In IR 2017-123, IRS Commissioner John Koskinen reported significant success in reducing personal identity theft. From January to May of 2016, 204,000 taxpayers reported being victims of identity theft. However, for the first five months of 2017, the number of identity theft victims declined 47% to 107,000 taxpayers.

Koskinen stated, “The IRS, state tax agencies and the tax community have worked hard to turn the tide against tax-related identity theft. We are making progress in protecting individuals, but still have more work to do, especially in the business tax area and involving tax professionals. Continued lapses in simple security measures can happen in tax professional offices and other businesses as well as at home.”

As Koskinen observed, the news was different for identity theft involving business related tax returns. There were 10,000 reports of business returns with identity theft issues in the first five months of 2017. The number of similar incidents in 2016 was 4,000 for the full year. Cybercriminals continued to target tax professionals. Most of the fraudulent income tax returns were for corporations, trusts or estates.

Koskinen noted, “It is especially difficult to identify any tax return as fraudulent when criminals are using information stolen from tax preparers. The stolen data allows criminals to better impersonate the legitimate taxpayers.”

In the information letter, the IRS updated recommended steps for business protection against identity theft.

1. Education – Explain the dangers of phishing activity to all staff. Warn them to be especially wary of emails that claim to be from clients.
2. Software – Install and use excellent quality security software. Security software should automatically update each day.
3. Passwords – Use strong passwords. These will have multiple characters, upper and lowercase letters and numbers.
4. Encryption – Use appropriate encryption methods for sensitive data. Back up your data every day and retain backups off site.

“Big Six” Agreement on Tax Reform

In the midst of uncertainty about health care reform, on July 27 six leaders of the House, Senate and White House claimed agreement on the provisions of tax reform. The six leaders were House Speaker Paul Ryan (R-WI), House Ways and Means Committee Chair Kevin Brady (R-TX), Senate Majority Leader Mitch McConnell (R-KY), Senate Finance Committee Chair Orrin Hatch (R-UT), Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn.

Their release stated, “We are now confident that, without transitioning to a new domestic consumption-based tax system, there is a viable approach for insuring a level playing field between American and foreign companies and workers, while protecting American jobs and the U.S. tax base. While we have debated the pro-growth benefits of border adjustability, we appreciate that there are many unknowns associated with it and have decided to set this policy aside in order to advance tax reform.”

The stated goals of the group of six leaders are to reduce individual and business taxes “as much as possible.” There would also be lower rates on passthrough businesses, even though they are now dropping the plan for a border adjustment tax.

A key issue is whether or not there would be expensing of new equipment. Chairman Brady has been an advocate of the border adjustment tax as a way to pay for this provision. He stated, “That means that expensing is an enormous pro-growth provision. You get some the greatest bang for the buck in growth from allowing those business to have a zero tax rate on new investment. Unprecedented expensing means that we recognize the growth aspects. We are pushing towards more than it is in the tax code today, and as far as we can, because that will drive productivity, wages and economic growth.”

The statement did not explain whether or not it will be possible to find $1 trillion in new revenue to cover expensing. There is no specific reference to any tax increase.

Ways and Means Committee Member Lloyd Doggett (D-TX) published a release and highlighted the challenges facing Chairman Brady in drafting a bill without the border adjustment tax. Doggett stated, “By finally abandoning their ill-advised border adjustment tax, Republicans have created a trillion dollar hole in their plan.”

Editor’s Note: The border adjustment tax was very unpopular in the Senate. The challenge for Brady is to release a bill in September without this revenue. If he continues to plan to release a revenue-neutral bill, then there will have to be a limit to expensing and probable smaller rate deductions in business, personal and corporate taxes. It is unknown whether there still will be a plan to repeal both the alternative minimum tax and the estate tax.

Tax Reform and Giving to Colleges

On a July 20 webcast by the National Association for College and University Business Officers, Brian Flaven of the Council for Advancement and Support of Education (CASE) discussed the potential effect of tax reform on charitable giving to colleges and universities.

There are two provisions of the White House plan that may impact gifts. First, the top rates may be reduced. Upper-income donors in 2017 may save as much as 39.6% in federal taxes on their charitable gifts. If the top personal tax rate is reduced to 33%, their tax savings will be lower.

