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This section list an
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CORPORATIONS
A corporation is a legal entity (technically, a (juristic person) which has a separate legal personality from its members.
The defining legal
rights and obligations of the corporation are: (i) the ability to sue
and be sued; (ii) the ability to hold assets in its own name; (iii) the
ability to hire agents; (iv) the ability to sign contracts; and (v) the
ability to make by-laws, which govern its internal affairs. Other legal
rights and obligations may be assigned to the corporation by
governments or courts. These are often controversial.
Stewart Kyd, the author
of the first treatise on corporate law in English, defined a
corporation as "a collection of many individuals united into one body,
under a special denomination, having perpetual succession under an
artificial form, and vested by the policy of the law with the capacity
of acting in several respects as an individual, ...".
Currently, the
modern business corporation is the dominant type of corporation. In
addition to its legal personality, the modern business corporation has
at least three other legal characteristics: (i) transferable shares
(shareholders can change without affecting its legal entity existence),
(ii) perpetual succession capacity (its possible continued existence
despite shareholders' death or withdrawal), and (iii) limited liability
(including, but not limited to: the shareholders' limited
responsibility for corporate debt, insulation from judgments against
the corporation, shareholders' amnesty from criminal actions of the
corporation, and depending on the jurisdiction the entity is registered
is, limitation of the liability of officers and directors for criminal
acts of the corporation).
The modern
business corporation's prevalence often obscures the fact that for
years other corporate business entities existed, before the emergence
of the modern business corporation. Investors and entrepreneurs often
form joint stock companies and then incorporated them to facilitate
conducting business; as this business entity now is prevalent, the term
corporation often is used to specifically refer to such business
corporations. Corporations may also be formed for local government
(municipal corporation), political, religious, and charitable purposes
(not-for-profit corporation), or for government programs
(government-owned corporation). As a generic legal term, 'corporation'
means any group of persons with a legal personality. Historically, the
modern business corporation emerged from the blending of the
traditional corporation with the joint-stock company.
Legal status
The existence of a
corporation requires a special legal framework and body of law that
specifically grants the corporation legal personality, and typically
views a corporation as a fictional person, a legal person, or a moral person
(as opposed to a natural person). As such, corporate statutes typically
give corporations the ability to own property, sign binding contracts,
pay taxes in a capacity that is separate from that of its shareholders
(who are sometimes referred to as "members".
The legal personality
has two economic implications. First it grants creditors priority over
the corporate assets upon liquidation. Second, corporate assets cannot
be withdrawn by its shareholders, nor can the assets of the firm be
taken by personal creditors of its shareholders. The second feature
requires special legislation and a special legal framework, as it
cannot be reproduced via standard contract law Hertig, The Anatomy of Corporate Law, pg 7.
In common law countries, classic statement of this principle is found in Lennard's Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 705, where Lord Haldane said:
- "My Lords, a
corporation is an abstraction. It has no mind of its own any more than
it has a body of its own; its active and directing will must
consequently be sought in the person of somebody who is really the
directing mind and will of the corporation, the very ego and centre of
the personality of the corporation."
The regulations most favorable to incorporation include:
- Limited liability
- Unlike in a partnership or sole proprietorship, shareholders of a modern business corporation have "limited" liability for the corporation's debts and obligations: see leading case in common law, Salomon v. Salomon & Co.
[1897] AC 22. As a result their potential losses cannot exceed the
amount which they contributed to the corporation as dues or paid for shares.
Limited liability regulations enable corporations to socialize their
costs for the primary benefit of shareholders. The economic rationale
for this lies in the fact that it allows anonymous trading in the
shares of the corporation by virtue of eliminating the corporation's
creditors as a stakeholder in such a transaction. Without limited
liability, a creditor would not likely allow any share to be sold to a
buyer of at least equivalent creditworthiness as the seller. Limited
liability further allows corporations to raise tremendously more funds
for enterprises by combining funds from the owners of stock. Limited
liability reduces the amount that a shareholder can lose in a company.
This in turn greatly reduces the risk for potential shareholders and
increases both the number of willing shareholders and the amount they
are likely to invest.
- Perpetual lifetime
- Another favorable regulation, the assets
and structure of the corporation exist beyond the lifetime of any of
its shareholders, bondholders, or employees. This allows for stability
and accumulation of capital, which thus becomes available for
investment in projects of a larger size and over a longer term than if
the corporate assets remained subject to dissolution and distribution.
This feature also had great importance in the medieval
period, when land donated to the Church (a corporation) would not
generate the feudal fees that a lord could claim upon a landholder's
death. In this regard, see Statute of Mortmain. It is important to note
that the "perpetual lifetime" feature is an indication of the unbounded
potential duration of the corporation's existence, and its accumulation
of wealth and thus power. (In theory, a corporation can have its
charter revoked at any time, putting an end to its existence as a legal
entity. However, in practice, dissolution only occurs for corporations
that request it or fail to meet annual filing requirements.)
Ownership and control
Humans and other legal
entities composed of humans (such as trusts and other corporations) can
have the right to vote or share in the profit of corporations. In the
case of for-profit corporations, these voters hold shares of stock and
are thus called shareholders or stockholders. When no stockholders
exist, a corporation may exist as a non-stock corporation, and instead
of having stockholders, the corporation has members who have the right
to vote on its operations. If the non-stock corporation is not operated
for profit, it is called a not-for-profit corporation. In either
category, the corporation comprises a collective of individuals with a
distinct legal status and with special privileges not provided to
ordinary unincorporated businesses, to voluntary associations, or to
groups of individuals.
For the purposes of the
next few paragraphs, the term "members" will be used to refer to
stockholders of a stock corporation and members of a non-stock
corporation.
