The State of Estate Planning – 2017

You probably feel as if the field of Estate Planning is in turmoil right now – uncertainty about income taxes, estate taxes and wealth transfer solutions seems so disruptive that Larry Brody, a widely respected estate planning practitioner, has titled an upcoming  presentation:  “What the Hell Do We Do Now?”confusion1

Is it really that bad?  Well, here are links to two excellent and recent AALU publications that may help answer that question.

The takeaways, first from the Survey: “Even in the face of major tax reform, clients and their advisors should remain optimistic and steadfast in their approach to implementing life insurance and legacy planning. Flexible, multi-faceted planning that can address both practical and tax issues is at a premium. Life insurance remains an ideal solution because of: (1) its unique attributes (instant, mortality-based liquidity and cash accumulation and death benefit payments on a tax sensitive basis) and (2) its ability to serve many critical objectives (tax, retirement, and liquidity planning, investment management and diversification, and family security).”

And from the Heckerling Institute: “Overall, Heckerling presenters were optimistic regarding the current planning environment, particularly as this is not the first time that the estate and life insurance industry has dealt with the prospect or passage of major tax changes (e.g., 2010 and 2012). Many planning approaches, like trusts, estate freezes, and life insurance, are inherently flexible and multi-faceted, and tax changes can actually enhance different structuring options and benefits. Accordingly, this environment should trigger thorough audits of client plans and open the door for a dialogue between allied professionals and clients, with interest in life insurance products continuing as both a solution to practical needs and as a complement to other planning approaches.”

We encourage you to read through both the Survey and the Heckerling Institute summary to help clear up some of the hyperbole and confusion that often arises when there’s talk of major tax policy changes.

Golden key and puzzle

If you’re like us, you’ll realize that 2017 will continue to offer plenty of new opportunities for planning and insurance professionals, no matter which way the wind blows.

 

 

 

 

A split dollar power play made Jim Harbaugh college football’s highest paid coach — what was that about?

– by Marc Schwartz

Last summer ESPN.com ran the headline: Michigan, Jim Harbaugh agree to increased compensation in form of life insurance loan.  We suspect that most sports fans just shrugged and moved on to see how the Cubs were doing, but those of us in the life insurance business sat up and took notice.  After all, we seldom get any press on the business page, let alone the sports page.  And this was indeed big news about a big compensation boost, using a relatively little-known but powerful combination:  Split Dollar and cash value life insurance.

Lightning dollar sign

(Related:  American Institute of CPA’s:  Split Dollar Insurance Plans)

ESPN’s article, though, did not use the words “split dollar” at all, and that was fine.  Sometimes we get  caught up in our own jargon and forget that people outside our industry – clients, CPAs, sports writers, for instance – only care about what the arrangement accomplishes.  Not only did this new agreement make Harbaugh the highest-paid head coach in college football, it left some other notable coaches in the dust.  (USA Today:  NCAA Football Coaches’ Salaries)  In this blog we’ll explain why both Michigan and coach Harbaugh found this unusual approach to be in their mutual best interest, regardless of what the plan is called.

At its simplest the arrangement looks like this:  the university loans $2 million a year to the coach for seven years in the form of premiums paid for a life insurance policy on the coach’s life.  The coach will pay no interest to the university, and will instead be required to pay tax on that unpaid interest as imputed income from the university.  The rate used to calculate that imputed income is determined in the Internal Revenue Code and published monthly by the Treasury Department as the Applicable Federal Rate (AFR).  In return, policy values secure the loan – both the cash values and the life insurance death benefit can be used to repay the loan, should the university and coach part ways, though there are additional strategies to exit the arrangement that might prove less painful.  For the coach, you can see the advantage to this right away:  life insurance payable to his spouse and children, cash value growing inside the policy tax-deferred, with the potential  to use that cash value in the future (preferably after several national championships).  All in return for the tax bill on the imputed income from foregone interest, based on what are currently very low interest rates (the February 2017 AFR for this kind of loan is a little over 1%).

So what’s in it for the university?  First, the arrangement ties the coach to the school for several years in order for all of the numbers to work to the coach’s full advantage.  The life insurance benefit is there from day one, but there is much more of a reward, in the form of potential equity available for tax-free policy loans when the coach retires, along with substantial long-term life insurance death benefits for the coach’s family.  Take a look at the sample presentation we have put together for a similar plan using an Index UL product to get an idea of how attractive this can be over the coach’s lifetime, and how much of an incentive it can be to keep the coach close to home.  Second, the university’s loans are secured.  The values in the policy provide the university with some assurance that its investment may be recovered if things don’t work out as planned.

