National Association of Estate Planners and Councils

August, 2008 Newsletter
Provided by Leimberg Information Services

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Contemporary Planning Ideas with Inevitable Changes Looming Over U.S. Tax Policy

LISI Commentator Team member Robert S. Keebler is a partner with Virchow, Krause & Company, LLP in Wisconsin.  Bob is the author of the AICPA's book titled, A CPA's Guide to Making the Most of the New IRAs, co-author of an AICPA national CPE course titled "Planning Strategies for Payouts From Qualified Retirement Plans and IRAs, and author of PPC's publication Retirement Plan Distributions and Guide to Retirement Plan Distributions.

Bob provides LISI members with his thoughts about where tax law is headed – and more importantly – lists and discusses planning opportunities that can and should be considered between now and the effective date of any tax law changes.


The grounds are set for a race to the White House between Senator John McCain of Arizona and Senator Barack Obama of Illinois.  November 4th, 2008 will prove to be a pivotal day in the lives of all Americans.  Inevitability, the current state of U.S. tax policy will change with a new President.  The degree of change will be very dependent on who is elected President and which party controls the House and Senate.  Nevertheless, change is eminent for affluent individuals with whoever is elected into office.


Senator Obama has indicated that it is his objective to maintain the Bush tax cuts  -  except for individuals earning over $250,000 a year.  This will likely be seen through increases in the capital gains and income tax rates.

Also, it almost guarantees that the estate tax will not be repealed.

Senator McCain proposed extensions of the 2001 and 2003 tax cuts.  McCain agrees with Obama that the estate tax probably will not be repealed.

This article is intended to shed light on several tax planning opportunities that can be carried out in the next few months before a new President takes office.

It is assumed that the capital gains tax rate will increase from the current 15% rate to either 20% or all the way up to 28% (the rate used during the first term of the Clinton administration).  The article will provide many examples of various planning techniques for your benefit.

Sale of Tangible and Intangible Property

Individuals who hold significant amounts of publicly traded securities would be wise to take a step back and look at their overall investment strategy.  It might be advantageous to consider selling all or portions of investments in order to obtain the guaranteed 2008 capital gain tax treatment.  This strategy should also be considered for closely held businesses and real estate holdings. 

Example:  John owns 100,000 shares of ABC Corp. stock as of July 2008.  His basis is $15 dollars per share.  John has owned the stock for over 3 years.  Currently, the stock is trading at $34 dollars per share.  John has an important decision to make.  Either sell now and lock in the 15% long-term capital gain on the stock or continue to hold the stock and subject his investment to more risk.

Sell now?  If John sells now he will incur a $285,000 long-term capital gain tax (i.e. $34 - $15 = $19 * 100,000 = $1,900,000 * 15% = $285,000).

Wait?  If he waits and his investment remains static, John will potentially expose himself to an additional $95,000 (i.e. $34 - $15 = $19 * 100,000 = $1,900,000 * 20% = $380,000 - $285,000 = $95,000) to $247,000 (i.e. $34 - $15 = $19 * 100,000 = $1,900,000 * 28% = $532,000 - $285,000 = $247,000) more of long-term capital gains tax (depending on what new rate is instated (i.e. 20% or 28%)).

Installment Sale?  Installment sales between related parties for amounts under $10 million for married couples ($5 million for a single individual) should be considered as another very interesting option.  This information can be found in Code Section 453.  §453(d) states that a person is allowed to elect out of the installment sale treatment and pay the tax now.  This election would be required by October 15th of the following year on an extended return.  This strategy provides a fantastic opportunity that will allow the client to have hindsight on their installment sale.  The client will be able to make an informed decision based on the changes that have occurred related to income tax rates.         

Example:  Courtney sells her brother (Marc) a piece of property worth $4.5 million dollars on June 25, 2008 in return for an installment note (assume the transaction meets all §453 rules).  Courtney also receives an extension for her 2008 tax return.  Courtney will have the option to elect out of installment treatment until October 15, 2009.

C Corporation Dividends

C corporations have an opportunity to distribute "qualified" dividends from excess retained earnings to their stockholders while this preferable treatment still exists.  C corporations may, in essence, be able to potentially distribute more wealth in the next six months than in the future.

Example:  XYZ Corp. has $25,000,000 of retained earnings.  It might consider distributing some of the cash as a one-time qualified dividend in the next few months.  If the corporation distributes $18,000,000 while favorable qualified dividend treatment is guaranteed, the transfer will hand out $900,000 (i.e. 20% - 15% = 5% & 5% * $18,000,000 = $900,000) to $2,340,000 (i.e. 28% - 15% = 13% & 13% * $18,000,000 = $2,340,000) additional dollars of wealth to its shareholders. 

Closely-Held Business Sales

Individuals that own large corporations looking to sell to third parties may be wise to conclude transactions before December 31, 2008.