There are two broad
classes of corporate governance forms in the world. In most of the
world, control of the corporation is determined by a board of directors
which is technically elected by the shareholders. In practice, with the
exception of takeovers, the board members are determined by the
previous board. In some jurisdictions, such as Germany, the control of
the corporation is divided into two tiers with a supervisory board
which elects a managing board. Germany is also unique in having a
system known as codetermination in which half of the supervisory board
consists of representatives of the employees.
The CEO, president,
treasurer, and other titled officers are usually chosen by the board to
manage the affairs of the corporation.
In addition to the
influence of shareholders, corporations can be controlled (in part) by
creditors such as banks. In return for lending money to the
corporation, creditors can demand a controlling interest analogous to
that of a member, including one or more seats on the board of
directors. In some jurisdictions, such as Germany and Japan, it is
standard for banks to own shares in corporations whereas in other
jurisdictions such as the United States and the United Kingdom banks
are prohibited from owning shares in external corporation.
Members of a
corporation (except for non-profit corporations) are said to have a
"residual interest." Should the corporation end its existence, the
members are the last to receive its assets, following creditors and
others with interests in the corporation. This can make investment in a
corporation risky; however, a diverse investment portfolio minimizes
this risk. In addition, shareholders receive the benefit of limited
liability regulations, making shareholders liable for only the amount
they contributed. This only applies in the case of for-profit
corporations; non-profits are not allowed to have residual benefits
available to the members.
Formation
Historically,
corporations were created by special charter of governments. Today,
corporations are usually registered with the state, province, or
national government and become regulated by the laws enacted by that
government. Registration is the main prerequisite to the corporation's
assumption of limited liability. As part of this registration, it must
in many cases be required to designate the principal address of the
corporation as well as a registered agent (a person or company that is
designated to receive legal service of process). As part of the
registration, it may also be required to designate an agent or other legal representative of the corporation depending on the filing jurisdiction.
Generally, a
corporation files articles of incorporation with the government, laying
out the general nature of the corporation, the amount of stock it is
authorized to issue, and the names and addresses of directors. Once the
articles are approved, the corporation's directors meet to create bylaws that govern the internal functions of the corporation, such as meeting procedures and officer positions.
The law of the
jurisdiction in which a corporation operates will regulate most of its
internal activities, as well as its finances. If a corporation operates
outside its home state, it is often required to register with other
governments as a foreign corporation, and is almost always subject to
laws of its host state pertaining to employment, crimes, contracts,
civil actions, and the like.
Naming
Corporations
generally have a distinct name. Historically, some corporations were
named after their membership: for instance, "The President and Fellows
of Harvard College." Nowadays, corporations in most jurisdictions have
a distinct name that does not need to make reference to their
membership. In Canada, this possibility is taken to its logical
extreme: many smaller Canadian corporations have no names at all,
merely numbers based on their Provincial Sales Tax registration number (e.g., " Ontario Limited").
In most
countries, corporate names include the term "Corporation", or an
abbreviation that denotes the corporate status of the entity. Of
course, these terms vary by jurisdiction and language. In some
jurisdictions they are mandatory, and in others they are not.[5] Their use puts all persons on constructive notice that they have to deal with an entity whose liability
remains limited, in the sense that it does not reach back to the
persons who constitute the entity; one can only collect from whatever
assets the entity still controls at the time one obtains a judgment
against it.
Certain
jurisdictions do not allow the use of the word "company" alone to
denote corporate status, since the word "company" may refer to a partnership or to a sole proprietorship, or even, archaically, to a group of not necessarily related people (for example, those staying in a tavern).
Back to Document Contents
CHARITABLE REMAINDER TRUST
Charitable
giving can be the answer to your income needs. Not only can you benefit
yourself, but you can also benefit your family and leave behind a
legacy.
If
you are like many people today, you own highly appreciated assets such
as real estate or stock that you are reluctant to sell because of the
significant capital gains taxes you would owe. At the same time, you
may be looking for ways to increase your income or diversify your
portfolio. Usually, that would mean selling those highly appreciated
assets, paying the high taxes and reinvesting with a substantially
reduced amount. Fortunately, there may be a solution to your dilemma; -
The Charitable Remainder Trust.
A
Charitable Remainder Trust, also known as a CRT, was created with the
tax reform act of 1969. It's an irrevocable trust designed to convert
an investor's highly appreciated assets into a lifetime income stream
without generating estate and capital gains taxes. CRT's have become
very popular in recent years because they not only represent a valuable
tax-advantaged investment, but also enable you to provide a gift to one
or more charities that have special meaning to you. A CRT can
potentially:
-
Eliminate immediate
capital gains taxes on the sale of appreciated assets, such as stocks,
bonds, real estate and just about any other asset.
-
Reduce estate taxes of up to 55% that your heirs might have to pay upon your death.
-
Reduce current income taxes with a sizable income tax deduction.
-
Increase your spendable income throughout the rest of your life.
-
Create a significant Charitable Gift.
-
Avoid probate and maximize the assets your family will receive after your death.
When
you establish a CRT, you or another beneficiary, such as your spouse or
another family member, receive income from the trust for life or for a
term of up to 20 years.
When the trust ends, the remaining assets pass to the qualified charity or charities of your choice.
Back to Document Contents
Private Family Foundations
In
recent years, several private foundations have gained prominence in the
media, and raised public awareness of their causes. Foundations,
including the Bill and Melinda Gates, are often created with one
philanthropic goal in mind. However, as the grantors often realize,
establishing your own foundation can often make smart money sense, as
well.
Plus, your last name does not have to be Rockefeller or Getty to start your own.
The Role of the Foundation
A
Private Family Foundation (PFF) is a separate entity, privately funded
by you. It is created with the specific purpose of contributing to
various charitable causes.
