Asset Protection Planning is not hiding assets or planning to perpetrate a fraud on your creditors.  It is designed to work with full disclosure to your creditors.  It is intended to be a professional, ethical and legal means to decrease the likelihood that your assets could be placed at risk of loss. Asset Protection Planning relies on the laws of Indiana, other states, the United States and sometimes foreign jurisdictions to lawfully provide these protections.  And it is also a part of your overall integrated estate plan.  Asset Protection Planning is generally tax neutral, meaning that when properly implemented it will neither save nor cost you income taxes.

Regardless what you may have heard or read, no Asset Protection Plan is foolproof, and it is unlikely to protect all of your assets from every type of risk. Instead, each technique offers varying degrees of protection.  What a good Asset Protection Plan does is provide you with significantly more protection than you had before you created a plan.

Asset Protection Planning is often accomplished by transferring assets from a less protected form of ownership to a more protected form of ownership.  As a common example, business owners and investors typically own businesses and property through corporations or limited liability companies offering limited liability to the owner, thus protecting the owner from the liabilities of the entity.

Asset Protection Planning is not new and generally is not exotic.  It entails developing strategies and structures uniquely designed to a particular situation and type of risk exposure, often including some of the following techniques:

• Risk Shifting/Avoidance in Contractual Matters
• Insurance (general liability, products liability, premises liability, malpractice, etc.)
• Limited Liability Entities
• Protected Retirement Plans
• Charging Order Protections Offered by LLCs
• Equity Stripping
• For Couples in Indiana, Holding Real Estate as Tenancy by the Entirety
• Domestic and Foreign Limited Liability Companies
• Foreign and Domestic Asset Protection Trusts
• Exemption Planning
• Gifting
• Premarital Agreements
• Certain Types of Trusts Used in Estate Planning

Asset Protection Planning is a vaccine, not a cure.  In other words, in order for most types of Asset Protection Planning to work, the plan must be implemented before a creditor asserts a claim against you.  Once a creditor asserts a claim against you, it is generally too late to implement an Asset Protection Plan.  It is also essential to remember that a generic off-the-shelf solution rarely works, and often do more harm than good.  Instead, the plan should be custom designed to integrate into your business, investments and other circumstances.

If you are interested in learning more about how Asset Protection Planning could benefit you and your family, please do not hesitate to contact Dennis Voelkel, Esq.  at voelkel@indiana-attorneys.com.

Beginning July 1, 2010, Homeowners Associations will be subject to new rules governing the display of political signs.  While most covenants prohibit signs, this law provides a standard to match that prohibition with freedom of speech.

Generally the law allows an Owner to display political signs on the grounds of property owned by that person or in the window of the person’s home, during the period from 30 days before an election until 5 days after the election.  The law does allow an Association to adopt rules to restrict the number and size of such political signs.

This law does not authorize the display of political signs on the Association’s common area.  The law specifically authorizes the Association to remove a sign that violates the rules provided in the statute or reasonably adopted by the  Board.

In a condominium or a zero lot-line townhome community, this law will allow Owners to display signs in their windows, but, absent board approval, it will not allow signs to be placed in the lawns, which are common area.  In a single family home community, the law will allow signs to be placed on the Owners lawn.

If the Board adopts rules governing such signs, the rules must be distributed to the Owners.  The rules may limit the number, but the law implies that more than one sign should be permitted.  The rule may limit size, but the law requires that the rule allow signs at least as large as assigns commonly displayed during election campaigns (the same size as a typical for sale sized signs)

If you have any questions, or if we can be of help drafting your rules, please contact Steve Buschmann at buschmann@indiana-attorneys.com

Risk is part of everyday life.  In both your business and personal life, you evaluate risk in any relevant decision you make.  Is this car safe?  Is this food healthy?  Will I lose money on this investment?  These are examples of how we analyze risk in our day to day lives.  For the small business owner, there may be less insulation between risk and possible loss than for a peer whose earnings come in the form of a salary paid by a larger corporation.  Hence, considering risk and ways to limit it should be part of the business owners’ regular review of the health and stability of their enterprise.

Marketing and advertising can help a small business focus on growth by finding more clients and creating either a broader or more profound presence in the marketplace.  However, a natural consequence of growth is increased risk exposure.  New clients or customers bring the possibility of financial rewards through serving their needs and sending those clients out to act as future referral sources.  But, that same new customer also represents an additional point of exposure to risk, as does a new vendor, new employee, new business partner, and so on.   A dishonest partner or sloppy employee can destroy a business in a fraction of the time it took to build it.  So, as you think about marketing and growth strategies, it is also important that you balance it with risk management strategies, as well.

