Saturday, August 29, 2009

Uncivil Society?

There is something rotten in the air. Spend a few minutes listening to talk radio, surfing the political blogs, or watching cable news, and it is undeniable that hatred and anger is on the rise, and seemingly spiraling out of control. Both the extreme right and the extreme left share in the blame. But just as much at fault are our political "leaders" who stand by silently (or even worse, offer encouragement) when some nut-job spouts hateful rhetoric.

Just a few days ago, video surfaced from yet another Town Hall meeting, this time hosted by Wally Herger, a non-descript Congressman from California. An audience member proudly announces that he's a "proud right-wing terrorist" and goes on to spout the typical anti-government nonsense. So does the esteemed Representative chastize this creep for his hate-mongering? Does he report him to the FBI? To the contrary, Herger praises the self-proclaimed "terrorist," saying, "Amen, God bless you," and then telling the audience, "there is a great American."

Looking back on our history, it seems we are heading back to the days of the "Know Nothing" party from the 1840's and 1850's. There's little room for reasoned and rational political discourse, just a lot of noise and sound bites designed to frighten those too lazy or ignorant to think for themselves. And if we insist on electing lightweights the likes of Wally Herger to positions of power, we only get what we deserve.

Sunday, August 23, 2009

Health Care -- Facts and Lies

I have no idea if the health care legislation proposed by President Obama would be truly effective, and those who are skeptical may be correct that the plan would do little if anything to improve our health care system, lower costs, or achieve either objective.

But the hysteria seen in the Town Halls and on talk radio would be laughable if it weren't so dangerous -- and disingenuous. Having counseled seniors and baby boomers regarding end-of-life issues for the past 15 years, my experience is that all clients have an opinion regarding their preference for end-of-life care, and they are eager to sign living wills and health care proxies to effectuate their personal desires. The proposed legislation provides a forum for discussing end-of-life care for those who haven't addressed this issue previously, and would help avoid another Schiavo fiasco.

Also, those railing against "rationing" under any new system are either blind to the fact -- or consciously ignoring the truth -- that under our present hodgepodge system, rationing already occurs. Anyone who has dealt with an insurance company in trying to obtain approval for a course of treatment that the insurer considers outside the standard protocol recognizes this reality.

Having for the past decade served on the Board of a not-for-profit hospital, I have seen first-hand that our present system too often rewards procedures -- that is, payment-for-testing -- rather than successful outcomes. It is analogous to the situation in the legal field, where billing by the hour provides a perverse incentive for the attorney by rewarding inefficiency and punishing a successful result achieved expeditiously.

To be fair, I do believe that some type of tort reform should be part of any health care overhaul, and I fault the Democrats for not showing sufficient courage to incorporate tort reform in the proposed bill.

I don't profess to have the answers for our health care system. But I do know that what we have in place today is unmanagable and unsustainable, and far too many people remain uninsured. Given how far the United States lags behind other industrialized nations in terms of both costs and outcomes, there is no question that change in some manner is long overdue.

Friday, August 21, 2009

Focusing on the Results, not the "Documents"

For the past decade I've been fighting the same fight: namely, getting clients to stop thinking of their estate plans in terms of the type of documents they need -- e.g., "I need a will," or "I need a trust" -- and instead shifting the focus onto the client's goals and objectives. Once the goals and objectives have been thoroughly discussed between the attorney and the client, then an effective estate plan can be designed to meet the client's needs. The various legal documents are simply tools in the lawyer's toolbox for meeting the clients objectives. The attorney's real value is in helping the client understand the implications of the planning as it fits the client's particular family and financial situation, and then in crafting the appropriate planning tools to realize the client's desires.

Here's an analogy: assume you are hiring a contractor to build a house. Do you simply tell the contractor to start building the house as he sees fit, but to be sure to use only Phillips head screwdrivers a Husqvarna electric saw, etc.? Of course not; you would surely have a blueprint of the house prepared by an architect or similarly qualified source, and would rely upon the contractor to use appropriate tools to get the job done right.

