On August 2, the Senate Finance Committee, on a bipartisan vote of 19 to 5, passed the Family and Business Tax Cut Certainty Act of 2012. Six Republican senators joined 13 Democrats to support the bill. This is one of the first tax bills with bipartisan support this year. The tax extenders bill has an anticipated cost of $200 billion over 10 years and is not offset by tax increases.

Approximately 75% of the current tax extenders are included in the bill. There are several significant provisions.

1) AMT Patch - The exemption for alternative minimum taxes for 2012 is indexed to $50,600 for individuals and $78,750 for married couples filing jointly.

2) Teachers' Expenses - The $250 above-the-line tax deduction for teachers, to offset the cost of books and school supplies, is extended for two years.

3) State and Local Sales Tax - The itemized deduction for local taxes is extended for two years.

4) IRA Charitable Rollover - The option for IRA owners over age 70½ to transfer up to $100,000 per year directly from an IRA custodian to charity is extended for two years.

5) Research and Experimentation Credit - The credit equal to 20% of qualified research expenses is extended for two years.

6) Enhanced Gifts of Food Inventory - The enhanced deduction for gifts of "apparently wholesome food" by taxpayers is extended for two years.

7) Appreciated Subchapter S Corporation Gifts - A provision that facilitates gifts of appreciated property by S Corporations is extended for two years.

Approximately 25% of the existing tax extenders have been omitted. This is a significant change from prior years in which all of the extenders have been included in the bill. Two charitable extenders were not included. These are the enhanced charitable deduction for gifts of book inventories to public schools and the enhanced deduction for corporations who make gifts of computers for educational purposes. Both provisions lapsed on December 31, 2011.

Senate Finance Chair Max Baucus (D-MT) stated, "The Senate Finance Committee worked together to craft a bipartisan extenders package. This effort has proven that legislating can still be done if both sides work together."

Senator Orrin Hatch (R-UT) continued, "This legislation demonstrates that there is a will to subject long-standing tax policies to the full and much-needed public scrutiny of the American people. This is a first step towards the ultimate goal of comprehensive tax reform that shows that there is a path to resolving the challenges we face as a nation."

Editor's Note: There are now reasonable prospects for passage of the tax extenders by the Senate. The key question of interest to charities and their donors is whether the House will also act on the tax extenders. If the House acts prior to September, it will permit charities to promote the IRA Charitable Rollover this fall. Many potential IRA rollover donors are waiting to see if Congress extends this gift plan. If it is passed, the IRA rollover will be valid for qualified gifts from January 1 to December 31 of 2012.

House Passes Tax Cut Extension and Fast Track Process

On August 1, the House of Representatives passed two different tax bills. The Job Protection and Recession Prevention Act of 2012 (H.R. 8) extends taxes at current rates for one year. It differs from the Senate plan in that the income and capital gains tax rates for upper-income taxpayers would be maintained at the current levels for 2013.

The Pathway to Job Creation through a Simpler, Fairer Tax Code Act of 2012 (H.R. 6169) creates a "fast-track" process for major tax reform in 2013. The fast-track bill includes specific goals for tax reform. These include two personal income tax brackets of 10% and 25%, a corporate tax rate of 25%, a tax system that raises revenue equal to 18-19% of gross domestic product and a worldwide tax system. The lower rates are achieved by limiting most itemized deductions.

The fast-track system creates specific procedures designed to force the Senate Finance Committee and the House Ways and Means Committee to submit bills for votes to the full House and Senate by the middle of 2013.

The White House opposed both of the House bills. It believes that extending the tax cuts for upper-income Americans "would hurt the economy both by increasing the long-term deficit and also by taking money out of the pockets of the families most likely to spend it in the near term."

It also criticized the fast-track legislative method. The White House is concerned that a fast-track system for tax bills would lead to tax cuts for high-income households and corporations.

Editor's Note: It is not likely that there will be any major action on these bills prior to the November election. However, this positioning by both parties will have major significance for the 2013 tax reform efforts. The level of activity in Congress suggests that many members of Congress now think it is quite probable that there will be major tax reform next year.