As a distinct, legal entity, The Private Family Foundation:
1. Contributes to a charitable cause and takes a tax deduction, while relinquishing personal control over your gift.
2. Minimizes your estate tax liability.
3. Avoids capital gains tax on the sale of appreciated property contributed to the charity of your choice.
4. Provides continuing employment and activity for your family members.
5. Identifies and preserves your family name for years to come.
Create and Control Your PFF
Any
Private Family Foundation must be created with a charitable "intent."
The Foundation is managed by a trustee or executive director that
oversees the Foundation's investments and distributes the Foundation's
assets.
You
can even appoint yourself as the trustee of your own Foundation. This
way, you maintain control over the assets contained in the Foundation.
Instead of making a one-time gift to a public charity (and losing
control of that gift), you can monitor your favorite charities. If one
non-profit changes its focus, or if a more meaningful cause comes
along, you can reallocate your Foundation's support.
Special Tax Advantages
Private
Family Foundations have special tax advantages, because they are
considered "charitable organizations" themselves. Because of this
classification, any earnings on Foundation assets are tax-exempt, and
can be distribute to the charities you choose.
If
established properly, a private family foundation can often avoid
capital gains taxes on highly-appreciated assets (see below). In
addition, interest and investment earnings that are not slapped with an
income tax can instead be used to help the charities or causes you
support.
Immediate Tax Benefits for You
If
you have highly-appreciated assets that you're holding to avoid steep
capital gains taxes, a Private Family Foundation could help. Any
appreciated assets that you transfer to a Private Family Foundation can
be sold by the Foundation with no capital gains taxes. This is because
of the Foundation's charitable status.
Second,
you can get an immediate tax deduction for any money or property to
grant to the Foundation. This deduction can equal up to 30% of your
adjusted gross income (20% for appreciated property). Any income tax
deduction not used in your contribution year may be carried forward
over the next five years.
The
valuation of these deductions depends on a number of things, including
original cost and the type of property being transferred.
Estate Tax Benefits
Every
dollar that you contribute to your Private Family Foundation means one
less dollar that is included in your estate. Gifts that are regularly
made to charities can instead be used to fund your PFF. And if you are
in a higher tax bracket, that could ultimately save up to 46% in estate taxes.
Best of all, you can make such contributions to a Private Family Foundation without affecting the $12,000 annual gift tax exclusion or the current $1 million Gift Tax Credit .
Required Distributions to Charities
Private
Family Foundations have certain laws they must abide by, because they
are a legal entity. For instance, by law, a Private Family Foundation
must distribute at least five percent (5%) of its assets each year to
public charities.
Let's
suppose you leave $2,000,000 to your Private Family Foundation. The IRS
says you must distribute at least $100,000 (or 5%) to recognized
charities in order for the Foundation to qualify for its special tax
advantages. Of course, you can select a higher payout if you choose.
But five percent is the absolute minimum.
The
annual payout is established when you first sit down with a qualified
estate attorney who has experience working with large estates. And the
difference between what the assets earn (e.g. 6% per year) and the
mandatory payout can be put back into the Foundation.
Employment for the Family
You
may arrange for your heirs and descendants to receive salaries as
"employees" of your Foundation. Simply name family members as
replacement trustees to succeed you after death or resignation.
Many
Foundations pay their directors using the difference between their
required distributions and their annual income. If your Foundation is
earning 10% annually on its assets, but only paying 5% annually to
charities, the difference can be distribute for legitimate expenses,
including salaries for the directors of the Foundation.
Ensuring Kids Don't Lose Out
While
charities will definitely benefit from your Foundation, your children
are deprived of the donated assets, after estate taxes are accounted
for. To remedy this situation, some individuals also choose to
establish a generation-skipping dynasty trust (like The Legacy Trust) to avoid estate taxes for up to three generations.
The
Legacy Trust, which is an advanced type of dynasty trust, also acts as
a shield for assets (subject to variations in state law). When properly
drafted and implemented, the Legacy Trust can also help place assets
outside your estate, outside the reach of creditors, judgments,
malpractice and divorce.
The
Legacy Trust can also provide a substantial benefit for your heirs,
particularly through the use of cash-rich life insurance. After funding
The Legacy Trust with annual gifts, it can purchase insurance payable
to your heirs (as beneficiaries of The Legacy Trust). The children
would then receive a lump-sum when you pass away, or you could have The
Legacy Trust support grandchildren (or even great-grandchildren). All
of these benefits are usually 100% estate tax- and income tax-free if
structured properly.
Foundations and Charitable Trusts
Private Family Foundations can also be combined with Charitable Remainder and Charitable Lead Trusts.
By doing so, you may able to draw a significant income for your
lifetimes and earn significant tax savings, while still maintaining a
large degree of control of your assets.
Be Careful of Those Caveats
As
with any estate planning strategy, there are drawbacks. There are
up-front legal costs that make it prohibitive for many estates under
$2-3 million.
Your
Private Family Foundation must also be legitimate, like a real
business. You must keep books and records to show how you arrived at
your decisions, and establish strict rules prohibiting self-dealing.
Salaries must be earned, with enough documentation to show that work
was actually performed.
There
are also potential excise taxes, and significant penalties if the
minimum 5% annual distribution is not adhered to. Nonetheless, after
seeking professional tax advice, you may be able to meet your
objectives through your own Private Family Foundation.
Back to Document Contents
THE FAMILY LIMITED PARTNERSHIP
No
Asset Protection document comes close to the protection and tax
benefits of the Family Limited Partnership. Since 1995 the popularity
of this document has been nothing short of miraculous. Sam Walton
founder of Wal-Mart successfully beat the IRS out of billions of
dollars in taxes when he died, but he was able to keep the business in
the family and his family kept full control of the family businesses.
A
major asset protection and estate planning tool is the family limited
partnership, i.e., a limited partnership in which members of the same
family hold interests. The values of such interests are significantly
discounted. Furthermore, the family limited partnership allows the
donor to act as general partner and thereby retain considerably more
control over the enterprise without risking adverse tax consequences.