Books on the topic of ‘risk management’ fill several shelves at the local bookstore or library.  However, even with all of the available analysis on the topic, good risk management can be accomplished using a basic three-part method; forming and operating a limited liability entity, using third-party insurance, and implementing sound business practices.  While there is no way to eliminate risk associated with running a business, implementing this three-part method will reduce significantly an owner’s personal liability for claims arising against the business.  What follows is a brief analysis of how each part works on its own and together.

Forming and Operating a Limited Liability Entity:

If you are operating a business that interacts with the public in any way, then your business has enough risk exposure to justify forming a limited liability entity.  Put simply, if you are operating a business, you should incorporate.  The primary benefit of forming a limited liability entity is that, when formed properly, state law recognizes that entity as a wholly separate legal ‘person’ distinct and separate from its owners and organizers.  The effect of this ‘legal fiction’ is that when the entity is properly formed, organized, and operated, the claims and liabilities arising against the entity will not pass through to the owners of the entity.  Those liabilities will be attributable to the entity alone.  While there are several forms of limited liability entities, such as S-Corporations, Limited Liability Companies, and Limited Liability Partnerships, each accomplishes the same basic purpose of shielding the personal assets of the entity’s owners from the creditors, judgments, or other obligations of the entity.

Third Party Insurance:

After forming a limited liability entity to shield a business owner against personal liability for business risk, the next step is to pool the business’s risk with other businesses and individuals.  This is done through purchasing insurance.  Buying insurance is the equivalent of purchasing admission into a club where all the other members are risk conscious businesses and individuals.  By agreement a portion of every members’ ‘admission’ is pooled to pay potential claims arising against the members.  If a limited liability entity is a shield protecting business owners from personal liability, third party insurance either funds the legal defense of the entity or pays claims that arise against it.  While limited liability entities protect business owners from losing their personal assets to business claims, third party insurance protects the business from losing business assets to claims.  Using an entity without insurance would make investment and growth of a business a moot point – while the owner’s home, car and personal funds would be shielded by the entity, only one major judgment against the business would wipe out all its assets without the backing of insurance.

Sound Business Practices:

Using sound business practices runs the gamut of sophistication for operating a business; from developing and refining detailed internal safety protocols to using good old-fashioned horse sense.  While incorporation and insurance are reactions to unseen risks, developing good business practices are proactive methods to steer clear of risks before they become liabilities.  So many business practices are industry-specific; it would be impossible to cover all of them for the purposes of this review.  However, some areas which affect almost all businesses are employees, premises, government, vendors, and customers.

For employees, some suggestions are using good screening and hiring practices, uniformly enforcing company employment policies, investing in training, and retention of quality workers.  For premises, some suggestions are complying with local licensing and permitting, keeping the premises safe for customers and employees, and developing a security or loss prevention plan.  Regarding government, know the regulations affecting your industry, especially in the area of taxation.  When dealing with vendors, know the markets for competitive prices, use good written contracts, and take the time to learn about your vendors to develop trust in their product, service and reputation.

Finally, and most importantly, for customers, use several of the previously mentioned techniques such as providing safe premises and using good written contracts where appropriate (or required by law).  But moreover, work to develop and maintain a reputation for excellent customer service.  In the most basic terms – happy customers don’t sue. Though it seems an oversimplification, customers, vendors and employees who are treated with professionalism, respect, patience, and fairness, even in the midst of serious disagreements, are less likely to turn to litigation (or violence!) to resolve the dispute.  While this is entirely within the control of a business owner, it is amazing how frequently it is overlooked.

If you are operating a business, even as a supplement to another job, or are otherwise self-employed and not using the techniques mentioned above, you could be compelled to pay the obligations of the business out of your personal bank account, with your car, a family heirloom, or even your home.  This should be sobering.  If you have employees, are you able to monitor them at all times?  If you are monitoring them at all times, why are you doing so?  The point of hiring others to assist you is to delegate responsibility so you can do other tasks.  Because you cannot be two places at once and may not be able to prevent an accident even if you could, you should implement these basic risk avoidance techniques.  Develop relationships with qualified insurance, accounting, and legal professionals.  Fortune 500 companies have insurance, accounting and legal departments; you should not act differently.   In doing so you will be on your way to minimizing risk, protecting personal assets, and improving your business’s chance for future success.  And you might find some peace of mind in the process.

Provisions of a new law governing homeowners associations should not be plowed to the side like last winter’s snowfall. Builders and developers (and occasionally their counsel) can at times discount the importance of their HOA governing documents by recycling forms drafted 20 years ago or using documents obtained from colleagues or competitors that were not even drafted with them in mind.

