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Idioms & Grantor Trusts: Having It Both Ways (For Now)

You can’t eat your cake and have it, too!
 
We’ve all said it many times and in every case we were talking about more than just desserts. Layered within the phrase is the more subtle and intended message that you can’t have it both ways; or that to get something you’ve got to give up something else.
 
Our conversations are peppered with idioms, those oft-used little word-packages whose literal meaning have nothing to do with what they actually communicate. For the outsider struggling to learn the language, idioms can cause more roadblocks to understanding that all the other irregularities of grammar and spelling that attend the King’s English. And it gets more confusing when an idiomatic truth proves unreliable; as in the case of grantor trusts.

These grantor/intentionally-defective/irrevocable/lay in the house that Jack built/life insurance trusts turn the idiom on its head by allowing, from at least a tax perspective, a taxpayer to have it both ways.

Consider the advantages a grantor trust can provide if all is properly done:
 
  • For estate tax purposes: All property in the trust is not included in the trust-maker’s taxable estate, offering significant tax savings on both the original principal and on appreciation after transfer to the trust.
  • For income tax purposes: The consequences of all that takes place in the trust flow back to the personal return of the trust-maker. This a) allows more control over the severity of the tax – especially if the maker has certain tax advantages in play, and b) avoids depletion of assets in the trust to make tax payments and, by paying the trust’s tax, allows for a gift tax-free benefit to the trust by the maker.
Let’s keep the ball rolling. While the maker is enjoying the best of both tax worlds, he or she also benefits in that:
  • Assets in the trust are protected from the claims of the maker’s creditors.
  • If the maker is married, he or she can maintain remarkable degrees of vicarious control over and access to property in the trust by establishing a life estate in the spouse.
If you want to hide a barn you shouldn’t paint it red. It’s no surprise that a planning device with this many advantages has caught the attention of the lawmakers.
 
If lack of familiarity with common idioms is hampering you then it’s time you pulled yourself up by your own bootstraps, put your nose to the grindstone, and began to get the lay of the land on such things. Or simply contact me with questions that come up in your casework concerning grantor trusts, at 706-614-3796 or tom@cpsadvancedmarkets.com. When we are done you will know your noodles.
 
By the way, my Mother never quite got the hang of making cakes from scratch. Her marble cakes were always so hard we just took them for granite.
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Is Insurance In A Qualified Plan Beneficial?

Whenever life insurance is proposed the first two client-questions that inevitably follow are: first, how much will it cost and then, are the premiums deductible (especially if the client is a business-person). Let’s deal with the second.
 
In a business situation life insurance premiums are never deductible. Even in an executive bonus arrangement the employer can write off amounts paid only because, in fact, the amounts are W-2 compensation, not because they are eventually spent on life insurance.

In the personal context there hovers about the discussion of tax-deductible costs for coverage the possibility of holding life insurance in a qualified plan.

It sounds good at first blush. Contribute to the plan and use the untaxed dollars to buy a policy. But take a closer look.
 
Permanent insurance outside a plan can be broken down into three parts.
 
On the bottom is basis, the after-tax dollars used to pay premiums (it can be a little more complicated than that, but let’s keep in simple). Above that is the potentially taxable, but currently tax-deferred gain in the policy, i.e. the reserves in excess of the basis. On top is the risk portion, the amount of death benefit over the policy values.
 
Two tax advantages to keep in mind with non-plan coverage are:
  • So long as the policy stays in force prior to death, the gain in the policy can be protected from taxation
  • In the event of death the whole kit and caboodle (basis, gain and risk) is paid to the beneficiary income tax-free
Now compare to the taxation of a policy in a qualified plan.
 
Untaxed dollars inside the plan are used to buy the life insurance. So far so good. But next the plan administrator must report each year as taxable income to the insured plan participant the “economic benefit” realized by the coverage. This is often calculated using the carrier’s one-year term rates acceptable to the IRS.
 
The result is an amount usually lower than the actual premiums paid. On balance the participant comes out ahead, but not with as much sizzle as they may have anticipated.
 
What will follow from there is one of two unavoidable tax disadvantages that are avoided with insurance outside the plan.
 