While it may be a surprise to find this kind of insurance-based solution headlining the sports page, such plans have broad application in executive compensation arrangements for all kinds of businesses.  In fact, the more attractive it becomes to spend money at the corporate/business level (because of lower corporate tax brackets), the more effective such plans can be.  So, the next time you are looking for a life insurance solution that can strengthen the executive-employer relationship and provide an incentive for a valued employee to stay on until retirement, remember the University of Michigan, coach Harbaugh – and Windsor.

 

 

 

 

 

 

 

At Halftime, IRS Blanked on the (Tax) Court

– By Marc Schwartz J.D. CLU, and Marty Flaxman J.D.

A recent tax court case ruling in favor of the taxpayer in an intergenerational Split Dollar arrangement has propped open a “discounting” planning door that, up to now, the IRS had tried to slam shut.  In the Estate of Clara M. Morrissette et al v. Commissioner, the tax court ruled that an intergenerational Split Dollar arrangement is covered by Split Dollar Regulations Section 1.61.22.  In plain English, the ruling establishes that single-premium life insurance policies, held in irrevocable trusts, can be taxed under the Split Dollar Economic Benefit regime, and are not required to use the Loan regime, as the IRS had insisted.   For the taxpayer this was very good news.  Here are some of the facts, courtesy of AALU’s Washington Report (WRN 16.05.10_1) from 10 May, 2016.

Gavel With American Banknote And Book

“Three dynasty trusts were established on behalf of the decedent, one for each of her sons. In 2006, six non-equity economic benefit so-called intergenerational split-dollar arrangements were created between Clara Morrissette’s revocable trust and each of the dynasty trusts. Her revocable trust advanced a total of $29.9 million as one-time single premiums to the dynasty trusts to enable them to purchase insurance on the lives of each of her three sons.  Clara died in 2009 with the arrangements still in place.

“The estate valued the amounts receivable by the revocable trusts from the dynasty trusts at $7.497 million. The IRS argued the arrangement was a gift at inception for the full $29.9 million dollar amount of the advances. That determination resulted in a gift tax deficiency of $13.8 million and a penalty of $2.7 million. The estate disputed the deficiency by filing a petition in Tax Court.

“The estate filed a partial summary judgment motion with the Tax Court confirming that the arrangements were in fact economic benefit split-dollar arrangements under Treasury Regulations Section 1.61-22, and the court entered a summary judgment in favor of the estate.

The IRS’s argument was essentially preemptive.  “The IRS has been arguing for most of a decade that single premium split-dollar arrangements could not use the economic benefit regime of the Regulations, but instead had to use the loan regime, because they provided ‘other benefits,’ or alternatively that the single premium payments ‘prepaid’ all future economic benefits provided under the arrangement, or that since future premiums had been prepaid, the arrangements were, in effect, reverse split-dollar arrangements, and under Notice 2002-59, term costs could not be used to measure the benefit to the donee trust.

“If the loan regime applied, since no interest was provided, the arrangement was a gift term loan under the Regulations, with the discounted present value of all of the imputed interest treated as a gift in the first year of the arrangement; if the single premium prepaid future economic benefits, they were all gifts in the first year of the arrangement.”

The tax court disagreed with the Service’s position and ruled in favor of the taxpayer.  But the tax court pointed out very early in its opinion that it was ruling only on the applicability of the Split Dollar regulations to the arrangements, and not on the discounted gift valuation by the taxpayer’s estate.   The appropriateness of that discounted valuation, which is really at the heart of the dispute, has yet to be decided.  If, however, that future decision comes down in favor of the taxpayer, “this technique may become a major means of transferring significant amounts of family wealth at greatly reduced tax costs.” (op. cit. AALU Washington Report)

In the meantime, the Morrisette case, as it stands today, provides an effective way to pay substantial premiums using intergenerational Split Dollar arrangements without incurring large gift tax liabilities and is very likely something of interest you can discuss with your centers of influence.

We’ll keep you apprised of what happens next on the discounted valuation issue.  Stay tuned.