing of capital and labor • Consideration should be made as to whether sharing arrangement constitutes a partnership – Liability issues – Entitlement to deceased “partner’s” share 197 Parent and Child Conducting Separate 2 Businesses • Child establishes comparable or complimentary business and gradually merges with the parents’ business – Tends to work well if parents are retirement age – Parent could become employee 198 66

8/3/2015 2 Joint Operators • Parent and Child may jointly start partnership, LLC, or corporate form of business – May be preferred structure if parents not retirement age – May involve multiple entities – May provide mechanism for equitable treatment of non ‐ business heirs 199 2 ‐ 3 Case Example #1 Small business with business heirs Critical to recognize when it is timely to bring the next generation into the operation Flexibility is crucial to maintain 200 3 Case Example #2 Sell ‐ out of small operation Business ends upon parents’ retirement and child moves into different career 201 67

8/3/2015 Case Example #3 Small operation transitioned via family agreement One business heir Successful family meeting Non ‐ business heirs agreed to reduced inheritance and be named beneficiaries of life insurance policies Plan in place that any appreciation in asset value would be shared if business heir sold out 202 3 ‐ 4 Case Example #4 The larger business with both business and non ‐ business heirs Issues Transfer of management to business heirs Equitable treatment of non ‐ business heirs What if there is an untimely death Role of insurance 203 5 Case Example #5 Complications of divorce An operating partnership had been created by Father and son ‐ in ‐ law Complications to parents’ estate plan Probably requires use of long ‐ term leases and contracts 204 68

8/3/2015 4 Case Example #6 Joint arrangements (keys to success) ‐ Expanding land base ‐ Operating partnership ‐ Maximization of payment limits 205 4 ‐ 5 Case Example #7 Complex entity arrangements 206 5 Case Example #8 Gifting strategy for multiple heirs 207 69

8/3/2015 Basic Entity Choices (See Pages 6 ‐ 7 for Summary Table) • Sole Proprietorship • General Partnership • Limited Partnership • Limited Liability Company • Limited Liability Partnership • S Corporation • C Corporation • Cooperatives 208 8 Major Considerations in Entity Choice • Income Taxation • FICA Taxes – Recent case – 7 th Cir. was amazed at stupidity of accounting firm in Rockford 209 9 Fringe Benefits • Health Insurance and retirement plans – Tax distinctions between various entities • Qualified retirement plan options 70

8/3/2015 10 Liquidation Costs • C Corp – Highest liquidation cost – Distributions in excess of stock basis result in capital gain • S Corp – Others • LLC – Distribution of assets on tax ‐ free basis • Discounting of Business Interests 8 ‐ 9 Major Considerations in Entity Choice • Continuity and Transferability of the Business • Management Structure – One Manager – Multiple Managers • Liability of Owners – Unlimited – Sole Proprietor, General Partnership, Gen. Partner of Limited Partnership – Limited – LLC, S Corp, C Corp, Limited Partner 212 Other Points Concerning Leases • Estate planning implications – Material participation and social security benefits – Material participation and post ‐ mortem estate planning techniques • Post ‐ death cash leasing (Secs. 6166 and 2032A) 213 71

8/3/2015 11 BUSINESS ORGANIZATION STRATEGIES 214 Single Entity Most U.S. Businesses 70 to 75% of farms and 50 ‐ 60 percent of non ‐ farm businesses 215 11 Multiple Entities  OPERATIONAL ENTITY  REAL ESTATE ENTITIES Sole Proprietorship Partnership LLC __lease____ LLC C Corporation S Corporation Equipment Parents’ Child’s capital capital 216 72

8/3/2015 11 Operational Entity • Typical choices include: – Sole proprietorship – General partnership – LLC – C Corp – S Corp 217 11 Operational Entity • Assets Possible to Be Placed into Business – Checkbook – Inventory – Equipment – Very Limited Real Estate 218 11 Landholding Entities • Selected entity is usually sole proprietorship or LLC • Typically not wise to put real estate in corporation 219 73

8/3/2015 11 HEIRS NOT IN THE BUSINESS How to achieve equitable treatment 220 11 Heirs not in the Business • Usually not wise to involve non ‐ business heirs in day ‐ to ‐ day operations – Often do not distribute any income – Operational business may have day to day decisions that do not match objectives of business heirs – Ownership usually small compared to on business heirs – Little incentive for business heirs to buy out interest of non ‐ business heir • Value of non ‐ business heir’s minority interest has severe value discount 221 11 How to Treat Non ‐ Business Heirs • Inheritance or gift • Beneficiaries or life insurance • Beneficiaries of retirement plans • Acquire interest in business real estate – Possibly in conjunction with gifting 222 74