Once
the property is transferred to a limited partnership, state law
transforms what a partner owns from a direct interest in the property
into an interest in a limited partnership. Because a limited
partnership restricts the rights of limited partners, including the
right to vote on partnership matters, the right to receive income, and
the right to transfer the interest, the value of an interest in a
limited partnership is substantially discounted in relationship to the
underlying assets of the partnership. This discount affects the value
of the partnership interest not only for tax purposes, but also for
debtor-creditor purposes.
Numerous
factors should be considered in connection with the formation of a
family limited partnership and the transfer of property to the
partnership, including, without limitation, income tax, gift tax,
estate tax, state property tax, and certain non-tax consequences, such
as the continuance of casualty insurance on the property and the
possible triggering of the due-on-sale clause in mortgages to which
property is subject.
In
addition, the partnership must be properly maintained in order for it
to be effective for both asset protection and tax purposes. For
example, it must be treated as a bona fide separate business that
conducts business with unrelated entities or at least has the capacity
to do so. Thus, partners who use any property that is transferred to
the partnership should pay fair market value for the use of such
property. Moreover, partners should keep in mind that what they own are
interests in a limited partnership and not the underling assets of the
partnership. Accordingly, financial statements of individual partners
should not list assets of the partnership, rather such statements
should only list limited partnership interests and at the discounted
value.
In
review, there are two types of partnerships. One is the general
partnership. The General Partnership is an entity where two or more
people go into business together. Usually a written agreement outlines
the partner?s investment and percentage of ownership. If no partnership
agreement exists, there is an implied partnership of equality or what
ever verbal agreements the partners have agreed upon.
The
major disastrous feature of the General Partnership is the unlimited
liability of all the partners. Not only is each partner responsible for
the partnership, the partners are responsible to each other. A child
belonging to one family can have an auto accident that could put not
only his family in jeopardy, but also the families of all the partners.
Many large partnerships have been destroyed through lawsuits that an
individual partner caused. If one partner signs a contract for the
partnership, both partners are liable for the entire amount of the
liability. Remember the big 8 accounting firms? We now call them the
big ? firms. Unlimited liability is dangerous ever for the largest
firms.
I
believe that a General Partnership is by far the most dangerous
business entity available. I refuse to suggest a General Partnership
for any of my clients. I just won?t get involved with one. They are
lawsuits waiting to happen. When a lawsuit strikes, everyone looses
except the lawyers. As for percent of ownership, a 10% owner is
responsible for 100% of the debt. It will come down to whoever has the
deep pockets pays the bills.
The
Family Limited Partnership on the other hand works differently. The
Family Limited Partnership consist of two types of partners. General
Partnership and Limited Partners. A Limited Partnership is not
responsible for any liabilities of the partnership. Using the Family
Limited Partnership entity, a partner can be both a 1% general partner,
and a 49% limited partner. The General Partnership 1% has liability,
but the 49% limited partner has no liability at all.
General
Partnerships make all of the decisions for the partnership. Acting as a
Limited Partnership the partner has no voice in any decision on the
everyday workings of the Family Limited Partnership, but may vote on
some designated issues similar to the stockholder of a corporation.
Limited partners may invest money into the partnership but they don?t
have management powers and consequently have no liability for all of
the debts of the partnership.
All
partnerships are pass through tax entities. It pays no income tax. The
partners pay tax on their percentage of ownership on any profits the
partnership makes. Each partner receives a form K-1 that is then
entered into the proper forms on the partners 1040 income tax form.
Losses are also carried to the partners personal income tax return
which can benefit the partner in case of occasional losses the
partnership may experience.
The
Family Limited Partnership is the number one entity for Asset
Protection. Keeping the family wealth from the lawyers. We use the
Family Limited Partnership in conjunction with other entities to
completely protect the partner?s assets.
Usually
the Family Limited Partnership consist of a husband and a wife. Both
husband and wife can structure it to act as a 1% general partner, and a
49% limited partner. The limited portion can also be divided among the
children. .
The
final step is to transfer the assets into the Family Limited
Partnership. Assets are transferred into the Family Limited Partnership
in one of two ways. They are titled in, or we list them on a schedule
"A". Once the assets are transferred into the Family Limited
Partnership, they are owned by the Family Limited Partnership. The
husband and wife no longer own a direct interest in the assets. They
now own a controlling interest in the Family Limited Partnership. As 1%
General Partnership they have full control over the affairs of the
partnership. They can buy and sell any asset they wish. They have full
rights to distribute any profits out to any of the partners, or they
can retain all the profits in the partnership.
Being
alive today in a lawsuit happy society it?s not a question of if you
will be sued, but when. With tens of millions of lawsuits each year,
and over one million hungry attorney?s, it?s just a matter of time. If
you are one of the many that get sued, your life will change forever.
You will dread the day it happens. You will however, retain the assets
in the Family Limited Partnership.
In
a common scenario the husband gets sued for some malpractice or work
related action. The courts grant the plaintiff a judgment against you.
The judgment gives the plaintiff the right to collect the
million-dollar judgment from you. The judgment creditor would like to
seize the bank accounts, stocks, and every other investment and other
assets he owns. The lawyers soon discover that he owns no assets in his
name. Both husband and wife don?t hold any direct interest in any
assets placed into the Family Limited Partnership. To his amaze, he
cannot seize any assets, even the ones in the Family Limited
Partnership.
Under
the Uniform Limited Partnership Act, a creditor of a partner cannot
reach into the partnership and take specific partnership assets.
Key Benefits
-
Complete Asset Protection.
-
Maintain Complete Control of the Assets.
-
Enjoy tax benefits not enjoyed by other entities.
