December 1, 2000

Year-End Tax And Estate Planning Review

Holland & Knight Alert
William R. Lane Jr.

Given the uncertain outcome of the presidential election at the time this is written, it is unclear what the future will hold for federal tax policy. Any tax cut proposals discussed during the campaign may be hampered by possible legislative gridlock tempered by economic realities and polite jawboning by Federal Reserve Bank Chairman Mr. Greenspan. Obviously, the implications to your estate plan arising from major changes to the federal gratuitous transfer taxes (estate, gift and generation skipping transfer tax) are enormous, and you should pay close attention as Washington proceeds next year to adjust federal tax policy (along with the Federal Reserve's reaction to that). A warning to the wary, however. Tax reform resulting in the ultimate elimination of the estate tax may be accompanied by loss of the "basis step-up" for capital assets at death for federal income tax purposes.

There will be more to say about these issues as the spring turns to summer and political issues are clarified. Having said that, however, there are a number of items for you to keep in mind as the calendar year winds down and the holidays approach.

Use Gift Tax Annual Exclusions And "Ed/Med" Exclusions

Do not overlook the estate planning opportunities associated with the use of your federal gift tax annual exclusions. While many individuals make their $10,000 annual exclusion gifts early in the calendar year to avoid losing them if they die prior to making them in a given year, many people still enjoy making these gifts at year end in conjunction with the holidays. If gifts are made by personal check at year end, please be sure that the checks to the donees are negotiated and paid prior to year end. This will avoid problems qualifying the gifts for the annual exclusion if the donor dies prior to the time the checks are paid by the bank, or if the checks are not paid by the bank by year end. This rule is different than that used in connection with year-end gifts to charities, where deposit of the donation in the mail by year end is sufficient to obtain the charitable deduction for income tax purposes.

In some cases, you should consider making your "annual exclusion" gifts for 2000 and 2001 in close succession, i.e., right before the end of 2000 and right after the start of the new year. For example, if the "annual exclusion" gifts consist of property that requires a professional appraisal, such as interests in real estate or in a closely held business, you can generally make the same appraisal serve "double duty" by following this technique. If the gifts are made within days of one another, the end-of-December appraisal is likely to be acceptable evidence of a beginning-of-January value. It may also help the planning process to focus on two successive annual gifts at the same time. Further, we ordinarily recommend making annual exclusion gifts at the beginning of the year in any event - even if the gift simply consists of writing a check - since the annual exclusion is "wasted" if not used prior to death, and a full year's worth of appreciation in the gift is shifted gift tax free if it is made early rather than late.

Additionally, many people overlook the use of the unlimited annual exclusion available to donors who make direct payments for medical care or tuition expenses for the benefit of a loved one. The Ed/Med exclusion is in addition to the $10,000 annual exclusion. The payments must be made directly to the provider of the education or medical care, and cannot be made to the beneficiary who in turn uses the money for those purposes. Please call us if you have any questions regarding these issues.

Charitable Gifts

As we approach the new year, many people are looking for ways to reduce the income tax bite for 2000 and charitable giving can be a good way to do so. In addition to cash or contributions of property to your favorite charity, there are more elaborate mechanisms (e.g., charitable remainder trusts and charitable lead trusts) that can meet estate planning goals, provide tax benefits, and benefit your favorite charity.

Applicable Exclusion Amount/GST Exemption

As you may know, the applicable exclusion amount is the lifetime amount that can pass estate and gift tax free. Currently, it is $675,000 and will remain at that amount for 2001. Subject to expected changes in the law next year, it will reach $1,000,000 by 2006.

The generation skipping transfer tax exemption is currently $1,030,000 and is scheduled to be adjusted for inflation for 2001. It is possible that the inflation adjustment will increase the GST exemption to $1,060,000 in 2001.