8/3/2015 11 ‐ 12 How to Treat Non ‐ Business Heirs • The non ‐ business heir may not be distributed an equal share in the value of assets • If non ‐ business heir were to receive real estate – Subject to long term rental contract in favor of business heir’s business – Subject to purchase options favoring business heir – Placed into an entity in which either all heirs are co ‐ owners 223 11 ‐ 12 How to Treat Non ‐ Business Heirs • Seldom is it recommended that real estate be inherited by children as tenants in common – Joint decision making difficult – Each co ‐ owner has power of partition – Usually no structured buy ‐ out provision – Often questions of rights of possession 224 12 TRANSFERRING ASSETS 225 75

8/3/2015 12 Transferring Assets • Gifting Strategies – FLP? – Petter, Hendrix, Wandry (defined value clauses) • Rental Strategies • Sales Strategies – Real estate – Equipment – Residence • Inheritance Strategies 226 12 ‐ 13 Social Security Planning • Retire at or before full retirement age? • Complication with pre ‐ paying expenses 227 13 USING TRUSTS TO PROVIDE FOR SPOUSE AND NEXT GENERATION 228 76

8/3/2015 Credit Shelter / Marital Deduction Trusts  Funding during life or by will First death Credit shelter excess Marital $5,000,000 earnings from both trusts Surviving principal for living needs Spouse Second death Beneficiaries 229 Single Person Parent’s death Title to Child assets Child Child One Two Three 230 Generation Skipping Parent’s death Title to earnings assets Child principal for needs Child’s death 231 77

8/3/2015 13 ‐ 15 CUSTOM DISTRIBUTION PLANS WITHIN TRUSTS 232 Distribution Plans within Trusts • Business assets being distributed to business heir • Buy out and rental options of assets • Rights of refusal and purchase option to business heir • Non ‐ business assets to non ‐ business children • Shared appreciation among all heirs • Sharing estate settlement costs in proportion to assets received 233 16 Succession Planning & Divorce • Major concern for many – What if divorce occurs after gifting has begun? – What if divorce occurs after an inheritance has been received? – Role of trusts – Role of buy ‐ sell agreement – Consider how the possibility of divorce might affect business entity selection – Who should be co ‐ owners – spouses? – What might happen if the son ‐ in ‐ law is in the business – How would the business be impacted? 234 78

8/3/2015 18 TRANSFERRING LEADERSHIP AND MANAGEMENT 235 18 Leader • Vision • Financial • Provide Leadership • Personnel • Facilities, equipment… • Business structure • Day to day decisions • Conflict Management • Public relations 236 Leader • Identifying the next leader • Training the next leader – Mentoring – Gradual – Educate – Challenge • Developing exit plan – Income needed – Sources of income 237 79

8/3/2015 18 OUTSIDE ADVISORS 238 18 Gleaning from Outside Advisor • Possible advisors – Accountant – Attorney – Business Consultants – Counselors – Financial planner – Insurance agent – Lender – Mediators – Other respected business persons 239 18 Gleaning from Outside Advisor • Form an advisory committee – Bare your soul – Could be mutual sharing – Could be persons some distance away • Form a board • An investment, not just a cost 240 80

8/3/2015 EXECUTING THE PLAN 241 The Use of Life Insurance as a Succession Planning Tool • General Comments – Tax favored status – What if estate tax (and stepped ‐ up basis) is repealed – If in ILIT, death benefits not subject to FET or GSTT Life Insurance • Benefits of life insurance in business succession process – Estate liquidity and asset preservation • Ownership in ILIT • Proceeds payable to business owner’s estate via loans or buying assets from estate at FMV • ILIT could buy decedent’ s business interest at discount – Freeze accomplished – Cash received by surviving spouse could be gifted to non ‐ business heirs and/or fund ILIT for benefit of non ‐ business heirs 81

8/3/2015 Benefits of Life Insurance • Wealth replacement • Estate equalization • Fund a buy ‐ sell • Tax hedge • Retirement income • Fund stock redemption • Liquidity • NQDC Benefits of Life Insurance • Key ‐ person insurance • GRATs • Asset protection planning • Private annuities and SCINS • Family bank ILITS • Basic planning points – Death benefits held at death • Allows use of grantor’s gift tax exemption and GSTT exemption amount • Multiple beneficiaries can have interest in death benefits • Draft with flexibility in mind 82