However the larger issue is the White House proposal to double the standard deduction. This change will simplify tax-filing for many Americans because they will no longer be required to itemize. The downside for nonprofits is that charitable gifts are the largest itemized deductions for many senior Americans.

Currently, about 30% of American taxpayers itemize. By itemizing deductions, taxpayers are able to claim and deduct their charitable gifts. If there is a new tax bill with a much larger standard deduction and repeal of deductions for state and local taxes, the number of itemizers may be reduced from 30% to as low as 5%.

Flaven notes, “We have really been encouraging the Administration and Congress to consider the universal charitable deduction as a way to help offset some of these unintended negative consequences on charitable giving that result from the doubling of the standard deduction and other aspects of tax reform.”

The CASE solution is to move charitable giving “above the line” and enable taxpayers to benefit both from charitable deductions and the standard deduction.

If the charitable deduction were moved above the line, CASE predicts that there would not be a decrease in giving, but there could be an increase of $4.8 billion in charitable giving each year.

Applicable Federal Rate of 2.4% for August — Rev. Rul. 2017-15; 2017-32 IRB 1 (19 July 2017)

The IRS has announced the Applicable Federal Rate (AFR) for August of 2017. The AFR under Section 7520 for the month of August will be 2.4%. The rates for July of 2.2% or June of 2.4% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2017, pooled income funds in existence less than three tax years must use a 1.2% deemed rate of return. Federal rates are available by clicking here.

Your Family Letter – Memorial Services

A family letter is a key part of a good estate plan. It is much more personal than many of your estate documents. A family letter allows you to share your heart and show appreciation and gratitude to family members. During a time when family members are grieving, it also helps them to complete many practical steps to protect your property.

The family letter may have up to ten different sections. Each section will cover an important but separate topic.

Estate Data

Your estate organizer usually has four parts. It will explain the family names and key information, identify your attorney, CPA and other financial and health advisors, cover all of your assets and financial information and outline your estate planning choices.

The estate organizer may be printed or you may use an online version. Your family letter should explain where the information is located. If you are using an online estate planner, it’s important to know your account name and password so the information will be available.

Important Documents

Your important documents will generally be safeguarded in three different ways. First, many individuals have a safe deposit box. The safe deposit box typically holds birth certificates, death certificates, degrees and other legal agreements, marriage or divorce documents, military discharge records, property deeds, a personal property inventory, stock and bond certificates and vehicle titles.

Second, you may have a fireproof box at home. This box will frequently include your insurance policies, your living will, medical power of attorney or advance directive, trust documents and your will.

Third, there are some items that should be left with your attorney, friend, agent or another trusted person. These are items that may be needed while you are still living or will be necessary very soon after you pass away. These documents (or copies of documents) could include your financial power of attorney, a durable power of attorney for healthcare or advance directive, your living will, trusts and your will.

Accounts and Passwords

Because an increasing number of records and information are retained online in personal accounts, you will want to be certain that your personal letter lists all accounts. You may decide to include passwords with the personal letter. Alternatively, if you are entrusting all of this information to a specific person or other location, that should be identified.

With the rapid movement to online banking, online mutual funds and securities accounts, donor advised fund accounts, health savings accounts and your email accounts, you may have six to 10 accounts with various passwords. It will be important to have all of this information recorded.

Your Family History

While your estate organizer will include basic information about you and your family members, there is an excellent opportunity in your family letter to discuss your family history. This can include a few short paragraphs that give the names and background of your parents. List all of their children or other key relatives in your family. Your history may discuss marriages, divorces and any blended family relationships. Finally, the family history will show the date of death for persons who have passed away.

Family history can include discussions of your activities, interests and career. It enables all of your extended family to have a good picture of your entire life.

Care for Children, Grandchildren or Pets

If you are responsible for any children, grandchildren or pets, this is an opportunity for you to explain your plan for their care. While your estate planning documents will normally appoint guardians for your children or grandchildren who are under your care, it still may be beneficial for the guardian to receive recommendations from you on their education and other areas of development that you understand very well. If someone is to care for pets, you may have recommendations on the way in which that is done.