If the participant retires or otherwise separates from service most plans do not allow the policy to remain in the plan. If the policy is distributed its FMV (usually the account value) must be recognized to the extent of the FMV exceeds the accumulated economic benefits recognized over the years of participation, i.e. the gain is taxed, a result that would not have happened with coverage outside the plan. The participant can buy the policy out of the plan, but the result is the same. The heretofore untaxed gain in the contract is not purchased with after-tax dollars.
 
If the participant dies while the policy is in the plan the beneficiary receives the death benefit tax-free only to the extent that it exceeds the policy value minus the accumulated economic benefits. Again, the gain in the policy is taxed, unlike when a death benefit is received for coverage outside the plan.
 
There will always be taxation of the policy gain. In addition, if the insured anticipates death tax liability, either federal or state or both, the proceeds from a plan-owned policy cannot be kept out of the taxable estate. Both are things to consider before hastily buying coverage inside a qualified plan with the hope of, at least, part of its cost being paid for with untaxed dollars.
 
Call with any question concerning coverage inside or outside a plan.
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Uncovering Sales Opportunities And Limiting Liability Exposures Through Trust Owned Policy Reviews

While many advisors implement conservative, guaranteed solutions in trust owned policy arrangements, this is not a universal practice.
 
In a low interest rate environment, many policies that are held in trust may be under-performing and do not have the underlying guarantees to ensure that the policy does not lapse prematurely and that the primary objectives for the insurance planning are obtained.
 
Consider This Scenario
 
In a recent conversation with a carrier representative, they shared an instance in which the trust beneficiaries brought a law suit upon the writing agent, the broker general agent and also the carrier for failing to implement a sound insurance strategy and perform periodic reviews to avoid a premature lapse.
 
Fortunately, there had been a policy review conducted within the last 36 months in which the under-performance was identified and an alternative solution was recommended.
 
The insured (parents of the trust beneficiaries) elected not to pursue this recommendation and failed to inform their children that the review had taken place. The courts held that this effort was enough to avoid adverse litigation and the case was dismissed.
 
Penetrate A New Market
 
This story can be a great conversation starter with any CPA’s, Estate Planning Attorney’s or Trust Companies. You may even know a friend or family member who is serving as a trustee who could be exposed to this potential liability.
 
By offering a complimentary policy review of any trust held policies, you can strengthen your relationships with these professionals – which can lead to future referral opportunities.
 
There may even be a more cost effective policy solution available even if the current plan is not under-performing.
 
We can help streamline the policy review process and for more complex trust planning designs; we can leverage our Director of Advanced Markets, Tom Virkler, JD.
 
Given that most policies held in trust are larger face amounts on older individuals, doing one of these reviews each month could result in a sizable increase in your income.
 
For assistance with a policy review, please contact your Life Sales Rep.
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Properly Documenting Your Clients Intentions

In the most important episode of his life Paul Revere did not fire a shot. But his willingness to spread the alarm averted what could have been an early military disaster for the revolutionists of Massachusetts Bay.
 
Planners, too, in addition to fulfillment of their usual responsibilities must fill the role of an alarmist if they are to keep their clientele financially whole.

The sad truth is that if your clients do not take the time to plan correctly the government is poised to do it for them poorly when the need arises.

State laws allows for a citizens to assure that their affairs are handled according to their wishes, but they must takes steps to document their intentions properly.
 
Proper documentation can be achieved through the execution of these three basic planning documents:
  • A durable Power of Attorney that permits an appointed agent (attorney-in-fact) to conduct financial transactions for your client under the terms expressed.
  • A Health Care Directive (a/k/a – healthcare proxy, living will, durable power of attorney for health care) that appoints an agent to make health care decisions if the client becomes unable to do so.
  • A Last Will & Testament that, upon death, allows the client to a) decide who will receive the assets owned by the client, b) appoint who will manage those assets, c) state preferences for the guardian of the client’s minor children, and d) appoint trustees of trusts created by the Will.
If these are not in place a client must understand that there is legislation in every state that will make these decisions for them.
 
Broaden the influence you have with and the comprehensiveness of the service you provide to your clients by asking them if they have taken the time have drafted at least the three fundamental planning documents listed above.
 