On a $37 million gain, a five percent increase in the capital gains tax rate equates to $1,850,000 (i.e. $37,000,000 * 5% = $1,850,000).

However, on the same $37 million gain, a 13% increase in capital gains increases the tax by $4.81 million (i.e. 28% - 15% = 13% * $37,000,000 = $4,810,000).

Trigger Long-Term Capital Gains?

Clients with concentrated stock positions in publicly traded companies may wish to consider reducing those holdings before the end of the year.

For companies with considerable growth, care should be taken to bring the client's financial advisor into the conversation at an early stage in that companies that have substantial increase in value over the last five years may see market pressure on their price if sales supply exceeds demand (i.e. everyone desires to sell LMN corporation because it has run up in value over the last 24 months and the sales pressure outweighs the demand).

Example:  John holds a 1% interest (13.8 million shares) in BCD Inc.  BCD Inc. has 1.38 billion shares outstanding.  The stock is currently trading at $21 per share ($289.8 million).

John might want to consider selling off some of his interest, because when the "lay" investor becomes aware of the capital gains increase there may be a huge sell off.  If the stock devalued by 35% in a short period of time, not only could John see higher capital gains rates when he pulled out, but he could also have over $101 million (i.e. 35% * $289,800,000 = $101,430,000) of value pulled out from under his feet in a short period of time.       

REVISIT Charitable Remainder Trusts?

The effect of the increase in the capital gains rate will be very important in the area of Charitable Remainder Trusts (CRTs).  CRTs provide the ability to diversify highly appreciated, highly concentrated asset holdings without incurring an immediate capital gain.

This strategy may be very favorable in a higher capital gain environment and may also maximize income tax deferral.

Due to the recently lower capital gains rates, the use of CRTs diminished over the last few years.  However, if the capital gain rate goes to 28% there will certainly be a revitalization of their use.

Example:  Jordan has a portfolio of highly appreciated stock that she transfers to a CRT, which in turn sells the stock to a third party. Jordan pays no immediate income tax on the sale. She receives back an annual stream of payments for her life and when she passes away the remaining balance is transferred to a named charity.  Clients who are charitably inclined may want to consider this option.

The other issue here that comes into play with the capital gains rates changing is the character of the capital trapped in a CRT.  If and when the rates increase, the IRS will have to determine treatment of these "trapped capital gains."

The Service can either increase the rate with all other capital gains or it can leave them at the 15% rate which was achieved at the time of sale of the underlying assets.

If they are treated the same as other capital gains and the tax increases, you are in no different position than when you started (so long as the client is charitably inclined).

If the Service leaves these capital gains at 15%, this will become a tremendous tool for many clients.

In the end, this strategy will prove to be a "heads you win, tails you tie" situation.

Real Estate Investors SELL?

Clients with significant real estate holdings who desire to sell property and not carry out like-kind exchanges (§1031) are well advised to sell property before December 31, 2008 (so long as an adequate price can be obtained).

Depending on the nature of the transaction, it may even be worthwhile to execute a §453 installment sale to a related entity.  If capital gains rates only go to 20%, one could maintain the installment sale and not pay tax. However, if the rates were to go to 28%, one could elect out of installment treatment, pay the tax in 2008, and receive a basis boost to the new basis. This option may offer the best of both worlds to the real estate investor.

WARNING: The related party rules of §1239 must be consulted for depreciable property. A meticulous reading of §1239 and its associated regulations must be preformed for each specific situation to avoid possible conversion of capital gains to ordinary income.

Example:  Spencer owns 60% of STL Inc. Spencer's sister Abby is looking to sell some of her real estate.  She has no ownership interest in STL Inc. STL Inc. agrees to purchase a $500,000 piece of property (depreciated value of $300,000) from Abby.  Since Spencer and Abby are family members under §267(c)(4), §267(c)(2) states that Abby will be attributed what her brother owns.  In other words, a 60% interest in STL Inc. is attributed to Abby because of §267(c)(2).  Thus, the $200,000 (i.e. $500,000 - $300,000 = $200,000) gain on the sale of depreciable property by Abby to STL Inc. would be taxed as ordinary income to Abby under §1239.

Estate Planning TACTICS:

Political insiders in Washington agree that there will most likely be an estate tax under either administration. Over the past few years, the Joint Committee has been actively seeking change in a number of influential estate planning areas.  These planning methods need to be considered in the next half year, because when a new administration takes over there are no guarantees that the options will be available:

Low Interest Rate Transactions: Today's financial environment is right for property to be transferred to a trust for one's family. The low interest rate and weak economy drive this strategy. Any married couple with assets in excess of $7 million and/or any individual with assets in excess of $3.5 million should take aggressive steps to take advantage of the low interest rate environment.