Gifts to Disregarded Entities are Deductible

In Notice 2012-52; 2012-35 IRB 1 (1 Aug 2012), the Service approved gifts to disregarded entities created by qualified Sec. 501(c)(3) charitable organizations. Many charities have created single-member LLCs (SMLLCs) for various purposes. A common strategy is to create an SMLLC to receive, hold and manage real estate gifts. The SMLLC may reduce the potential liability risk to the parent. If the real estate is subsequently sold, the cash proceeds may be then distributed to the charitable parent.

Charities and their advisors have long advocated charitable deductions for gifts to the disregarded entities. In Notice 2012-52, the Service approves the use of disregarded entities and confirms that gifts to those organizations will be deductible.

The Notice states, "If all other requirements of Sec. 170 are met, the Internal Revenue Service will treat a contribution to a disregarded SMLLC that was created or organized in or under the law of the United States, a United States possession, a State, or the District of Columbia, and is wholly owned and controlled by a U.S. charity, as a charitable contribution to a branch or division of a U.S. charity."

The Notice encourages charities to disclose the parent-SMLLC relationship on a receipt or contemporaneous written acknowledgement to the donor. For example, an SMLLC owned by Favorite Charity might include this language on its receipt:

"SMLLC is wholly owned by Favorite Charity of City, State. It qualifies as a branch or division of Favorite Charity. Under Notice 2012-52, gifts to SMLLC are qualified for charitable deductions under Section 170 of the Internal Revenue Code."

Appraisal Reconsidered and Rejected

In Steven Rothman et ux v. Commissioner; T.C. Memo. 2012-163; No. 17547-10 (Jun 2012) the Tax Court denied a $290,000 façade easement charitable deduction because the appraiser had used a percentage method. Following a decision by the U.S. Court of Appeals for the Second Circuit in Scheidelman v. Commissioner, 682 F.3d 189 (2 d Cir. 2012), the taxpayer petitioned for a reconsideration of that decision.

In Scheidelman, the Court of Appeals stated that a percentage appraisal method with accompanying data could comply with the Reg. 1.170A-13(c)(3) requirements of the Income Tax Regulations. Based upon that decision, the taxpayers requested reconsideration.

In Steven Rothman et ux v. Commissioner; T.C. Memo. 2012-218; No. 17547-10 (30 July 2012) the Tax Court reviewed the 15 requirements of a qualified appraisal. It vacated the portion of the original Tax Court opinion that disqualified the appraisal because of the percentage method, but it noted that there were at least three specific reasons why the Rothman appraisal still did not meet the requirements.

The appraisal did not disclose the terms of the agreement between the National Architectural Trust and the donors, it did not communicate the existence of mortgages on the property and it appraised a property interest greater than the one contributed.

Because the appraisal failed to satisfy eight of the 15 requirements, it still is not valid. However, the taxpayers are permitted to present to the Tax Court their basis for claiming a failure due to reasonable cause.

Applicable Federal Rate of 1.0% for August -- Rev. Rul. 2012-21; 2012-32 IRB 1 (18 July 2012)

The IRS has announced the Applicable Federal Rate (AFR) for August of 2012. The AFR under Section 7520 for the month of August will be 1.0%. The rates for July of 1.2% or June of 1.2% 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 2012, pooled income funds in existence less than three tax years must use a 1.8% deemed rate of return.

Written by The Wealth Advisors Trust Advantage

Trust & Estates Magazine is the primary periodical for the fiduciary industry and is considered "must reading " for bank trust officers. The February 2012 edition contained a "Perspective" entitled "Emerging Directed Trust Company Model." (Joseph F. McDonald III, "Emerging Directed Trust Company Model," Trusts & Estates (February 2012) 

The author of the "Perspective" is Joseph F. McDonald III, an attorney at McDonald & Kanyuk PLLC in Concord, New Hampshire. McDonald's "Perspective" clearly makes the point that directed trust companies represent a superior trust model for today's affluent clients. The ability to create "multi-participant trust" governance structures (or what are more referred to as directed trusts) in trust friendly states has threatened to topple the bank trust departments' market share among affluent clients. The "Perspective" infers that a "tipping point" has arrived in the fiduciary business in favor of financial advisors who now have the ability to align their services with a growing group of  directed trust companies who operate under a new trust model free from embedded constraints and cost structures of the "traditional" trust model.