Memberships

You may have memberships in a number of organizations. Some memberships, such as those in a golf course or in a club that purchases various types of sporting event tickets, are transferable to heirs. It would be helpful to your family for you to list any memberships that you have so they can handle them properly.

Care of Your Body

When you pass away, your body may be in the custody of a medical center or nursing home. If you have previously decided to make any organ donations, it is helpful to explain that decision in your family letter. The requirements for making organ donations are typically covered under state law. In many cases, decisions on organ donations are made when you sign your living will or advance medical directive.

Funeral or Memorial Services

The cost of many funerals now exceeds $10,000. If you would like to assist family members in the decisions surrounding your funeral or memorial service, the family letter is an excellent way to do so.

First, your family will need to decide whether to have a burial in a cemetery with a casket or to use cremation services and an urn. You may have personal or religious reasons for preferring one or the other.

With a casket and burial in a cemetery, your family will generally make use of a funeral home. Because there now is significant competition in the industry, funeral homes are starting to offer advance prices and package services. If you desire a specific range of services, type of casket or prefer not to be embalmed, those directions are helpful to your family.

There are funeral consumers’ alliances in many locations. Your family may find assistance and guidance on www.funerals.org. This guidance may help them make good decisions during a very difficult time in the midst of grief over your loss.

If you are a veteran, your family may want to contact the Department of Veterans Affairs. You may qualify for a gravesite at no cost in one of the 130 national cemeteries for veterans and their spouses.

Obituary

In your funeral or memorial service, there will be eulogies. It is also customary to have a printed description of your lifetime. This will frequently include your basic history, awards, achievements, military service and lifetime employment. If you have specific requests for information to be included in the obituary, it is helpful to your family to give them guidance. You may have certain principles or values that are important to you that you would like to share through the obituary. This is an opportunity for you to communicate your values to the public.

Final Words and Blessings for Family

Your family letter may conclude with a word of blessing. It is a tradition in many cultures for the elders to provide a blessing for the next generation. This is frequently done when the elder is still living, but certainly your family letter provides a similar way to bless your children, grandchildren, nephews, nieces and other family members.

Your final words of wisdom and blessing for family members will be of great comfort as they grieve for your loss. It is an appropriate and fitting way to conclude your family letter.

A family limited partnership (FLP) is usually created by a husband and wife. It has several purposes. An FLP can save estate taxes and permit transfers to family members. While it is uncertain what the future exemptions and estate tax rates will be, large estates are nearly certain to face major taxes in the future. The FLP is a favored method for reducing estate tax.

Another benefit is protection of assets. The FLP interests can be given to children and other relatives. It is very difficult for any creditor to reach FLP assets. The protection also extends to limiting rights of in-laws if a child or grandchild is married and later divorced.

Parents typically are interested in transferring value but retaining control. With an FLP, they can retain the general partnership interest and control the management of the FLP assets.

There are several considerations with an FLP. First, there are legal and accounting costs to create the FLP. In addition to these costs, property must be transferred. There may be transfer costs or property tax consequences upon the funding of the FLP.

Because the FLP interests are frequently given to family members, there will need to be an appraisal by a person who holds himself or herself out to the public as an appraiser. In addition, the selected appraiser must have appropriate credentials.

Finally, the parents will need to consider succession. At the point they no longer wish to manage the FLP, a child or other person will typically assume the role of general partner.

How the FLP Works

Assume that Bill and Alice have been successful real estate investors. They hold a number of parcels of development land, commercial buildings and apartment buildings. Bill and Alice would like to maintain control of their investment assets, but would like to start transferring equity to children.

An excellent solution is to create the “Jones FLP.” Bill and Alice will be 1% general partners and 99% limited partners. In some circumstances, children already have assets and may contribute them in exchange for appropriate percentages of the limited partnership interest. But in the case of Bill and Alice, they transfer all of the assets to the FLP.

Bill and Alice transferred 11 parcels of commercial real property to the partnership. These 11 parcels include development land, commercial buildings with leases and apartment buildings. After transfer of the real estate, they employed a qualified appraiser to value the limited partnership interests.