INSURANCE TRUST
Inter
vivo trusts of life insurance policies have come into wide use as
estate planning devices. Principal advantage of insurance trusts is
that they permit a greater flexibility in investment and distribution
of trust estate than may be possible under settlement options generally
available in the policies themselves. Another advantage is that such
trusts, like other gifts of insurance policies, may afford substantial
estate tax savings.
Of
course, a significant benefit of setting up an irrevocable insurance
trust is to protect the policies from attachment by creditors of the
policy owner.
Insurance Trust
An
insurance trust may be either funded or unfunded, revocable or
irrevocable, and may be created by either the insured or another. In an
unfunded insurance trust, either the policy is paid up or the trustor
or another, contemplates making future periodic premium payments.
Revocable Insurance Trust
A
revocable life insurance trust involves transferring insurance policies
to a trust during the insurer's lifetime. Generally, the insured
retains ownership of the policies rather than assigning them to the
trust.
When
an insured creates an unfunded revocable life insurance trust, just the
life insurance policies are transferred to the trust. The insured
remains obligated to pay the insurance premiums. A funded revocable
life insurance trust is created when the insured also transfers
income-producing property (e.g., cash or securities) with which the
future premiums on the insurance policies can be paid.
Since
the trust is revocable, the grantor can change its terms to suit his
changing plans; he can change the trust provisions during his lifetime,
cancel the policies, or cancel the trust. Thus he retains all rights in
the policies during his lifetime. At the grantor's death, the trust
becomes irrevocable.
Life Insurance Trust as Asset
Protection Device
Limitations and Benefits
There
are no estate tax savings insetting up a revocable trust because the
grantor retains taxable powers over the policy during his lifetime.
Therefore, the trust property is included in his estate upon his death.
Nor are there any income tax savings, since if the trust is funded,
income generated from the property transferred to the trust is taxable
to the grantor.
A revocable life insurance trust nonetheless holds several other advantages:
1. The expenses and publicity of probate are avoided;
2. The need for a guardian is eliminated;
3.
The trustees can collect the life insurance proceeds much faster after
a settlor's death because they don't have to wait for the will to be
probated and testamentary trust set up; and
4.
A revocable living trust gives grantor the opportunity to see how the
trust is operated while he's alive; if he doesn't like it, it can be
changed or revoked.
A
revocable life insurance trust offers no benefit against the claims of
creditors. A creditor can compel the grantor to revoke the trust and
take the assets back in order to satisfy a judgment.
Irrevocable Insurance Trusts
An
irrevocable life insurance trust can be created by irrevocably
transferring ownership of the policies to the trust. The trust may be
funded or unfunded. An unfunded in-evocable trust is created by an
irrevocable transfer of only the life insurance policies. Since the
trustee of the trust will have no funds with which to pay premiums,
another party, e.g., the insured or trust beneficiary, must pay the
premiums.
A
funded irrevocable trust is created when transfer is made to the trust
of the policies plus income-producing property, the income being used
to pay the premiums.
The
irrevocable insurance trust serves the useful function of insulating
the donor's insurance policies from the claims of creditors.
Estate Tax Savings
In
addition to shielding assets from creditors, an insurance trust, can
provide significant estate and income tax savings, and possibly, may
have gift tax consequences.
Life Insurance Trust as Asset Protection Device
If
the donor irrevocably transfers to the trust all "incidents of
ownership', in the policies, and the proceeds are payable to the
trustees, the proceeds generally are not included in the donor's gross
estate. Note, however, that any gift to the trust made within 3 years
of death will automatically be included in the decedent's estate.
Suppose
an insured wants to leave life insurance policies to his wife and
children in such a way so as to avoid including the proceeds in either
his or his wife's estate. He can transfer the policies to an
irrevocable trust. He can give his wife a life income in the proceeds,
with the principal passing to his children on her death.
More
flexibility can be added, however, without sacrificing the estate tax
advantage. For instance, the insured can give trustee the discretionary
power to use principal for the wife's benefit. He can also give his
wife a limited power to appoint the principal among the children
without having the proceeds included in her estate.
Incidents of Ownership
Under
Section 2042 of Internal Revenue Code, the gross estate includes the
proceeds of life insurance on the decedent's life if the decedent
possessed any incident of ownership in the policy at his death or if
the proceeds were payable to the decedent's executor or for the benefit
of the decedent's estate.
The
term "incidents of ownership" in a life insurance policy refers to the
economic benefits of the policy, including the right to change the
beneficiary of the policy, to surrender, cancel, or assign the policy,
or to borrow on its cash value. If the decedent possesses any one of
the incidents of ownership on the policy on his life (or if he had
relinquished such interest in contemplation of death), the proceeds of
the policy are included in his gross estate.
If
the decedent did not possess any incidents of ownership at the time of
his death, such proceeds are still includible in the decedent's gross
estate under Section 2035 if the decedent made the transfer with
respect to the policy within three years of death.
Income Tax Savings
It
is possible to set up an irrevocable inter vivo life insurance trust
that has income tax advantages as well as estate tax advantages, if the
trust is funded with income-producing property. Unless the trust is
funded with income-producing property, there is no income tax
advantage. Therefore, the grantor must give up ownership and control of
the property.
If
the income is or may be used to pay premiums of insurance on the life
of the grantor or his spouse, such income will be taxed to the grantor
under Section 677 of Internal Revenue Code. However, it is possible to
avoid taxation to the grantor if an adverse party must consent
Life Insurance Trust as Asset Protection Device
to
the use of the trust funds for premium payment purposes. An adverse
party includes a beneficiary who stands to lose if trust money is used
to pay premiums. However, the beneficiary holding that power may then
be taxed on the income used to pay the premiums.
Illustration:
Grandfather sets up an irrevocable funded life insurance trust with
insurance on his (the grandfathers) life for the benefit of his
grandchildren and provides in the trust instrument that trust income
will be used to pay the premium unless his son (the father of the
grandchildren) demands that the income should be paid to him.