Financial advisors and other estate planning professionals should understand the extent of this fundamental change within the fiduciary business and the potential benefits directed trust companies can provide to the affluent clients. The time has arrived to conduct a search for one or more firms providing directed trust services. The small investment of time and effort expended in the due diligence process of selecting a directed trust provider will be rewarded several fold in terms of increased AUM and client service.

Contrasting Models

The "Perspective" describes the inherent risk management and cost issues facing the bank trust departments as they attempt to provide comprehensive trust services to customers. The "traditional model" assumes the trustee is liable for any and all activities undertaken as trustee and, as a result, a cumbersome, multi-disciplined, multi-layered, and expensive administrative process is required to mitigate risk and exposure to litigation.

"A large bank trust department designed to deliver bundled trust services requires elaborately structured risk management policies and procedures to allow the bank's personnel to perform the multiple fiduciary responsibilities inherent in the role and limit the bank's exposure for claims of breach of fiduciary duty. The directors, officers, and support personnel are compensated commensurate with their experience, expertise, and level of responsibility.

"The classic regulated corporate trustee collects from each of its trusts annual fees of between 50 and 120 basis points, depending on the value of the trust's principal. These fees have historically been adequate to cover the trust department's extensive overhead..."

"Before directed trusts became popular, the high costs of operating in a regulated industry with significant barriers to entry for alternative business models gave the incumbent bundled service providers significant pricing power and created an almost infinitely elastic demand for their services."

Unlike the traditional bundled model, directed trusts typically involve the inclusion of an "investment advisor" to manage the trust assets, a trust protector, a co-trustee, and potentially, a "distribution advisor" responsible for providing the trustee with directions concerning discretionary distribution powers. The adage "less is more" clearly applies to directed trusts in terms of reduced and greater control by grantors and beneficiaries. Financial advisors seeking to transfer existing trusts from banks should communicate to prospective clients the inherent distinction between the traditional and directed trust model. Prospective clients are far more likely to accept the logic of the structural distinctions as opposed to the traditional argument that banks are poor money managers.

Demographic Trends

In addressing demographic trends, McDonald states "Several demographic, industry, and legal trends have coalesced to drive the increasing demand for directed trusts and the [Directed Trust Companies] that serve them."

"Unlike in previous generations, when wealthy families were more conservative investors and looked to the institutional stability of banks as their trustee and investment advisor/manager of choice, today's affluent prefer a specialized approach that gives them the flexibility to choose their own investment professionals. They increasingly reject the notion that a jack-of-all-trades can be a master of any. That's particularly the case in the modern world of complex dynasty trust administration involving layers of discretionary distribution powers and wide-open trust investment standards. The new directed trust structures offer the best of both worlds."

This "best of both worlds" is described as the family's ability to have the comfort of selecting a state regulated and adequately capitalized financial institution to serve as administrative trustee at a reasonable fee. While on the other hand, the family has access to a much broader universe of investment options and contrasting investment styles which are not generally offered by, or available through, bank trustees. Financial advisors seeking to transfer large trust relationships should focus on the increase of overall governance by the family, including, but not limited to, control of the investment management process. The increase of overall family control is beyond question or debate. A prospective client can easily see the benefits inherent in a directed trust arrangement and make the trust transfer decision accordingly.

Six Progressive States: Birds and Trusts Migrate to Better Climates

In the area of directed trusts there are progressive and regressive state laws. States such as South Dakota, Delaware, Alaska, Nevada, New Hampshire, and Wyoming have adopted laws favorable to creation of directed trusts for the purpose of creating a robust trust industry within the state. Fortunately for the affluent, and their advisors, trusts may be " moved" to favorable trust states. The change of trust situs, or place of administration, can be accomplished through a number of methods including decanting, application of local trust modification statutes, non-judicial settlement agreements, virtual representation, and court approval. The ease of trust migration varies widely from state to state. There is a strong trend among the states in favor of decreased court involvement and the ability to modify trusts by agreement of the interested parties, particularly with regard to administrative matters under which the appointment of a successor trustee is often included in the state statute.

McDonald states "these progressive states recognize that the popularity of long-term (even perpetual) trusts as wealth management, asset protection and wealth transfer tax avoidance structures, combined with tremendous concentrations of fungible financial wealth, liberal choice and conflict-of-law principals, as well as the relaxation of interstate banking restrictions, have created a national market for directed trust services. A family living in a regressive state needn't move to a progressive state to secure the benefits of a directed trust established and administered in that jurisdiction."...