Well, in a "traditional" estate planning scenario, clients seem to assume that they know the appropriate "tools' to use for the planning, rather than relying upon the attorney to use his or her professional expertise to select the proper planning tools. Just as absurd, in traditional estate planning, experience tells me that the attorneys all too frequently fail to provide adequate counseling to the clients to structure an appropriate estate plan for that particular family; instead, the attorney acts as a mere "scrivener" in producing a "word processed" estate plan.

Sunday, August 16, 2009

The Federal Estate Tax: Coming Down to the Wire

Back to blogging after time for some travel (business and pleasure) and catching up at work. As August reaches the half-way point (and it's finally hot), it's time to take stock of the state of the federal estate tax law. While healthcare reform is dominating the news, when Congress returns from the August recess, estate tax reform will almost certainly be on the agenda.

In 2009, the federal estate tax exemption is $3.5 million. That is, upon death every person can pass $3.5 million of assets to non-spouses free of federal estate tax. Assets in excess of $3.5 million are subject to tax at a rate of 45%. Many states, including New York, have separate state estate taxes; New York only permits $1,000,000 of assets to pass to heirs free of estate tax.

Under both state and federal law, an unlimited amount of assets can pass from a deceased spouse to his or her surviving spouse under a rule known as the unlimited marital deduction. However, upon the second spouse's death, all of that spouse's assets in excess of $3.5 million are taxable, including assets inherited from the first spouse to die. Essentially, a direct transfer of assets to a surviving spouse results in the "forfeiture" of the estate tax exemption of the first spouse to die.

Preserving the exemption for the first spouse to die is rather simple. An amount equal to the estate tax exemption (e.g., $3.5 million) can be funded into a credit shelter trust for the benefit of the surviving spouse and, if desired, other beneficiaries such as descendants. The surviving spouse can be the Trustee of the credit shelter trust; the spouse can be entitled to income from the trust, and principal distributions of any amount can be made to the surviving spouse or other beneficiaries for "health, education, maintenance and support." Maintenance and support are very broad terms and essentially mean that distributions of principal may be made for any need to support the beneficiaries' needs, including vacations, homes, cars, and the like. If that isn't enough, the credit shelter trust may be drafted to grant the surviving spouse a "5 x 5" power that permits the spouse to invade the principal of the trust for any purpose in an amount not to exceed the greater of $5,000 or 5% of the trust principal (typically valued as of December 31 of the prior year).

But all that may change dramatically come 2010 if Congress does not act. Under the existing estate tax legislation passed in June 2001, the federal estate tax is repealed for one year only; that is, assets of any amount may be passed upon death to both spouses and non-spouses free of federal estate tax. A downside of the existing law is that while the estate tax would be repealed in 2010, the current unlimited "step-up" in basis for inherited assets will also be repealed, with only $1.3 million of assets to be eligible for a full step-up in basis ($4.3 million if there is a surviving spouse), with any "excess" assets to be transferred at a "carryover" basis.

This rule has been tried once before in the mid-1970s and was quickly repealed as unworkable. Imagine trying to determine the basis of old AT &T stock purchased 50-years ago that has since split multiple times and been spun-off into numerous successor companies. The complexities of trying to determine cost basis of a decedent's assets will surely drive-up the costs of estate settlements and lead to howls of protest.

So with all the uncertainty, what's Congress likely to do? Given the timing, the current assumption is that while Congress wrestles with a long-term solution, it will extend for at least one year the current $3.5 million estate tax exemption, along with the unlimited step-up in basis.

Two of the most likely long-term proposals include:

1. "Freezing" the exemption at $3.5 million with a maximum tax rate of 45%, but also indexing the exemption for inflation; the proposal would also "reunify" the estate and gift tax credits (currently the lifetime gift exemption is $1 million), and permit "portability" of the estate tax exemption from one spouse to the other. However, the proposal would place limits on "valuation discounts" for planning vehicles such as "family limited partnerships" that are frequently used by high-net worth individuals to minimize estate and gift taxes.

2. Making permanent the exemption level at $2 million, indexing that level for inflation, and establishing progressive tax rates of 45 percent for estates valued between $2 million and $5 million; 50 percent for estates valued at $5-to-$10 million; and 55 percent for estates valued over $10 million. This proposal also includes reunification of the estate and gift tax exemptions and "portability" between spouses.

As Congress tackles this issue this fall, I'll keep my readers posted as to breaking developments.