We do not practice law or offer legal advice (nor do you), but will look at a client’s planning documents to direct them better when they have them reviewed by legal counsel. Give us a call.
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Sweat Equity, Without The Equity

The business world abounds with stories of the entrepreneurs who managed success building an undercapitalized venture largely because they made little or nothing in the early years, choosing rather to channel revenues back into the growth of the business.
 
But there are often unsung heroes in these stories of delayed gratification: those talented and enterprising key employees who, captured by the vision and its opportunities, also sacrificed, giving up other more “sensible” opportunities, committing to onerous work schedules, and settling for less salary during their “salad days” so they might share in the bounty down the road.

The difference is that they have no ownership interest; and therein lies the sales opportunity.

Business owners with a conscience will be sure to reward such sacrifice among loyal employees when company fortunes turn.
 
Unfortunately there are some things over which the they have no control, like their unexpected premature death, or the level of obligation that successor owners might feel for those employees who played a role in getting the company to the dance.
 
There is an easy and economical way business owners can protect loyal employees, and the concept should be a club in the bag of every agent working the small to mid-sized business market, or who wants to be a player there.
 
Contact us to discusses how you can increase business sales using the concept of “loyal employee insurance.”
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Buy-Sell Planning While Generation Straddling

Two of the top ten reasons that younger women say that they marry older men are, first, they have a better read on those with a more promising future, even if it is shorter; and second, if they sprain their ankle they can use their husband’s cane.
 
Pretty funny, but not unlike a couple of the underlying reasons it might make sense for a young entrepreneur to associate with an older colleague in a business venture.
 
The “kid” has the track record of the potential partner to serve as a good indicator how much the codger will bring to the table in the time remaining in his or her active work life. And the older businessperson has picked up things along the way that may come in handy to overcome unexpected hurdles (the cane, just in case you aren’t following the analogy).

But a disparity in age always seems to create a fly in the ointment when it comes time to do some business transition planning.

When insurance ledgers are run in anticipation of insuring for a buy-out in the event of death there is often sticker shock over the difference in cost between coverage for the young ‘un and the old fogie.
 
Clients expect some spread in cost due to age, but not that much – and it doesn’t help that the older proposed insured’s medical history isn’t as positive as it used to be (after all, you generally don’t use a cane because there has been an improvement in health).
 
If properly addressed this bump in the road shouldn’t be a problem. Assume a case where the partners will buy each other out with policies they own on each other on which each will pay the premium.
 
Consider:
 
  • Because the need for coverage is a measurable period of time that is less than life expectancy, term insurance can be used to considerably lower cost up front. And it is usually eligible for conversion if the policy is needed longer for any reason.
  • The higher premium burden of the younger partner can be neutralized by double-bonusing the cost of coverage to both. This equalizes the expense by creating a zero after-tax outlay and the business is now seen bearing the overall cost of the transition plan.
  • After that, focus on the benefits each is to derive from the agreement: either a) the assurance that their heirs will receive a fair price in the form of cash for the business interest, or b) the assurance of funds to buy out a deceased partner and future full ownership of the business. What each partner derives from the buy-sell is exactly the same, exactly what they want, and exactly what they need.
An uninsurable partner creates different problems, but policy cost due to mere differences in age or insurable health should not be an objection.
 
Two other reasons in younger women’s top ten are that an older husband will introduce them to a whole previous generation of chick flicks (Thelma and Louise, Steel Magnolias and Breakfast at Tiffany’s), and he can help with homework.
 
Contact us with any and all questions that come up in buy-sell planning for clients of any age.
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Buy-Sell Redemption Agreements – There’ll Be Some Changes Made!

There’ll be a change in the weather
And a change in the sea
And from now on there’ll be a change in me
My walk will be different
My talk and my name –

It was a bit before my time, but you can go on YouTube and call up the sultry singer, Julie London, performing the Overstreet/Higgins song, There’ll Be Some Changes Made.  And if a business redemption agreement could carry a tune, this is what most would be singing in response to the recent United States Supreme Court decision in the case of Connelly v. United States.

The Connelly brothers owned a building supply company and had a business transition agreement where, upon death, the company would redeem and retire the shares of the deceased at an agreed price.  The company owned life insurance on both to fund the redemption. 