Not now. On July 1, 2009, a new law went into effect changing how homeowner’s associations (HOAs) operate. Signed into law on May 13, 2009, the new provisions of House Bill 1071 will require all homeowner’s association documents to be written and enforced in compliance with the new law. This will impact residential developments that have not yet incorporated or otherwise adopted governing documents by July 1, 2009, and all new associations created thereafter.

While many changes only apply to newly created associations, an existing association may elect to be covered by the new provisions by amending its governing documents. Other changes, though, will apply to all associations regardless of when created.

Application of the New Law:

The first step to understanding these changes is to understand how the new law is applied. While the July 1, 2009, date is relevant, the act covers any organized entity, incorporated or not, that governs or otherwise manages individually owned residential dwellings. Thus, the act would cover a single family residential development and condominiums, too. However, where the statute provides that the new law’s application is distinctly linked to the subdivision of property, those provisions do apply to condominiums. The reason for this is that Indiana’s planning and zoning statutes specifically provide that condominiums are not subdivisions and cannot be governed by local subdivision control ordinances. Therefore, when dealing with a condominium development regime read the statute carefully to determine if certain provisions are based upon the subdivision of property or not; this will help to determine if those provisions apply to condominiums.

Provisions that Apply to Lien Assessments for All Subdivided Associations:

In 2007, a bill was passed by the General Assembly that curtailed an association’s ability to enforce its lien rights for collection of delinquent assessments. While not fully restoring the potency of an association’s ability to collect delinquent assessments, the new Act makes several improvements that make lien enforcement viable.

The prior law caused HOA liens to expire after one year, thereby forcing associations to either lose their secured claims against the real estate liened or to initiate foreclosure litigation sooner than preferred. The new bill creates some balance by prohibiting an HOA from foreclosing its lien within the first year of being filed, but allows the lien to remain in force for five years rather than expire after one year. The prior law required an HOA to foreclose on its lien within 30 days of being notified by the property owner to do so; the HOA now has one year from the date of that notice to initiate foreclosure. The language of the lien statute is applicable to subdivided land; therefore, it would not alter the lien provisions contained in the condominium statute.

Finally, the new law requires an HOA’s board of directors or other governing body to address an item of business at a regularly scheduled meeting, or a special meeting if one is not scheduled, if the Board is petitioned by at least 10 percent of the members of the association. This provision duplicates requirements of the Indiana Non-Profit Corporation Act of 1981, but now also applies to organized, but unincorporated, associations.

Provisions Applying to Governance of Associations Formed After July 1, 2009:

Several provisions of the new law relating to the operation of associations only apply to new associations formed after July 1, 2009, or existing associations that elect to opt into the law. Opting in requires a majority vote of the members of the association, unless amending the HOA’s existing bylaws require a greater than majority vote. It is unclear from the language of the law if an existing association that opts in retains the ability to opt out later. As a result, an existing association should tread cautiously down the path of opting into the new law. These provisions, except for a contract approval provision, are not linked to the subdivision of land and therefore would include condominiums as well as subdivided developments.

A new association is required to maintain a current roster of all members of the HOA, including the members’ mailing addresses, legal description of a members’ property and e-mail addresses or fax numbers of its members. E-mail addresses and fax numbers may be kept only with the consent of the member.

This roster must be made available to any member upon request and can be used only for association-related business. However, maintaining member privacy once the roster is distributed is not discussed in the statute.

The law requires an HOA to prepare an annual budget to be approved by a quorum of the members. Either the proposed budget or a notice that the proposed budget is available must be sent to the members. In the absence of a quorum, an association’s board of directors may approve an interim budget not to exceed 110 percent of the last approved budget, but, only if the association’s governing document permit such an interim budget.

If the governing documents do not permit an increased interim budget, then the last approved budget can be used as an interim budget until a quorum approves a budget. Further, if a proposed budget results in a change in member assessments, that change must be specifically noted in the budget notice.

Regarding entering new contracts or special assessments for projects, an association is not permitted to enter into any contract, regardless of the budget process, that increases a member’s assessments by more than $500 per year without first holding two meetings regarding the contract. Also, the contract must be approved by at least two-thirds of the members of the association, regardless of the quorum provisions contained in the governing documents.