Expectations Regarding Directed Trust Companies

Financial Advisors and their prospective directed trust clients need to recognize the distinctions between directed trust providers and traditional trust providers. Directed trust providers are by definition "upstart" companies whose services and infrastructure are tied to the present and future as opposed to the past. The following excerpt from the Trusts & Estates article illustrates the point.

"[Directed Trust Companies] can operate lean and mean in inexpensive, highly utilitarian ,Class B office space, with more manageable risk management policies and procedures, less high-priced management personnel, no investment professionals, and an appropriate number of administrative personnel to handle their accounts."

Despite the realities described in the excerpt above, financial advisors and prospective customers often fall into the practice of using the same due diligence inquiries regarding a directed trustee as they would a traditional bank trustee. Questions regarding staffing levels, years in business, number of accounts, and assets under management all require an analysis which incorporates a fundamental understanding of the directed trust model which is non-investment management, non-custodial and often non-discretionary with regard to distributions. Prospective trust clients need to be informed that the directed trustee is engaged to discharge limited duties in a "multi-participant trust".

Conclusion

Recent changes in state trust laws, customer demographics, and technology have coalesced to bring fundamental changes to the trust marketplace. The traditional bank trust department model suffers high embedded costs, inflexible policies and procedures regarding risk management, and customer demands for increased participation in the management and control of trusts.

The emergence of the directed trust model has dramatically changed the trust marketplace by empowering the affluent with increased control of the trust's investment management, distributions, and overall governance. Financial advisors, attorneys and CPAs should fully understand the distinction between traditional and directed trust models and create appropriate client expectations regarding directed trust providers. 

SOURCE: Steve Leimberg's Asset Protection Planning Email Newsletter - Archive Message #200

“After approximately 15 years since the first DAPT legislation passed, not a single DAPT has been tested all the way through the court system.  Most likely this is because such a large supermajority believes that if tested the DAPT will work to protect its assets from a creditor of the settlor.  However, despite the very high likelihood of protection, if there is a way to increase the odds of success even more, then such a strategy should be utilized whenever possible.

The Hybrid Domestic Asset Protection Trust (“Hybrid DAPT”) is such a strategy, and it is very simple.  The Hybrid DAPT is like a regular DAPT except that the settlor isn’t an initial discretionary beneficiary of the trust, but can be added later.”

EXECUTIVE SUMMARY:

Asset protection has become one of the hottest areas of law and has become the ideal complement to estate planning.  Consequently, the Domestic Asset Protection Trust (“DAPT”) has become one of the most popular asset protection tools in the planner’s toolbox.  As more states have enacted DAPT legislation, practitioners have started doing more DAPTs for their clients.

FACTS:

After approximately 15 years since the first DAPT legislation passed, not a single DAPT has been tested all the way through the court system.  Most likely this is because such a large supermajority believes that if tested the DAPT will work to protect its assets from a creditor of the settlor.  However, despite the very high likelihood of protection, if there is a way to increase the odds of success even more, then such a strategy should be utilized whenever possible.

Your inside look at who's who in the trust industry catering to registered investment advisors (RIAs), family offices and broker-dealer representatives.

Listings for their technology used, custodians, fees, in-house experts, trust support and more.

Read the full report.

Summit Trust Company has just structured a new portfolio to invest in international real estate.  The purpose is to allow interested investors to have an opportunity to invest in an alternative asset class that that is not subject to the U. S. Stock Markets or the U. S. economy.  It is just coincidental that the first property that is being purchased for the portfolio is located in Cuenca, Ecuador.  That city is featured in the article that follows this announcement.

The portfolio is being managed by Julius Geday, who has spent the better part of the first three months of this year in Cuenca, searching for the best properties to place in the portfolio.  The feedback that we have gotten from current clients is very positive, and two of our clients who have extensive experience with life in Cuenca give us encouraging information that confirms that Cuenca is the place to be for international real estate.

If you have any interest in learning more about this brand new investment, please contact This email address is being protected from spambots. You need JavaScript enabled to view it. .  We may be conducting meetings on the topic in the very near future.

George P. Brown Ph.D
Phone: 215-822-6601
Email:  This email address is being protected from spambots. You need JavaScript enabled to view it.