After the appraisal was completed, Bill and Alice then begin to transfer limited partnership interests to their children and to trusts for grandchildren. The appraiser reduced or discounted the gift values due to the lack of control and for lack of marketability. Because the limited partners only own a small interest in the partnership and cannot force distributions, they do not have a high level of control. The appraiser determined that there is an 18% discount for the lack of control.

Because a limited partnership interest in real estate also makes it very difficult to sell at full value, there is a discount for lack of marketability. The qualified real estate appraiser determined that another 17% discount on total value is appropriate for lack of marketability. The two discounts together add up to a total of 35%.

When Bill and Alice make gifts of limited partnership interests to children and to trusts for grandchildren, they make use of both their present interest annual exclusions and a portion of each person’s gift exemption.

Over a period of years, Bill and Alice were able to transfer a substantial portion of the limited partnership interests to family. However, because they still own the general partnership interests, they control and manage the real property. After a majority of the limited partnership interests are transferred to children, the growth in value of the assets will largely benefit their children rather than Bill and Alice.

Through this method, they can reduce future estate taxes and also maintain control. In addition, because it is difficult for the children to transfer the assets or for spouses of the children to acquire control, there is a substantial level of asset protection.

Creditors of the children are very restricted in their ability to gain control of the assets. Generally, under most state law, a creditor can only attach rights to distributions from the partnership. This makes it very difficult for any creditors to acquire a significant right to partnership assets.

Benefits and Disadvantages of Jones FLP

There are several specific FLP benefits that Bill and Alice appreciate. First, they are general partners and they have control. Second, because of the discounts they are able to make much larger gift transfers with little or no gift tax. Third, the assets are quite well protected from any creditors or spouses of the children. Fourth, assets transferred to the trust will be outside the probate process. While federal estate taxes will apply, even those will be greatly reduced. Fifth, the centralized management of the real estate property can be transferred to a successor general partner when they are ready to retire. This will enable the assets to be preserved long-term for the benefit of the family.

There are some disadvantages of Jones FLP. First, there is the cost involved in creating the documents, transferring the assets and maintaining all of the business records. Second, if there is excessive control by Bill and Alice, then the IRS may claim that they in effect have too much control over the assets. In that case the IRS may assess an estate tax based on the full value of the assets in their estate, including the value of the FLP assets.

Third, if there are too many limits on sale of the FLP interests by children, the IRS may claim that there is no “present interest” annual exclusion. For transfers that exceed the lifetime gift exemption, the IRS may assess a gift tax. Finally, FLP valuations by the appraiser may be questioned by the IRS. That could lead to an audit and litigation with the IRS.

Jones FLP Do’s

There are several actions that should be taken to make certain that the Jones FLP functions as intended.

1. Written Document – The written FLP document must state all of the rights and duties of the general partner and of the limited partners.

2. Business Licenses and Tax ID Numbers – The partnership must be treated like a business entity. There may be state business licenses and it will be necessary to obtain federal and state tax ID numbers for the partnership.

3. Title Transfer – To function properly, the partnership must receive title to Bill and Alice’s real property. They will deed the property from themselves as individuals to the partnership. There may be transfer taxes as a result of those deeds. However, it is essential that the title be properly transferred to Jones FLP.

4. Retain Assets – Bill and Alice must retain sufficient assets for their lifestyle. If they transfer all of their assets into the Jones FLP, then the IRS will claim that this is not a business entity but is simply a personal entity. If it is managed as a personal entity, Bill and Alice’s estates could face a very large estate tax on the full value of the assets.

5. Avoid Comingling Assets – Jones FLP needs to have a proper business purpose and be conducted like a business. If business assets and personal assets are comingled, then the IRS may claim that this was not treated like a business.

6. State Filing Taxes – There may be state franchise taxes or other taxes that apply to Jones FLP. The FLP should comply with all state requirements.

7. Federal and State Income Taxes – While partnerships pass through income and deductions, it will be necessary to obtain the assistance of a CPA who is knowledgeable about partnership taxes and tax returns.

8. Create FLP While Still Healthy – There have been “deathbed” FLPs created that the IRS contested. It is preferable to create Jones FLP while Bill and Alice are still healthy. It can then function for a number of years to demonstrate the business purpose of maintaining and operating their real estate enterprise.