Likewise, an association may not borrow more than $5,000 or 10 percent of the last approved budget, whichever is greater, unless the debt is approved by a majority of the members. However, this section links the voting rights for such an approval to subdivided property giving each lot or unit one vote. This would not alter condominium voting procedures, as some condominium arrangements do not provide for ‘one unit = one vote’ but set voting, assessments and other rights and responsibilities based on the size of the living unit at issue, thus giving proportionate rights to the owners based on the size of their condominiums. Other than this particular voting provision, condominiums formed after July 1, 2009, would need to conform to all the other new provisions noted.

An association may not suspend the voting rights of any members for non-payment of assessments unless the governing documents provide for such suspension and the member’s assessments are delinquent for more than six months. This provision does not prohibit denying a member access to common amenities, such as association-owned pools or parks, if a member’s assessments are delinquent.

Finally, the act states that “the governing documents must include grievance resolution procedures that apply to all members of the homeowner’s association and the board.” No further guidance is given to what an acceptable grievance resolution procedure is and in what context such a procedure must be employed. By contrast, the General Assembly used the term “grievance resolution procedure” rather than the more legally meaningful “alternative dispute resolution,” which would encompass the realm of mediation and arbitration.

Given the vagueness of the language and until further clarified by either the General Assembly or a court, a grievance resolution procedure could be crafted that simply gives an owner the opportunity to petition the association’s board of directors on an issue or complaint without going so far as to engage the special meeting provisions required upon a 10 percent member petition, referenced above.

Penalties for Non-Compliance:

The new act does not contain any stated penalties for non-compliance. As such, the likely results of non-compliance would be to make the relevant portion – or possibly an entire set – of governing documents unenforceable in Court. A well-drafted set of governing documents should contemplate “saving” the remainder of the document with a savings clause if one provision is faulty, but if poorly prepared, an entire set of documents could be disregarded by a Court due to an error.

Further, if an HOA refuses to comply with certain sections of the act – such as holding special meetings or entering contracts without proper approval if it is required – then those contracts could be declared invalid, an injunction could be entered or a member may be able to bring a civil tort action against the association seeking various remedies, such as general damages, punitive damages or attorneys’ fees.

HB 1071 is the first law that seeks to specifically govern the operation of homeowner’s associations (HOAs). Compliance with it should not be overlooked. As counsel to a builder or developer, you should urge clients to review thoroughly their governing documents and make required changes. Property management clients or builder clients also managing their developments until turned over to the owners must be notified of operational changes on assessment collections, budgeting, covenant enforcement and borrowing, among other things. Take the time to educate your developer or property manager clients on how to comply with this new law and help them avoid becoming a test case on the penalties for non-compliance.

On November 1, 2009, the City of Indianapolis’s new Office of Code Enforcement started its plan review process for Class 1 structures. The term “Class 1 structure” references the Indiana Building Code. Class 1 structures are typically commercial, industrial and multi-family structures, not single or two-family structures. Under this new review process, any new Class 1 structure must undergo a thorough pre-permit review procedure with the Office of Code Enforcement. Prior to November 1, 2009, Class 1 structures in Indianapolis only needed to receive a Design Release from the State of Indiana before submitting a permit application with the City. Under this process, plan review was conducted on a permit-by-permit basis with design changes being suggested after the construction started. The new pre-permit review will be done before any local permits are issued. One of the purposes of the new process is to view large structures as a whole, rather than in a piecemeal fashion permit by permit. The Office of Code Enforcement believes this will catch more building design flaws earlier in the building process, thus enhancing building safety and saving time for plan revisions early on, rather than when individual permits are requested.

The new pre-permit review requires that plans be submitted to the Office of Code Enforcement before building permits will be issued. These plans must include:

Ø A numbered index furnished on the cover of the plans,

Ø The area and scope of work of the project, including the project address,

Ø Scaled site plans, foundation or basement plans, and detailed floor plans,

Ø Exterior wall elevations with wall sections and details,

Ø Floor and roof details,

Ø Electrical, Mechanical, and Plumbing plans,

Ø Fire detection, alarm, and fire-extinguishing plans, and,

Ø A material specification manual.

As you might surmise, this new process can add time to a project timeline if not properly planned for. Also, a city cannot issue building permits on a project until a Design Release is issued by the State. However, the Office of Code Enforcement can begin its review process before the State issues its Release. This may be an attractive option for a commercial builder as the City estimates the initial plan review process could take between 15 and 20 business days.

What does the new pre-permit review process mean for new commercial and multi-family projects? Here are just some of the practical considerations builders will be adjusting to under this new process:

Ø No matter how it is presented as a time-saver, or as a method to decrease construction insurance rates, this process will take an important construction resource; TIME. Three to four weeks of delay in a pre-permit review can alter project delivery schedules, contractor scheduling, financing, and every other facet of a project. If a new project is to start in July and the new pre-permit review process is not factored in, the real start date is in August, which is maybe not a big deal. However, if a project is to start in October, then this new process can push a project into November, and in Indiana, weather then becomes a factor.