Saturday, August 1, 2009

The Myth of Corporate Asset Protection

Most small to medium sized businesses are established as corporations. Many if not most of these businesses have just a few shareholders. For the principal owners of many closely held businesses, the corporate stock is far and away their largest single asset.

The corporate structure is touted to business clients by CPA's and attorneys to satisfy a number of objectives, but particularly as a means to protect the shareholders' assets. On a prior blog post, I recently discussed hearing a radio advertisement directed to the general public encouraging the use of corporations for asset protection purposes.

Unfortunately, the business owner who relies upon his or her corporation to protect their assets from creditors may be in for a rude surprise. While a corporation will shield the individual shareholder from liability against the corporation's creditors, the corporation will not protect the shareholder's stock -- which in almost every instance is considered personal property of the shareholder -- against claims from the shareholder's own personal creditors. We refer to this scenario as reverse veil piercing. Let's look at an example of the danger this type of exposure may pose:

Lou owns 100% of the stock in a plumbing supply company located in Orange County. Through hard work, integrity and good business practices, the value of Lou's company -- and the value of his stock -- has grown to $7 million. Lou is 63, and he is looking forward to being able to sell his business to a larger regional competitor and finally enjoy the fruits of his labor.

One day Lou and his wife, Monica, are babysitting for their 7-year-old grandson, Dylan. Having the attention span of a typical 7-year-old, Dylan leaves his skateboard by the front steps. Minutes later Lou's neighbor, Frank, comes by to drop off a flyer about the upcoming neighborhood block party. Frank is an orthopedic surgeon just entering the prime of his earning years. As he makes his way to the stairs of Lou's house, Frank trips over the skateboard and suffers a fractured vertebrae, leaving him paralyzed from the neck down.

After a trial, a jury awards Frank a $10 million judgment against Lou and Monica. Even with their $2 million umbrella insurance policy on top of their $1 million homeowner's liability insurance, Lou and Monica will still owe Frank $7 million to satisfy the judgment.

Well, at least Lou's corporation will protect his $7 million worth of assets in that business, right? Not so fast. All of Lou's personal property -- including his stock in his company -- can be seized by Frank to satisfy the legal judgment. Once Frank takes ownership of Lou's stock, Frank can appoint himself to the Board of Directors, fire Lou as President, and sell the company or its assets. Lou would end up seeing his entire life's work dismantled in a flash.

So, what could Lou have done differently to truly protect his business assets from his personal judgment creditors? Lou could have established his business as a limited liability company, or "LLC." LLC's were first created in Wyoming in 1987, and have since been statutorily approved in every state. Under the laws of many states, a judgment creditor cannot seize a membership interest in a limited liability company to satisfy a judgment. Instead, the judgment creditor is limited to what is known as a "charging order" that only permits the judgment creditor to distributions made to the judgment debtor from the LLC. If in our example Lou had established his business as an LLC, he would retain control over his company and can restrict distributions made to members from the business. Frank would not be able to require Lou to make distributions, and would be frustrated in his efforts to collect on the judgment. Frank (and his lawyers, who would only get paid by collecting on the judgment) would be more inclined to negotiate a settlement on terms favorable to Lou.

But what if Lou's business were already established as a corporation? Fortunately, Section 1003 of the New York limited liability law permits another "business entity" to be merged into an LLC, with the LLC to be left as the "surviving entity." Upon following the procedures outlined in the statute, Lou could have converted his corporation into an LLC formed under either New York law, or the law of another state if preferred.

In addition to the asset protection benefits inherent in the LLC structure, an LLC can be taxed as a corporation. In Lou's case, he would certainly elect to continue to be taxed as a corporation after the merger. There would be no difference if Lou's company were a "C" or an "S" corporation, as an LLC can elect to be taxed under either form. However, it is imperative to consult a tax professional before embarking upon a merger to avoid negative income tax consequences.

Given the LLC's many benefits, why would anyone consider establishing a corporation for their business? The only true advantage is that a corporate form is suited for entrepreneurs who intend to "go public" and sell shares in the company to a wide range of investors. LLC's are not structured to be publicly traded entities. However, for the remaining 99%+ of business owners who will always remain closely held, the LLC is the only way to go.