Both assumed, along with just about everyone else, that the receipt of the death benefits from the company-owned policy would not inflate the fair-market-value of the business for death tax purposes.  Rather, any increase would be offset by the company’s obligation to purchase the deceased owner’s interest. 

SCOTUS did not agree.  The Court of Last Resort ruled unanimously that a business’s obligation to redeem a deceased owner’s interest is not necessarily a liability that reduces the business’s value for purposes of the federal estate tax.  Consequently, death benefits received on a company-owned policy increased the business’s fair-market-value by the same amount, any agreement to redeem the insured’s interest notwithstanding!

Much commentary is sure to follow, but consider a couple initial thoughts that your business-owning clients should discuss with legal and tax counsel:
  • All existing redemption agreements funded with business-owned life insurance should be reviewed.
  • If a currently funded redemption arrangement will result in unfavorable increases in death tax, perhaps structuring the business transition under a cross-purchase arrangement might prove more beneficial.
  • Opting for a cross-purchase buy-out will require attention to avoid adverse income tax problems if ownership of any existing life contracts is changed.

It is worth reviewing the first three pages of the Connelly decision HERE.  Then call with any questions you have concerning clients and their current business transition plans, and those who are or should be implementing buy-out arrangements.  Contact Tom Virkler at 706-614-3796 or tom@cpsadvancedmarkets.com

For What It’s Worth:  As it will do, YouTube will call up related Julie London videos including the old Marlboro commercial in which she sings and lights her partner’s cigarette in a rather come-hither manner, quickly getting the whole viewing audience smokin’.  Connelly v. U.S. may soon make redemption agreements about as scarce as those cigarette television ads!

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Premium Dollars from Tax Savings – Replaying the Hand with Form 1040

In our everyday talk we depend on idioms more than we realize.  These expressions, whose understood meaning have nothing to do with their strict definitions, allow us to make a point more quickly, more directly, or more diplomatically.  And the world of common playing cards is a fruitful source of often-used idioms.

Consider:  Having someone at a distinct advantage suggests that we hold all the cards.  And it is to our benefit if we don’t overplay our hand.  We keep our intentions hidden by holding those cards close to our vest, or by keeping an ace up our sleeve.  Closing the deal might require that we lay all our cards on the table with the risk that all might still collapse like a house of cards.

Taxes are an irritating presence in our lives.  It often seems the IRS is playing against us with a stacked deck. 

But part of the problem may be that we aren’t playing with a full deck when it comes to taking advantage of various tax reduction strategies. 

And a wise advisor who can assist in this will generate tax savings using the previously unrealized funds to pay premiums for much-needed insurance coverage.

And while we must play the hand we are dealt, a good carrier marketing piece is available to help your client, through a simple line-by-line review of their Form 1040, to play future hands more profitably and, perhaps, replay a past hand finding tax savings in an earlier filed return.

Available upon request, the brochure guides you and your clients through their Form 1040 (based on the 2023 versions) allowing for assurance that all available deductions were taken last year and providing suggestions how taxes might be reduced for the current year.

Contact Tom Virkler at 706-614-3796 or tom@cpsadvancedmarkets.com about access to the brochure and arrangements for a scheduled call with you, your clients, and – if needed – clients’ legal and tax advisors.

For What It’s Worth:  During the 1930s the U.S. Playing Card Company produced a deck with five suits for use when playing contract bridge, all to introduce new strategic possibilities to the popular game.  The fifth suit was eagles, and the color was green.  But the increased complexity proved unpopular, even among more talon-ted players, so the upper-deck was discontinued.

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You Find the HNWs – We’ll Make the Case for You!

There’s an old story about the moving men who had no trouble getting the grand piano onto the front porch but couldn’t get it through the door into the living room.  It is a pretty funny tale, but I don’t have time to elaborate now.

Only to say, that advisors often encounter a similar circumstance when they have the ear of a high-net-worth client, but don’t know  quite how to proceed with a plan for them to save, literally, millions of dollars in estate taxes before the lifetime exemption drops by 50% at the stoke of twelve on January 1, 2026.