Ø Costs will increase: the new permit process imposes a new filing fee of several hundred to a few thousand dollars depending on the project. These fees should be planned for, but should not be deal-killers. What is implicit with the process is now your design professionals and counsel on a project will be splitting time between the State Emergency Management Agency – the department that governs the State Design Release process – and the Office of Code Enforcement for the pre-permit review. And, if changes are made by one agency, those changes need to be communicated to the other. A State Design Release petition must have a licensed engineer or architect’s certification on it, so any such changes cost not only time, but also money in the form of professional fees. You should fully expect your soft cost budget to increase under this new process.

Ø This new process will not apply to new single family residential development, renovation or rehabilitation of existing structures, or for any other structures that do not qualify under the State’s residential building code, such as equipment storage buildings.

The real impacts, both positive and negative, of the new pre-permit review process will not be known for some time. Increased building safety and the potential for improved insurance ratings are certainly good things, but there will be ‘growing pains’ for this brand new process that will undoubtedly yield unexpected hold-ups in permits and higher invoices from design professionals who deal with these problems. As such, the best legal and practical advice that can be given is “plan accordingly.” Increased costs and delays are bound to occur – the better your project planning at the outset of a project, the more likely you will be to either avoid or absorb these problems during the permit approval process.

Federal estate tax planning has become a less important planning objective for an increasing number estate planning clients due to a combination of the substantial increase in the federal estate exemption in recent years and the decline in the net worth of many clients due to the slide real estate and stock values.

The Estate Tax

As of the date this article is written, we continue to lack certainty regarding the structure of the federal estate tax, including the amount of the estate tax exemption and the rates for the current year — 2010. However, it appears likely that the federal estate tax will neither be eliminated (as many have hoped) nor return to the $1.0 million level in 2011 (as now provided by law). General consensus is that the federal estate tax exemption will find its new home in the ballpark of $3.5 million per person (the estate tax exemption for 2009). Estates over this amount were taxed at the rate of 45% in 2009.

Background of the Family Exemption Trust

Basic federal estate planning for a couple simply entails designing the estate plan to utilize the estate tax exemptions of both husband and wife. If the estate tax exemption is $3.5 Million per person then couples with the proper federal estate tax planning through Family Exemption Trusts (a/k/a A/B trust, family trust, bypass trust, credit shelter trust) potentially should be able to eliminate federal estate taxes on estates of $7 million or less.

Gifts to a spouse or charity are not subject to federal estate tax. Therefore, such gifts do not utilize a client’s federal estate tax exemption, which is lost if not used at death. Gifts to a spouse are added to the surviving spouse’s estate and taxed at his/her death if the surviving spouse’s total gross estate exceeds the exemption amount. Therefore, if each spouse is going to take advantage of the federal estate tax exemption, he/she needs to give the assets to someone other than a spouse or charity. One option is to simply pass the assets on to the next generation. Of course, surviving spouses in most situations are hesitant to do so because they would lose complete control over and access to the assets. And that is where the Family Exemption Trust comes in. Assets passing to the Family Exemption Trust are deemed to have passed on to the next generation for estate tax purposes, thus utilizing the first spouse’s exemption, while the surviving spouse continues to retain access to the assets as a beneficiary of the trust.

The Family Exemption Trust is often designed with the surviving spouse receiving all of the income from the trust for life along with the right to be paid principal pursuant to certain standards. A common standard for distributing trust assets to a spouse is for the spouse’s “health, education, maintenance and support.” These are magic words in estate planning because this “ascertainable standard” even enables the surviving spouse to serve as the trustee of the trust, capable of making distributions to him/herself without the trust being considered part of surviving spouse’s estate. There is no minimum access that the surviving spouse must be given, but there is a maximum access and control that if exceeded would result in the trust assets being deemed part of the surviving spouse estate for federal tax purposes, thus completely defeating the estate tax planning benefit of the Family Exemption Trust.

The Problem with Many Older Estate Plans

Many older estate plans, some of which were drafted when the estate tax exemption was below $1.0 Million, require the mandatory funding of the Family Exemption Trust, often through funding formulas that put all of the first spouse’s assets in the Family Exemption Trust. Now, when clients realize that they may no longer need a Family Exemption Trust for federal estate tax planning purposes, most instinctively want to eliminate it so that assets pass outright to the surviving spouse. Also, some clients are surprised to learn that their estate plans provide that at the death of the first spouse, all of the assets of the first spouse pass to Family Exemption Trust, with none of it going outright to the surviving spouse.