8/3/2015 Page 1 of Practical Estate Planning ILITS – Accomplishing Flexibility • Donor powers – Change beneficiaries that will receive Crummey powers – Use tiered Crummey powers – Beneficiaries holding contingent remainders can have a vested interest in ILIT ILIT Drafting Provisions • 5 and 5 power applied to entire ILIT • Ordering rule for donee holding mutiple withdrawal rights • Special powerholder with limited power to appoint trust property during grantor’s lifetime Beneficiary Powers • Testamentary limited powers of appointment in beneficiaries • Power of grantor, grantor’s spouse and beneficiaries to change trustee 83

8/3/2015 Trustee Powers • Discretion to satisfy Crummey notice requirements • Crummey powers satisfied against all trust property • Allow trustee to appoint guardian for minors likely to receive Crummey withdrawal right 15 Corporate Buy ‐ Sell Agreements • Entity purchase agreement – Contract between stockholders and corporation • Cross purchase agreement – Contract between stockholders • Hybrid agreements – Contract between corporation and stockholders whereby stockholders agree to offer their shares first to the corporation and then to other stockholders Advantages of Buy ‐ Sell Agreements • Prevention of the sale of stock outside the family unit • Relatively simple • Creates a ready market for the stock – Remedies a liquidity problem – Can help set a value for stock 84

8/3/2015 Disadvantages of Buy ‐ Sell Agreements • Hybrid type agreement may pose difficult tax issue – Must meet technical requirements of Sec. 302(b) or Sec. 303 • Less tax problems with cross ‐ purchase agreements 15 Buy ‐ Sell Agreement and Life Insurance • Provides funds to cover purchase price or down payment – Premiums not deductible and can cause ongoing expense 4 Other Post ‐ Mortem Issues • Buy ‐ out of deceased shareholder’s stock could jeopardize estate’s making Sec. 6166 election – Watch acceleration of deferred taxes • Planning around this? • Buy ‐ sell could trigger gift of stock to trust for surviving spouse not to qualify for marital deduction – Rinaldi case 85

8/3/2015 16 Funding a Buy ‐ Sell • Life insurance often funds if death is triggering event – Proceeds received by beneficiary without income tax liability 16 Funding a Buy ‐ Sell • Problems with life insurance – If proceeds received by C corporation can increase C corporation’s AMT liability by increasing C corporation’s current earnings – May not be sufficient to fund lifetime redemption caused by stockholder’s disability or retirement Funding a Buy ‐ Sell • Accumulated earnings – May not be a “reasonable need of the business” and, thus, could subject corporation to accumulated earnings tax 86

8/3/2015 Funding a Buy ‐ Sell • Buy enough permanent life insurance to fund post ‐ mortem buyouts, obtain debt financing to pay for stock bought other than at death , with use of excess of postmortem purchase price over insurance death benefit to pay off loan Income Tax Treatment • Cross ‐ purchase agreement – Gain is capital gain regardless of character of corporation’s underlying assets (unless shareholder is dealer in stock) – If estate sells stock shortly after shareholder’s death, no gain recognized if agreement sets sales price at date of death value – Purchasing shareholders increase basis in total holdings of corporate stock by price paid for shares purchased via agreement Income Tax Treatment • Redemption agreement – Must satisfy Secs. 302 or 303 to avoid dividend treatment • Big potential problem for post ‐ mortem redemptions 87

8/3/2015 Income Tax Treatment • Hybrid agreement – Corporation must redeem only as much stock as qualifies for sale or exchange treatment under Sec. 303, and other shareholders must buy balance of available stock. Income Tax Treatment • “Wait and See” agreement – Definition – Alternative approach – Combination for funding 14-15 Dynasty Trusts • The GSTT – Tremendous planning opportunity through balance of 2012 to fund GSTT trusts – Watch for Administration’s continued attempts to limit planning opportunities • Limitation on GRATs • Elimination of valuation discounts via FLPs 88

8/3/2015 14 ‐ 15 The GSTT • Clearly of interest to wealthy clients • Don’t overlook GSTT trusts for clients with more modest wealth • May not be of interest for small estates Dynasty Trusts • Avoidance of transfer taxes for multiple generations • Lasts as long as allowed by maximum term allowed by local law Dynasty Trusts • Mechanics – Irrevocable trust – Spendthrift provision – Initial funding tied to grantor’s transfer tax exemption • Take note of the net investment return possible with enhanced exemption through 2012 89