Tax Cut For Certain Long-Term Capital Gains

If you are an investor, then one aspect of the Taxpayer Relief Act of 1997 having a deferred effective date will now be of interest to you. Effective January 1, 2001, noncorporate taxpayers holding capital assets for more than five years will qualify in certain instances for reduced long-term capital gains tax rates.

For tax years beginning after December 31, 2000, gains from the sale or exchange of property held more than five years that would otherwise be taxed at the minimum long-term capital gains rate of 10% instead will be taxed at the rate of 8%. Certain types of property, such as collectibles and certain small business stock or depreciable business property do not qualify for this benefit.

If you are in the higher bracket for long-term capital gains (generally, 20%), gains on certain assets sold or exchanged after five years, and whose holding period begins after December 31, 2000, will be taxed at the maximum rate of 18%. If property was acquired after the effective date pursuant to an option to purchase granted prior to the effective date, the sale of that property will not qualify for the lower rate.

Thus, the 8% rate applies to post year 2000 sales of assets held for more than five years, while the 18% rate applies only if the holding period for five-year property began after December 31, 2000.

A taxpayer may elect to cause a "deemed" sale and repurchase of property in 2001 to allow property owned prior to the effective date to qualify for the lower tax rate on an actual sale five years thereafter, which will cause a recognition of gain (but not allow recognition of loss) during 2001.

Obviously, the planning implications to this forthcoming law change are complicated, and we invite you to give us a call if you wish to discuss this issue in more detail.

Review The Status Of Your Estate Plan

Despite the lack of estate tax-related legislation during this year, given the likelihood of legislative change during the next Congress, we suggest that if you have not reviewed your estate plan with us within the last three to four years, you consider the status of your estate plan in light of your present family, business and financial situation and give us a call if you have any questions or concerns. It may be time to fine tune your present estate planning arrangements or to consider significant enhancements to your prior planning. We have found a three- to four-year cycle to be a logical time to review matters if there have not been other reasons for you to do so. Obviously, a complete immediate repeal (or gradual phase-down) of the federal estate tax could result in a very immediate need to update your estate plan.

Business And Compensation Planning

For those clients with ownership interests in closely held businesses, the year end may be a good time to review your business plans and business agreements. Although many agreements may not be sensitive to year-end, some - such as establishment of retirement plans - do require action before year end. Also, professionals may want to pay year-end bonuses from professional corporations. While other financial affairs are being reviewed, it may be convenient to examine whether shareholder buy-sell agreements, partnership agreements, LLC operating agreements, etc. previously entered into are appropriate under today's circumstances.

A little known change in the Internal Revenue Code, resulting from a legislative change several years ago, became effective this year to liberalize and expand the amount of contributions a business may make on behalf of certain employees to qualified retirement plan arrangements that contain a "defined benefit pension plan" in addition to a "defined contribution plan" (such as a profit sharing or "401(k)" plan). In certain instances we have observed this year, business owners age 50 or more who for years had contributions on their behalf capped at $30,000 per year have seen tax deductible contributions on their behalf to their company's qualified retirement plans increase to over $100,000 annually. This could dramatically increase the current income tax shelter attributes of your company's retirement plans.

A new plan designed to take advantage of this provision of the law would need to be adopted on or before the end of your corporation's fiscal year (often December 31) to permit increased contributions for this fiscal year. If you own a family or closely held business that presently has a qualified plan and wish to consider making additional tax deductible contributions in excess of your current plan limits, please give us a call.

Intangible Tax Planning (Florida Residents)

Do not overlook the Florida intangible personal property tax, which is assessed on taxable intangible personal property owned by a Florida resident on January 1 of each year. Although the Florida Legislature has recently reduced the tax rate in larger situations to 1.0 mil (0.001), many individuals and families in recent years have taken advantage of opportunities to restructure the ownership of taxable assets in permanent or temporary arrangements to minimize or eliminate the application of the tax. Recent legislation liberalized the planning opportunities in this area. Let us know if you would like to discuss prior to year end the application and minimization of this tax.

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