Asset Protection and the Elimination of the Family Exemption Trust?

Should the Family Exemption Trust be eliminated where it serves no federal estate tax planning purpose? It depends.

There are benefits to funding the Family Exemption Trusts other than federal estate tax planning. Family Exemption Trusts provide substantial asset protection benefits. They also increase the likelihood that the first spouse’s children (or other intended beneficiaries) ultimately receive the assets.

In most cases, assets in the Family Exemption Trust are protected against the surviving spouse’s creditors. Because the surviving spouse does not have the ability to withdraw the assets from the trust, the surviving spouse’s creditors generally cannot do so either.

Because the Family Exemption Trust becomes irrevocable at the death of the first spouse, the surviving spouse does not have the ability to change its terms. Therefore, the surviving spouse cannot disinherit a child following an argument. In addition, the surviving spouse does not have the right to give the trust assets to someone else. This may be an important consideration if the surviving spouse remarries, and the new husband or wife exercises influence over the surviving spouse. Once the assets leave the trust then they cease being protected.

In evaluating whether or not to keep or eliminate the Family Exemption Trust, you should ask yourself the following questions:

• Do you wish to achieve greater asset protection by keeping the assets out of the surviving spouse’s name? [This is especially important if the surviving spouse is or may someday be engaged in a potentially risky profession or business.]
• Do you wish to provide greater assurance that part of the marital assets will ultimately pass to the children (and not to the surviving spouse’s new husband or wife) by placing limits on the surviving spouse’s access to those assets? [This protects against influence from both the new spouse and certain children who seek to exclude other children.]
• Do you wish to protect the surviving spouse from potential loss if he/she remarries and then divorces? And, if you are the surviving spouse, do you want the ability to tell a future spouse that the assets are not yours to share?

In light of these important considerations, some clients will choose to partially fund the Family Exemption Trust even though it is unnecessary for federal estate tax purposes. In other instances, clients will choose to keep it simple and just leave everything outright to the surviving spouse.

Optional Funding of Family Exemption Trust via Disclaimer

In most estate plans, the surviving spouse should retain the option to fund the Family Exemption Trust through a disclaimer. A disclaimer is a formal statement that essentially causes the assets to bypass you and pass to the next beneficiary in line to inherit. In this case, that would be the Family Exemption Trust. Therefore, with disclaimer exemption planning the surviving spouse can decide whether or not to fund the Family Exemption Trust after consulting with advisors and weighing the facts that then exist, such as estate and income tax laws, the likelihood of remarriage, or the need for asset protection planning.

Second Marriages and Blended Families

The planning goals for first marriages are often different than those for subsequent marriages. In the case of first marriages, where the children belong to both the husband and wife, spouses are far more likely to leave the assets to the surviving spouse, knowing that their children are also the natural heirs of their spouse.

On the other hand, in blended families, couples are more likely to want to protect against the surviving spouse disinheriting children from a prior marriage. In such cases, clients may desire some level of mandatory funding of the Family Exemption Trust, and occasionally even leave some or all the assets directly to the children, thus bypassing the surviving spouse entirely.

Leaving Assets Directly to Children’s Trusts

Younger couples, recognizing the likelihood that the surviving spouse will remarry, sometimes desire to leave a portion of their assets to their children in trust instead of the surviving spouse. These couples seek the assurance that their children will not be deprived, especially in respect to the education of the child, as the result of influences exerted upon their surviving spouse by a new husband or wife.

Summary

Deciding whether and to what extent couples should use a Family Exemption Trust arrangement, even if they do not have federal estate tax planning concerns, requires an informed and thoughtful analysis. In addition to providing federal estate tax savings, Family Exemption Trusts provide important asset protection benefits and greater assurances that your assets ultimately pass to your intended beneficiaries.

It is common that trusts are drafted so that the trustee has the discretionary power to distribute income and/or principal for the beneficiary’s health, education, maintenance and support.  And when the beneficiary attains a certain age, the principal is distributed.  Frequently, principal is distributed in installments, such as when the beneficiary attains the ages of 25, 30 and 35, so as to give the beneficiary a second and even a third chance to use the assets wisely. 

While the distribution pattern above is a fine place to start the discussion, the proper distribution pattern should be based on the desires of the client, the nature of the assets in trust, and the strengths, weaknesses and needs of the beneficiary.  On occasion, a 25 year old may be prepared to receive his/her inheritance; however, this is certainly the exception and not the rule. 