8/3/2015 Dynasty Trusts • Tax aspects – Not subject to GSTT if grantor allocates sufficient GSTT exemption to make inclusion ratio zero • Must elect to allocate exemption to transfers • Need to preserve GSTT inclusion ratio for any additional property transferred to the trust Dynasty Trusts • Tax aspects – Treated as an irrevocable trust • Initial funding subject to gift tax and will use up grantor’s unified credit to extent of excess over present interest annual exclusion Dynasty Trusts • Can be structured as grantor trust – Income accumulated tax ‐ free – During settlor’s lifetime, settlor taxed on trust income and gains – How to achieve grantor trust status: • Trust terms give discretion over distributions of income and principal that can be exercised by majority of trustees that are related or subordinate to settlor 90

8/3/2015 Trust Term • Tied to state’s rule against perpetuities – Establish situs in state with relaxed or no rule • Trust term should so state • Appoint trustee located in jurisdiction with favorable rule – Works for personal property – Real property governed by law of state where located Dynasty Trusts • Trustee considerations – Important to select carefully • Consider limitations on trustee’s exercise of power • What is the process for replacing a trustee Dynasty Trusts • Trustee as a fiduciary? – Most courts require that trustee must commit serious breach before removal will be allowed – Statutory procedures may apply – UTC provision does not focus on trustee conduct – Trustee retained powers and tax issues 91

8/3/2015 Structure of the Trust • Commonly drafted as spendthrift trust so as to provide asset protection – Beneficiary cannot assign or transfer or encumber an interest in net income or principal of trust • No creditor attachment until distribution – Trustee has absolute discretion over distributions Converting the C Corporate Farming Operation (and other businesses) to Pass-Through Entity Classification Conversion of a C Corp. to an S Corp. (i.e., Extracting Assets from a C Corp.) • BIG tax as a result of the 1986 Tax Reform Act – Applies at 35% rate on appreciation of asset value for assets contained in C corporation (I.R.C. §1374) • In addition to regular corporate tax • Applies to any asset carried over from C corp. that is disposed of within 10 years after conversion – 7 years for gain recognized in 2009 ‐ 2010 – 5 years for gains recognized in 2011 ‐ 2014 • BIG for each asset liquidated is limited to its net unrealized gain as of date of S election • Consider the fact pattern on page 2 92

8/3/2015 Extracting Assets From a C Corp. • Step 1: – Make an S corporation election • Asset valuation occurs and gain is “locked in” – no double tax on any additional appreciation in value • Make election by 15th day of 3rd month after start of tax year • If S corporation exists for 10 years from election date, no double tax on asset appreciation What To Consider Before Making S Election • 100 shareholder limit • NOLs belong to a particular entity – any unused C corporation NOL is lost – But NOL is available to reduce BIG • Cash basis corporations recognize receivables and payables as built ‐ in items when received/paid • Liquidate certain assets before making S election? – See example at bottom of p. 3 What To Consider Before Making S Election • Unused NOLs of C corporation cannot be used by S corporation to offset future S corporation income (except offset built ‐ in gain) • S corporation compensation issues – Payment of “reasonable” wages • Payroll tax issue – Watson case – No cases involving issue of reasonable compensation where salary at least at FICA wage base 93

8/3/2015 Extracting Assets From a C Corp. • Step 2: – Consider alternatives to selling assets within the 10 ‐ year built ‐ in gain recognition period • Sell corporate stock in lieu of asset liquidation – Probably can be sold at a discount • Do a like ‐ kind exchange – Replacement property still subject to 10 ‐ year BIG period • Do a long ‐ term lease with option to purchase after the expiration of the 10 ‐ yr BIG period • Liquidate assets when S corporation’s taxable income can be reduced to zero – Limited technique due to carryover issue Step Three – Other Issues • The “Sting” tax – For S corporations that were C corporations and have C corporate earnings and profits, S election terminates if three consecutive years of passive receipts more than 25 percent of gross receipts. • 35 percent rate of tax on excess net passive income – Watch cash leasing arrangements – May need to prepay farm expenses – Distribute all accumulated C corporate E&P before end of first S corporate year ‐ end Other Issues • Income tax liability incurred on distribution of C corporate earnings and profits – Qualified dividends – Favorable rates presently – Impact on taxability of social security benefits • Corporate stock redemption 94

8/3/2015 Issues Arising Upon Death of 7 Shareholder • S corporate stock passing to ineligible shareholder – Bypass trust must be a QSST or ESBT Liquidation Tax Issues • No gain recognition results when cash or property is distributed to the decedent’s estate/heirs (in exchange for stock) to complete the liquidation – The pass ‐ through gain is offset by a matching loss from liquidation of the stock – Watch for character mismatch (i.e., recognition of ordinary income and capital loss) Inside and Outside Basis • At death, decedent’s stock gets FMV basis, but nothing happens to S corporation’s basis in corporate assets – Example on page 8 • Significant asset appreciation in S corporation • Heirs not interested in farming • Need to liquidate in same year as asset sale – easy to do if no heirs interested in farming and only one shareholder 95