In
this case, the income would be taxed to the son, which is fine if the
son is in a relatively low bracket. If the son is in a high tax
bracket, however, giving the son the right to require that the income
either be paid to him or accumulated for his benefit as decided by the
trustee may be a way around the tax. In such case, the income would
probably be taxed to the trust because the son's power over the income
is not held solely by himself.
Illustration:
Father creates an irrevocable life insurance trust for his two
daughters and transfers to the trust various income-producing
properties. Assume father's income is in the 28% income tax bracket,
and the daughters' incomes are taxed at the minimum rate of 15%. The
trustee distributes to the two daughters income that each one uses to
pay premiums on life insurance policies on their father's life.
Say
the premiums on the policies cost $1,000. Due to his higher tax
bracket, father would have had to have pre-tax income of $1,400 in
order to have a $ 1,000 left after taxes to pay the premiums. However,
by distributing the income to the daughters and using that income to
pay the premiums, daughters would need to have income in the aggregate
amount of $1,170 in order to have a $ 1,000 left after taxes to pay the
premium , thereby realizing a saving of $230.
Gift Tax Consequences
A gift of an insurance policy to an irrevocable trust or a gift of premium to
the trust is subject to the usual gift tax rules. If die beneficiaries
of the trust have no present right to income or principal, the gift is
one of future interest, and no annual gift tax exclusion is allowable.
On
the other hand, if the trust contains a Crummey power permitting the
beneficiaries to withdraw the value contributed to the trust in the
particular year, or the amount of the available annual exclusions,
whichever is smaller, then the grantor and the spouse of the grantor
may claim the annual gift tax exclusions.
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LIMITED LIABILITY COMPANY
A limited liability company (denoted by L.L.C. or LLC) is a legal form of business company in the United States offering limited liability to its owners. In that respect, it is similar to a corporation, and is often a more flexible form of ownership,
especially suitable for smaller companies with a limited number of
owners. Unlike a regular corporation, however, a limited liability
company with one member may be treated as a disregarded entity, so the
member is often singled-out as a person performing the actions of the
LLC. A limited liability company with multiple members is typically
treated as a partnership for tax purposes, thereby avoiding double taxation.
Choosing to operate as member management creates a flat member or
partnership structure. Choosing manager management creates a two-tiered
management structure potentially convertible into a corporation, with
the attendant tax consequences. LLCs use IRS Form 1065 and Schedule SE
(Self-Employment Tax). It is often incorrectly called a "limited
liability corporation" (instead of company). LLCs are organized with a
document called the "articles of organization", or "the rules of
organization" specified publicly by the state; additionally, it is
common to have an "operating agreement" privately specified by the
members.
Operating
as an LLC form of partnership does not mean that appropriate federal
partnership tax forms are not necessary, or not complex. As a
partnership, the entity's income and deductions attributed to each
member are reported on that owner's tax return.
LLCs
can lose their tax advantage without the partnership structure. The
possible label "disregarded entity" for income tax purposes singles out
the one-member owner of an LLC as actually earning income and
deductions directly, it is the owner, then, who reports as a business
proprietor, rather than as an LLC operating an active trade or
business. An LLC passively investing in real estate and owned by a
single member would have its income and deductions reported directly on
the owner's individual tax return on a Schedule E tax form. And an LLC
owned by a corporation--in other words, an LLC with a single corporate
member--would be treated as an uncorporated branch and have its income
and deductions reported on the corporate tax return, creating double
taxation.
Florida
has one of the strongest LLC's in the nation. Many file the forms over
the Internet, but without a proper Operating Agreement and proper
funding, all may be for nothing. Have an expert prepare Florida forms.
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LIVING TRUSTS
A. Living Trusts
No
area of financial and estate planning is surrounded by more mystique
and misunderstanding than the role of living trusts, also known as
inter vivo trusts. In fact, due to the complexities of trusts, Sections
641 through 682 of the Internal Revenue Code were passed by Congress to
set forth the parameters by which the income tax considerations of
trusts are measured. Also, Sections 203 1 through 2043 hold many
pitfalls for the unwary because of the estate-tax ramifications of
trusts. With so much confusion in this area, it is important to have a
basic understanding of this type of trust.
A living trust
is a trust that is established while you are alive. When establishing a
living trust you transfer title of certain property into the trust. You
can retain control of the property if you name yourself as trustee. The
assets will be used for the benefit of the named beneficiaries, such as
yourself or your spouse, and later to your heirs such as your children.
B. Testamentary Trusts
Unlike a living trust, a testamentary trust
is established after your death. To establish a testamentary trust, you
would include a provision in your will that creates a trust upon your
death and specifies the parts of the estate to be placed into the
trust. Also, a testamentary trust by itself as an estate-planning tool
may not be as effective as a living trust. For one reason, the trust is
not established until your death, so the estate must go through probate
before the trust can be established. Unfortunately, many who have a
testamentary trust provision in their Will think that they will avoid
probate because they are using a trust. Obviously, more important than
using a trust is using the right trusts. Later chapters of this book
will further discuss probate and how trusts can avoid estate taxes. <Top>
C. The Advantages of Living Trusts
People establish a living trust for some of the following reasons:
-
Probate can be avoided on the assets held in the trust.
-
A living trust is tax neutral.
-
The bypass trust and marital deduction trust for estate tax purposes can appropriately be placed inside the living trust.
-
A trust can be revocable, meaning that you can amend, alter or cancel it at any time.
-
Through a trust you can select competent people or institutions to mange your properties during your life and upon your death.
-
Under proper circumstances, trusts can afford a substantial measure of liability protection for the assets held therein.
-
Irrevocable trusts can avoid probate with income tax advantages while also eliminating estate and inheritance taxes.
-
The trust is a personal and private document that is not available for public inspection.
-
A living trust can go into
effect immediately, unlike a testamentary trust set up in a will, which
only goes into effect following death.