Because proper planning can save your wealthy clients so much money, and because the unavoidable tax liabilities can be funded easily and economically with life insurance, this is one piece of furniture you want “in the house!”

And we will help it happen by clearly addressing with you and them all the common questions most have concerning “high exemption planning,” all to prepare for the eventual meetings with tax advisors and legal counsel – and all before it starts costing anyone any money! 

We know they will ask. . .
  • How much can using the full high exemption really save me?  We will simply and clearly show how the $13,610,000 exemption can save your client over $4,000,000 in taxes in 20 years versus the reduced exemption after 1/1/2026.  Both exemptions can save a married couple almost $9,000,000!
  • What if I gift the full exemption and Congress chooses not to have it reduced?  We will explain how simply loaning the assets to an irrevocable trust allows your client to easily reclaim them if the exemptions aren’t lowered.  If the reduction is to occur the debt can be forgiven and the assets are removed immediately from the taxable estate.
  • Do I have to give up control of the gifted property?  We will explain the common practice of holding assets in a Family Limited Liability Company with voting and non-voting interests.  Your client simply gifts the larger non-voting portion while holding onto the voting share and retaining complete control of the FLLC.
  • Can the benefits of any gifted property be retrieved if needed later?  Yes, if your client is married. We will explain how the assets can be transferred to a trust in which the spouse has a lifetime interest with broad access, if needed, but not have them includible in either spouse’s estate at death.

The prospects are single clients worth north of $7,000,000 and married couples with a combined net worth over $14,000,000.  Make an appointment with us to get on a conference or Zoom call with your high-net-worth clients.  Contact Tom Virkler about arrangements at 706-614-3796 or tom@cpsadvancedmarkets.com.

For What It’s Worth:  Concert grand pianos are the largest moveable musical instruments.  They reach 9-1/2 feet in length, weigh up to 1400 pounds and usually cost between $100,000 and $200,000.  Despite it being a small and simple upright model, Sam’s piano from the movie Casablanca was auctioned in 2014 for $3,410,000.

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Executive Bonus With Cost Recovery!

Okay, let’s start with a few premises and see where it leads: Love is blind/ Marriage is an institution/ Love and marriage go together/ Therefore, marriage is an institution for the blind.
 
I don’t know if Aristotle would approve of the structure of that syllogism, but it does illustrate that when you put two things together you can sometimes get surprising results, for better or for worse.
 
Take, for example, the three most common non-qualified benefit scenarios that usually involve life insurance: deferred compensation, split dollar, and executive bonus.
 
For simplicity and ease, an employer will usually choose an executive bonus arrangement, i.e. the executive buys insurance, the employer pays for it and reports the amount each year as taxable compensation.

The problem is, the employer often wants recovery of all or part of the plan cost if the executive cuts and runs early.

It takes a little more work and costs a little bit more, but this can be accomplished by putting two things together, for the better in this case. Try treating a split dollar plan like an executive bonus arrangement that turns over control of money paid to the executive only according to the terms of an agreed upon “vesting-like” schedule.
 
Here’s how it works:
 
Employer-paid premiums in the executive-owned policy are treated as loans. Each year the executive must recognize as income only deemed interest on the loan, usually to the tune of the AFR rates. This is an additional tax cost incurred by the executive. But current rates are so low the amount is usually not significant. Besides, if the employer chooses, the extra tax cost can be “zero-ed out” with a bonus. The employer’s rights to recover company cash from the policy if the executive goes are secured by a collateral assignment.
 
As time goes on, and according to the terms of the agreement, the loan is forgiven in increments. The amount of each reduction in the loan is reported as income to the exec and deductible to the employer – the same as an executive bonus plan.
 
As the loan drops, so does the amount of imputed interest recognized by the executive. Once the loan is reduced to zero the collateral assignment is released and we are back to a plain old vanilla executive bonus arrangement.
 
Sound logical? How about this: Some philosophers have three vowels in their name/ Socrates has three vowels in his name/ Therefore, Socrates is some philosopher. If you don’t really care then try this: All human beings are different/ All apathetic people are indifferent/ Therefore, no apathetic person is a human being.
 
Call with your next executive benefit case and we’ll show your client how they can assure recovery of funds if the participant leaves, without a whole lotta fuss.

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