8/3/2015 The Timing Issue • Gain from sale of corporate assets recognized in same year of capital loss triggered by corporate liquidation – If business not liquidated in year of asset sale, heirs have capital gain to recognize, but no offsetting capital loss • Capital loss would only offset capital gain for year plus $3,000 of ordinary income Liquidations and Multiple Shareholders • Example on page 9 – Distributions of property treated as sale of property at FMV to the shareholders • Corporation recognizes gain to extent property’s FMV exceeds its basis • Upon distribution to shareholders in exchange for stock, corporate ‐ level gain passes through to all shareholders based on percentage ownership 9 Liquidation and Multiple Shareholders • Distribution of property to single shareholder in liquidation of stock interest results in taxable event for all corporate shareholders – Need for a buy ‐ sell agreement that facilitates all remaining shareholders buying deceased shareholder’s stock – See example on page 9 • Liquidation alternative – divisive reorganization (p. 10) 96

8/3/2015 Liquidation Reporting Requirements • Form 966 filed within 30 days after adoption of resolution or plan to dissolve a corporation or to liquidate part of all of corporation’s stock Other Exit Strategies • What if S corporation is to continue, but a shareholder wants out? – Basis issues (buy ‐ out of one shareholder by another) • Example on p. 11 Converting A C Corporation to an LLC (primarily non ‐ farm) • Step one: – Form LLC and transfer assets to it in exchange for interest in corporation • Transfer is tax ‐ free • Step two: – Shareholder transfers additional funds to LLC in exchange for interest in entity • Transfer is tax ‐ free 97

8/3/2015 C to LLC Conversions • Corporation and shareholders should receive interest in LLC equal to the FMV of the assets transferred to the LLC – If insufficient funds or property transferred to LLC, IRS could assert that excess value was transferred to the corporation’s shareholders who then contributed it to the LLC • Dividend to shareholders C to LLC Conversions • Forming an LLC with unrelated third ‐ party investor – No gain or loss and carryover basis – What about the transfer of intangibles? • Goodwill might attach to shareholders rather than the corporation (see “Note” at bottom of page 12) C to LLC Conversions • Corporate liquidation and liquidating distributions – After transfer to LLC, corporation liquidates – Potential gain or loss • What is the benefit of conversion? – Former shareholders no longer taxed on distributions from LLC (unless distributions exceed basis) – Still have to watch passive loss rules 98

8/3/2015 14 LLCs and Passive Loss Rules • Per se rule of I.R.C. §469(h)(2) – Non ‐ material participation for limited partner interests in a limited partnership (unless Treasury specifies differently in regulations) • Exception applies if one of three tests (out of the seven overall tests) satisfied • Courts have rejected the IRS position – Late 2011 proposed regulations • Entity classified as partnership • Holder of interest must not have management rights Potential Disadvantage of Conversion to LLC • LLC members remain liable for full amount of self ‐ employment tax on guaranteed payments, plus member’s share of any pass ‐ through ordinary income 14 ‐ 16 Tax Differences Between S Corporations and LLCs • S corporation retained earnings not subject to self ‐ employment tax – Payroll tax advantage • LLC owners can contribute and withdraw property generally tax ‐ free • In an LLC, debt is included in basis – can more easily take advantage of losses • LLC charging orders (under some state statutes) – Not applicable to single ‐ member LLCs • Differences in rules governing distributions 99

8/3/2015 Summary and Conclusion • Clients with assets in C corporations present difficult issues for practitioners – Often disappointed upon learning about how difficult it can be to extract the assets – Business succession complications – Always difficult to plan when the rules get changed 19 Obamacare Final Regulations 3.8% Tax on Passive Sources of Income • 3.8% additional tax on AGI over $200,000 ($250,000 mfj) • Net Investment Income (NII) – Interest, dividends, annuities, rents, royalties – Passive income from trade or business – Income from financial trading business – Income from commodity trading business – Income from sale of passive assets – Gains from sale of investment assets 19 ‐ 20 Rents – Final Regulations • Two provisions: – Property rented to a non ‐ passive activity (self ‐ rental income) is not investment income – Property that is properly grouped in a non ‐ passive activity is not investment income 100