-
Property can be added or deleted from the trust at the complete discretion of the trustor's (creators).
-
A
living trust is not generally under the supervision of any court,
whereas a testamentary trust, in some jurisdictions, may be under the
continuing supervision of the probate court, thus requiring periodic
accounting to the court. Such accountings may become public
information, which may divulge personal and business details including
facts and figures to competitors.
WILLS
LEAVE NOTHING TO CHANCE - IF YOU DON'T HAVE OR DON'T INTEND TO HAVE ANY OTHER FORM OF ESTATE DOCUMENTS:
The
will is the lowest document in financial planning. It gives the
lawyers a free look into your estate, and in most states, a 7% + fee to
probate the will at your death. Always use a living trust to handle
your estate after you die. If you do nothing else, prepare a will.
As with most families, your will is a statement directing the
disposition of your property when you die. Not only does a Will ensure
that your assets go to recipients of your choice; it also specifies how
and when they are to receive them. If, for example, a beneficiary is
young or financially unsophisticated, the Will might provide that the
property goes to a trustee or a guardian for a specified period of
time, with the income of the trust being assigned to the beneficiary.
If
you die without leaving a valid Will, however, the disposition of your
property will be in accordance with the intestacy laws of the state in
which you reside. The property will go to your next of kin in
proportions and in a sequence mandated by the state. If there is no
Will, and there is no known next of kin within the definition of state
law, your property may revert to the state.
What the Will should do: Most
importantly, the Will should name the executor who will administer your
estate. This means locating all assets, pursuing claims and collecting
what is due, disposing of assets in the most favorable manner possible
and following specific instructions or exercising such discretion as
you have decided on. To ensure that those of ability, interest, and
loyalty manage your estate, you should name contingent or successor
executors
Further,
if you die without leaving a valid Will, or if the executor you named
is unable or unwilling to serve, a state court will choose an
administrator for your estate who is paid out of its assets. He may be
interested only in collecting his fee, which could be far greater than
the services he renders are worth.
After
you have selected a reliable executor and successor executor, don I t
let the matter rest there. If, over the years, they become unable or
unwilling to serve, adjust your will and name new ones. And if you have
minor children, the Will should certainly name a guardian for them.
Your choice of a guardian might be the most important asset you can
provide them. I believe the main purpose of the Will is for a
guardian of your minor children.
Your words and intentions may have to be interpreted:
Bear
in mind the fact that your Will is a legal document. A lawyer or
another qualified person should prepare it, but not just anyone will
do. Law, like medicine, is highly specialized. The attorney who handles
your business affairs may be competent in matters concerning contracts,
claims, and other commercial matters, but unless he has specialized
knowledge in the field of estate planning he is likely to overlook
various traps. There are standards that must be met if the Will is to
serve your purposes. In commenting on one suit where a decedent's Will
having been prepared by his brother-in-law, who was an insurance agent
and not an attorney, the court observed sadly, "This tax litigation is
the consequence." Do not make the mistake of thinking that any written
attempt to pass on property will create the desired dispositions.
Be
certain that the Will expresses what you have in mind without
ambiguity. Beneficiaries should be identified by name-"my son" means
little if another boy is born after the will is drawn. Review the Will
when children are born, marry, or die, and when Congress enacts
substantial changes in tax law
The
Will should provide for contingent beneficiaries if a named beneficiary
dies before you do, or if the beneficiary, for whatever reason, refuses
the bequest. This precaution prevents assets from being dissipated by
being divided many times among next of kin or even lost outright
through escheat, or reversion to the state.
What a will cannot do:
Even
with a well drawn Will, you do not have any form of asset protection.
You do not, in fact, have full discretion as to the disposition of your
property. State law dictates varying percentages of the estate that a
surviving spouse is entitled to receive. The state where you are
domiciled may require that a surviving wife receive 35 percent of your
property as dower; if you leave her a lesser amount, she can "take
against the will," receiving her 35 percent at the expense of your
other beneficiaries. The corresponding right that may be claimed by a
surviving husband is called curtsey. In some states, children are
entitled to specified percentages of the estate regardless of whether
the parent had made provision for them in his Will.
A
decedent's right to dispose of property is still further limited in a
few states for example, state law may hold that bequests to charitable
organizations are not valid unless made more than 30 days before death.
A
Will may not carry out a testator's wishes if he hasn't anticipated
various problems. It may not be possible on the basis of existing
records or the executor to prove that the decedent had clear title to,
or full ownership of, the property he wished to convey. The executor
may not be able to identify or locate certain assets. Or the Will makes
certain bequests, but the estate lacks the money or property to
implement them.
Conclusions and advice:
-
Make certain that your executor will know where your assets are and what your exact intentions are.
-
Have your Will reviewed when
there are changes in the tax law, in the needs of your beneficiaries,
in your income and theirs. If you move to a different state, check to
see whether formal requirements are different, such as the minimum
number of witnesses required,
-
Do not believe that you can leave your property to anyone you select, in whatever amount you see fit.
-
Do not think that once you have made a Will, everything will be taken care of according to your directions.
-
Do not assume that your
excellent family or business lawyer will be competent in the entirely
different field of estate planning.
-
Don't
ever believe that one asset in your Will has any type of Asset
Protection. What you have done, is to catalog all of your assets,
which will prove a disaster in the event you are sued. You must
protect all of your assets in approved documents. Every attorney knows
this, and you should question the competence of any attorney that
doesn't mention alternatives.
Key Benefits
Pure Trust, Constitutional Trusts, Family Estate Trusts, and Other Sham Trusts
Recent
years have witnessed a proliferation of vehicles calling themselves
trusts that are promoted with the promise that they can enable a
grantor to eliminate all obligations for income, estate, and gift
taxes. Among the names for these trusts are family estate trust,
constitutional trust, pure equity trust, Patrick Henry trust, offshore
estate trust, and tax haven double trust. In this discussion they will
be referred to as sham trusts. Using various challenges, the IRS has
had little difficulty defeating them.