Determining the proper distribution pattern requires the consideration of many issues, including the following:

·        Is the beneficiary in a happy marriage?  (Do you know?) 

·        What is the education level attained by the beneficiary and his/her ability to earn a comfortable living? 

·        Will the beneficiary be relying on the trust funds to pay living expenses? 

·        Will the beneficiary need the trust funds for retirement?

·        Does the beneficiary have a tendency to spend more than he/she makes? 

·        Does the beneficiary make sound financial decisions?

·        Is the beneficiary likely to engage in a risky occupation, business venture or behavior? 

·        Should the beneficiary be rewarded for good behavior, such as graduating from college, and discouraged from bad behavior, such as not going to college? 

·        Are the trust funds likely to be expended educating the beneficiary, thus making the timing of principal distributions less relevant? 

We find that clients increasingly wish to postpone the ages at which principal distributions will be made, especially where there is a significant sum of trust assets.  Sometimes, we preserve part of the assets for distribution to the beneficiary when he/she nears retirement age, such as at the age of 60.  In other instances, the assets are held in trust for the beneficiary’s lifetime, then distributed to the beneficiary’s children when they attain an appropriate age. 

In addition to postponing distributions for the purpose of avoiding the loss of assets, we also consider how access to money at too young of an age may affect the beneficiary’s internal drive for achievement.  I think most of us would agree that having assets handed to us generally reduces the motivation to work hard to achieve success.  Further, access to money at too young of an age may result in the beneficiary not acquiring the tools, provided by a good education and work experience, needed to prepare him/her for earning a living.  In addition, social scientists have found that our happiness is enhanced by the pursuit and attainment of our financial goals.  While money does not make people happy, the lack of it can make people unhappy.  And more specifically, the lack of security has been shown to reduce one’s happiness. 

At first blush, clients sometimes feel that they do not wish to postpone distributions to their children or other beneficiaries because they do not want to convey to them a lack of confidence in their judgment.  However, with the passing of time wise beneficiaries are usually grateful that the effort was made to protect them from exposing their inheritances to their own poor decisions or to the loss of the assets in a divorce or failed business venture. 

In summary, if your goal is to share the product of your hard work with your loved ones in a manner that will promote their happiness, you should carefully consider when and how distributions are to be made. 

Several years ago, hardly anyone had heard of limited liability companies (“LLC”). Now businesses operate as LLCs in all states, and the press and media have nothing but good things to say about them. Is all the hype justified? Much of it is, especially where the business involves the ownership of real estate. Limited liability companies offer an unprecedented combination of corporate-like liability protection and partnership pass-through taxation. In addition, if anonymity is a goal, you can achieve this by naming the LLC whatever name you desire so long as it is followed by the words “limited liability company” or a variation or abbreviation of these words.

Unlike limited partnerships, limited liability company “members” don’t have to limit their participation in the firm’s management to protect their personal assets from the firm’s creditors. Yet they can qualify for true partnership taxation.

LLCs also have a number of distinct advantages over S corporations for many businesses. They are not restricted to a single class of stock as S corporations are, so LLC members have a greater ability to allocate gains, losses, deductions, and credits. Also, there are no limits on the number or kind of shareholders, giving LLCs greater access to capital. In addition, LLCs have certain tax advantages over S corporations when it comes to the ownership of real estate.

All of this makes LLCs the entity of choice for holding real estate for start-up ventures. However, should established investments be transferred into an LLC? The answer is maybe. If the real estate is presently held in the name of one or more individuals, the property could and probably should be transferred and held in an LLC so as to achieve the liability protections to which the owners of LLCs are availed. In the case of multiple individual owners, holding property in an LLC will also provide for centralized management of the real estate, avoiding disputes that occasionally arise between individuals holding real estate as tenants-in-common. The transfer of real estate by an individual into an LLC generally will not result in a taxable event for income tax purposes.

Similarly, if the real estate is presently owned by a general partnership, the general partnership can usually be converted to an LLC, thus achieving liability protection, without causing a taxable event for income tax purposes. In fact, the conversion of a general partnership to an LLC can typically be accomplished without even changing your federal identification number because both entities are treated as partnerships under the tax code. There are very few circumstances today in which a general partnership is the entity of choice for real estate investments or for other types of businesses.

If the real estate is presently owned by an established corporation and the real estate has appreciated since it was purchased, the tax cost of converting to an LLC is probably prohibitive because distributing the real estate from the corporation will result in a taxable event.

In summary, most start-up real estate ventures should typically be organized as LLCs, and existing ventures should at least consider converting to an LLC.