FLP Don’ts

1. Transfer All Assets – If nearly all assets are transferred to the FLP, especially on the deathbed of the donor, then it appears that this is not a business investment but merely a substitute estate planning strategy. The IRS may contest the FLP discounts and could potentially win a claim for a very large tax deficiency.

2. Transfer Family Home or Vacation Home or Personal Assets – The FLP is a business enterprise and family homes and personal assets should be retained outside the FLP.

3. Unlimited Promise to Parents – If the children promise the parents that they can “take assets whenever needed” from the FLP, then the IRS may deny the discounts on the ground that the children and parents are not treating it like a business entity.

4. Do Not Omit Business Meetings – The appropriate business meetings, minutes and reports should be filed to indicate that the FLP is being operated as a business entity.

FLP-Lead Trusts

If Bill and Alice make currents gift to charity, a very effective way of maximizing the benefits of the FLP is the “double discount” combination of a family limited partnership and a lead trust.

The first discount is due to the transfer of assets into the FLP. Bill and Alice could transfer $4 million in real estate assets into a family limited partnership. While the underlying rent or income from the assets could continue (and it is best if the assets have no debt and therefore no debt payments), there is a substantial discount for lack of marketability and for minority interest. This discount could reduce the FLP value from $4 million to $2.5 million.

If the limited partnership interests in the family limited partnership are then transferred into a lead trust, there is a second deduction. The deduction is based on the present value of the income paid to charity. While Bill and Alice thought about a 6% payment on $4 million in assets or $240,000 per year to charity, this percentage of the discounted $2.6 million value is much higher. Therefore, the gift tax charitable deduction is much more substantial. With a lead trust that lasts for approximately eight years, they are able to obtain sufficient “double discounts” to transfer $4 million in assets. With the use of part of their gift exemption, there is no gift tax.

The benefit of the FLP-lead trust is that Bill and Alice are able to provide a very major inheritance for their family. They are significantly leveraging the use of their gift exemptions. This allows a reasonably short period of time for the payments to charity with a very large inheritance to family members at the end of that time.

Because the assets transferred to family members have a low cost basis to Bill and Alice, the children will receive FLP assets with a low cost basis. However, children could then use a tax-free sale and unitrust strategy to sell the appreciated assets with zero tax.

Bill and Alice are very pleased with this strategy and believe that this is going to be an excellent addition to their FLP plan.

FLP-Lead Trust-Unitrust

After attending a weekend conference where they were encouraged to think about the best ways to assist children in “becoming better persons,” Bill and Alice think it would be good for the children to stretch out the inheritance. They also believe that income and capital gain taxes for the children will continue to increase. Ideally, they would like to add a method or plan that would stretch out the inheritance and enable the children to reduce their future income and capital gain taxes.

One strategy to do that is to add a 5% charitable remainder trust to the end of the FLP-LT plan. The plan then starts with the Jones FLP interests that are transferred into a lead trust for eight years. At the end of eight years, the $4 million in assets may have grown to a larger amount. Assuming that they have grown to $5 million in value, then the two children of Bill and Alice would each benefit from a distribution of $2.5 million in assets to a 5% unitrust.

The unitrust would last for the life of each child. Each 5% unitrust funded with $2.5 million could produce an additional $125,000 of income for the life of the child. Because the trust may earn more than 5%, there may be inflation protection of this amount for the life of the child.

There are two major tax benefits for the child. When the appreciated assets of $2.5 million with low basis are transferred to the unitrust, they can be diversified tax free. In addition, earnings above the 5% payout compound tax free for life in the trust. Both of these benefits will save tens of thousands of dollars of income tax for each child.

Bill and Alice are delighted with the unitrust addition to their plan. The FLP-LT will leverage their transfers. After eight years, the lead trust principal is transferred to the unitrusts for the children. This will produce a long-term inheritance that they think is very helpful in encouraging the child to be a productive citizen.

In addition, there will be large savings in capital gains tax and future income tax for the children. With the belief of Bill and Alice that capital gain and income taxes will only increase in the future, these savings are a welcome addition to the overall plan.