Determine a client's living expense needs and isolate "excess capital." Once excess capital has been identified, gift away excess capital utilizing one's unified credit.

This strategy can also be combined with GRATs and sales to transfer growth from an estate to entities for the benefit of children, grandchildren, and other future generations.

The most prevailing techniques that exist today are dynasty trusts, defective trusts sales, and grantor retained annuity trusts.  These strategies can be used in conjunction with the valuation adjustment strategy for an even more effective end result.

Dynasty Trusts:  Under the current law in Wisconsin and a few other states (the majority of states have rules against perpetuities), trusts are allowed to exist into perpetuity.

This is a very powerful tool because taxpayers can transfer millions into a trust and the assets of the trust will never be subject to federal estate tax at any point in the future.  In the interim, the income from the trust could be distributed to children, grandchildren, and future generations on an estate tax-fee basis.  This is one of the most powerful techniques available today.

This is also an issue that has seen a significant amount of attention from Congress.  Client's need to be cognizant of the possibility that a new administration may disallow the use of Dynasty Trusts so they need to be implemented while the strategy is still available.


Create dynasty trusts in Alaska, Wisconsin, South Dakota, Delaware, or another jurisdiction where there is no rule against perpetuities.  Further, create dynasty trusts in a jurisdiction where there is no state income tax.

Valuation Adjustment Planning:  One of the more powerful techniques available to estate planners today is the use of valuation discounts.  It is not uncommon to see 25-40% combined discounts when the correct conditions are present.  These discounts could be on the "chopping block" for a new administration.

Example:  Martha and James are husband and wife.  They own MJ Co., which is valued at $275 million.  MJ Co. is controlled 50% by Martha and 50% by James.  For estate tax purposes, the entity could be valued at $193 million ($275,000,000 * 70.18% = $193,000,000) when applicable discount are used.  (Note this is an extremely simplified example)


A client with an estate in excess of $7 million should be "locking in" discounts today.  They should sell and/or gift property to trusts including grantor retained annuity trusts (GRATs) and intentionally defective grantor trusts (IDGTs) over the next six months.

Roth IRA Conversions:  There is a significant amount of retired clients that have enough control over their income to enable them to remain under the $100,000 Modified Adjusted Gross Income (MAGI) limitation, so they could convert their Traditional IRA accounts into a Roth IRA before the end of the year.

This is a very important tool, especially for clients with large IRAs.  If a client converts today, they have until October 15, 2009, to recharacterize the Roth IRA back into a Traditional IRA.  This may allow the client to have a hindsight view of market activity and the changes in tax policy (which will almost certainly be implemented before October 15, 2009).

The Roth conversion puts the client in a "heads you win, tails you tie" environment.  If the markets increase and the tax rates increase, the client will hold their investment in the Roth and reap the benefits on a very successful investment decision.

On the other hand, if the market continues the wane and tax rates remain static, the client will be able to recharacterize back to a Traditional IRA and pay tax on future distributions.  Essentially this puts the client back in the same position where they started with virtually no risk.  No savvy investor should ignore this available opportunity if they fit the profile of a Roth conversion.

Social Security Tax Base Changes:  

Our Social Security system is a very important issue in the upcoming election.  The current system currently only requires the first $102,000 of earnings to be subject to Social Security tax.  Social Security has provided limited benefits to America's older individuals.

Speaker Nancy Pelosi and Senator Barack Obama persistently seem to support that all wages should be subject to the Social Security tax.

Both have also discussed an "exposure bubble" with the first $102,000 being subject to tax and the amount above $250,000 being subject to tax (i.e. wages between $102,000 and $250,000 would not be subject to Social Security tax).

One planning technique to combat this type of Social Security taxation is to utilize an S corporation rather than a partnership. For example, DOC Medical Group held their CAT scan machine in a partnership, all the earnings on the radiologist work and from the CAT scans might be subject to Social Security tax under the tax policy of a new administration.

If, however, the CAT scan machine was dropped into an S corporation, S corporation dividends, to the extent they represented a fair return on capital would not be subject to the Social Security tax.  There is no doubt that if this proposal becomes law, millions of small business taxpayers will be switching from partnerships and LLCs to S corporations to reduce the impact of this tax.


An experienced advisor has a tremendous opportunity to work with their clients and minimize the potential negative tax consequences that may come with a significant change in the U.S. tax policy which could be seen when a new president takes office.  The timely execution of one or more of the strategies illustrated in this article may allow advisors to take advantage of the current lower rates and avoid unnecessary increased taxation.


Bob Keebler


LISI Estate Planning Newsletter # 1325   (July 23, 2008) at  Copyright 2008 Leimberg Information Services, Inc. (LISI).  Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission.


For information about Robert S. Keebler's CDs, seminars on CD, or speaking engagements, please contact Lisa Chapa at (920) 739-3361 or

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