If you’re like most people, you don’t like to think about planning your estate. But it’s an important part of ensuring the financial security of your loved ones. One of the easiest and most common tools used in estate planning is a program of giving gifts. Gifts can reduce the size of your estate that is subject to tax while still passing on wealth. Gifts can also serve a function in your income tax planning by shifting income-producing property to others who are in a lower tax bracket. Not only will gifts enable you to remove assets from your estate, but gifts will also enable you to remove future appreciation of such assets from your estate.

While many gifts are subject to gift taxation, you can give away up to $12,000 (2008) per recipient per year free of gift tax. These gifts also do not reduce the amount that you can pass free of estate tax. There is a great deal of flexibility in the types of property that can be transferred. Qualifying gifts can be money, real estate, stocks or other business interests, or even a life insurance policy. The gift may also be made through a trust so that the actual distribution of the property can be made at a time when the recipient has the maturity to deal with the asset.

You can give up to $24,000 (2008) per recipient per year if you’re married and your spouse consents to “split” your gifts. This is useful for spouses who do not own an equal amount of property. The spouse with less property can consent to gifts made by the wealthier spouse, thereby effectively doubling the amount that the wealthier spouse can give away tax free.

One important thing to remember when you make a gift of appreciated real estate is that the recipient must take your basis in the real estate. This means that if the recipient sells the real estate, any gain on the sale will be measured using what you paid for the real estate, not what the real estate was worth when he or she received it. In contrast, if real estate is transferred to another through your estate, the recipient can use the value of the real estate at that time in measuring any gain on the sale of the real estate. This increase in the tax basis is known as receiving a “stepped-up” basis. Consequently, choosing the right asset to give is an important aspect of any gift-giving program.

If used properly, a program of gift-giving can benefit everyone involved. If you have any questions about the best way of using gifts as part of your overall financial plan, please contact us.

A well-known, but sometimes overlooked, way to buy and sell real estate without paying tax at the time of the transaction is through the use of “like-kind” exchanges. In a like-kind exchange, investment property is traded for other investment property. The person transferring one piece of property receives different property but keeps the same basis as that for the old property. That way, the gain is deferred while other tax attributes are preserved.

Of particular interest are the flexible features that make a like-kind exchange an especially useful technique. First, properties do not have to be of identical type to qualify as like-kind. To take a few examples, commercial buildings may be exchanged for unimproved lots, farm land for city lots, and even cooperative housing stock carrying occupancy rights for a condominium interest in the same property.

Second, properties do not have to be exchanged at the same time. Therefore, it is not necessary to have already located the exchange property to make a like-kind exchange (an important consideration if the end of a tax year is looming). It is sufficient that the exchange property be identified within 45 days after the relinquished property is given up and that the identified property be received within 180 days.

To illustrate how these exchanges can work,
consider the following example:
Fred owns an interest in an office building. He bought it years ago for $10,000, but today it is worth at least $100,000. Fred has decided to move to Florida and convert his office building interest into an ownership share in a Florida apartment building. Allison wants to buy Fred’s office building interest, and for tax reasons she wants to own the building interest by December 31. Fred wants to avoid the high tax he would have to pay after a cash sale.

A solution is a deferred like-kind exchange. Fred transfers his building interest to Allison on December 31. Allison agrees to locate and buy a Florida apartment building interest of equal value suitable to Fred. (Fred can even insist that Allison put the purchase price in escrow, so long as Fred has no independent right to use the purchase price.) After Allison finds and buys the Florida property, she transfers it to Fred, and the like-kind exchange is completed. Provided the 45/180 day rules along with other requirements are satisfied, Fred receives the Florida property tax-free, with the same basis and holding period he had in the office building.

In fact, it is even possible to not include Allison in the latter transaction if a Qualified Intermediary is used. For example, Fred could sell his office building to Allison with the proceeds of the sale held by the Qualified Intermediary until Fred identifies a new piece of real estate (must be accomplished within 45 days) and closes on the new piece of real estate (must be accomplished within 180 days). At the second closing, the monies held by the Qualified Intermediary would be paid to the seller of the second piece of real estate and the like-kind exchange would be successfully completed without any further participation by Allison.

As you can see, a like-kind exchange can be an excellent planning tool. Even in situations where it is impractical to arrange a completely tax-free transaction, like-kind exchanges may still reduce the immediate tax consequences of altering your investment holdings. However, as with most tax planning strategies, in order to qualify for like-kind exchange tax treatment and benefit from the accompanying tax savings, certain technical requirements must be met. Careful planning should therefore be undertaken in arranging the transactions.