Common Structures:
While
many variations exist on the typical sham trust, there are almost
always several common features. The grantor creates a tutelary
irrevocable trust, either retaining broad managerial powers and
discretion or giving them to other family members. The grantor then
transfers to the trust all of her assets, and assigns to the trust the
right to all of the grantor's future services and to receive all
compensation paid for those services. In exchange, the grantor receives
certificates representing units of beneficial interest, some of which
the grantor may give away.
The
grantor then continues to do business or render services as always,
with checks from customers, clients, or patients being made to the
?Grantor Sham Trust.? The trust pays all of the grantor's personal
expenses, and supports the grantor and her family, including
maintaining the grantor's residence and paying transportation,
business, and medical insurance costs. In a few cases, the trusts name
as beneficiaries foreign trusts that, in turn, make ?grants? to the
grantor and her family.
Failure of Sham Trusts:
The
IRS has yet to taste serious defeat in challenging claims that sham
trusts can reduce income, estate, or gift taxes. The IRS first attacked
the sham trust with four rulings issued on the same day. In Revenue
Ruling 75-257, the grantor assigned to a trust the right to
the grantor's lifetime services. The grantor, his spouse, and a third
person were named the trustees and would take all actions by majority
vote. The trustees had broad powers to conduct all types of business,
and did employ the grantor and pay various of the grantor's personal
and business expenses. The IRS said that the trust was a sham attempt
at assignment of income in violation of the principles of the Supreme
Court's decision in Lucas v. Earl, and that it also violated Sections 674, 676 and of the grantor trust rules.
In
Revenue Ruling 75-258 the grantor created a slightly different type of
family estate trust, based on the issuance of transferable certificates
of beneficial interest that the grantor then transferred to family
members. Again, action was to be taken by a majority of the trustees.
In this case, however, the IRS said that the unincorporated entity had
more corporate characteristics than trust characteristics, and that it
was therefore an association taxable as a corporation.
In
Revenue Ruling 75-259 the IRS said that the grantor's retained
beneficial enjoyment in the trust, whether through direct or indirect
control over the activities of the trust or certificates of beneficial
enjoyment, brought the trust funds back into the grantor's gross estate
for estate tax purposes, under Sections 2033, 2036, and 2038. In
Revenue Ruling 75-260 the IRS also concluded that the transfers to the
trust were incomplete for gift tax purposes, until distributions were
made from the trust to persons other than the grantor.
The
IRS further clarified these rulings during the next five years. It
ruled that the fees to create a sham trust were not deductible under
either Section 162 (business expenses) or 212 (investment and money
management expenses), and that amounts paid to the grantor
under one of these trust arrangements were substitutes for compensation
and were subject to federal employment taxes. They also struck down a
version of the sham trust that involved the use of both domestic and
foreign trusts.
The
Courts have consistently sustained the IRS' arguments. The IRS has not
yet really tried to pursue treating these trusts as associations, but
it has been successful at ignoring them entirely as sham entities or
treating them as grantor trusts. In a few estate tax cases, the IRS
has also been very successful in having the trust funds included in the
deceased grantor's gross estate.
In
Service Center Advice 1998-006 (Mar. 6, 1998), the Austin Internal
Revenue Service Center requested from the National Office advice about
the tax reporting requirements for so-called pure trusts or Pure Trust
organizations. The Chief Counsel of the IRS advised the Service Center
that such a trust is still classified as a trust or another entity, and
it must file an application for a taxpayer identification number (Form
SS-4), from which the Service Center could determine the proper tax
classification of the entity. If it is determined to be a trust under
Regulation Section 301.7701-1(a), the trustee must file a fiduciary
income tax return (Form 1041). If the particular entity is
deemed not to be an entity separate from its owner, then the items of
income, deduction, and credit must be reported on the owner's
individual income tax return, and Form 1041 is not required.
References:
See
discussions in Goldstein, ??Family Estate? Trusts, ?Pure? Trusts and
?Constitutional? Trusts: Apocalypse Now,? 16 U. Miami Est. Plan. Inst.
ch. 7 (1982); Perkins, ?The Failure of the Family Trust,? 3 Tax Mgmt.
Est. Gifts & Tr. J. 20 (1981).
Revenue Ruling 75-257 . 1975-2 CB 251
Revenue Ruling 75-258. 1975-2 CB 503
Revenue Ruling 75-259. 1975-2 CB 361
Revenue Ruling 75-260
Revenue Ruling 79-324. 1979-2 CB 119
Revenue Ruling 80-321. 1980-2 CB 33
Revenue Ruling 80-72. 1980-1 CB 137
While
there are too many cases in point even to enumerate (most involving
taxpayers who represented themselves), the leading decisions are trust
taxable under the grantor trust rules); trust was a sham and economic
nullity);, appeal dismissed without opinion (10th Cir. 1980) (trust
taxable under the grantor trust rules); (osteopath transferred right to
future services to beneficial interests, court holds that transaction
is an anticipatory assignment of income, a sham, and in any event the
grantor trust rules would apply); (dentist created a ?family trust? and
assigned to it certain properties and the full right to his lifetime
professional services, remaining sole beneficiary and co-trustee with
his wife; held that the assignment of ?lifetime services? was invalid
as an attempt to assign anticipatory future income, the trust was a
sham); (income from farm was taxable to farmer, not to family trust he
had established, because trust lacked substance, as evidenced by vague
terms and lack of clearly ascertainable beneficiaries; penalties
imposed for failure to file, negligence, and delay of suit). See also
,, (taxpayers created sham trust to receive checks from their
customers; trust treated as sham, and one half of receipts taxed to
each of the two taxpayers who owned business as community property).
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