September 2005

MEMBERS’ CORNER
BY STANLEY TEPPER, CPA, MBA

MEMBERS’ CORNER

BY STANLEY TEPPER, CPA, MBA

 “ Retired and Still Working” – Carol Markman, National President of the National Conference of CPA Practitioners was interviewed by Newsday concerning the ability to continue to work after one reaches the age to receive full Social Security Benefits. Full Social Security retirement age increases to 65 and 8 months for people born in 1941, 65 and 10 months for people born in 1942 and 66 for people born from 1943 to 1954.

Use it or Lose it – Inherit an individual retirement account from someone who dies after turning 70½, and you must take your benefactor’s required distribution by December 31. Otherwise, you’ll face a 50% penalty on the money you should have taken out.

But if you prefer that the money go to the beneficiary next in line, the Internal Revenue Service will now let you disavow all or part of the IRA even after you take that initial required distribution. The only hitch: You have to demur within nine months of the account owner’s death.

(Business Week August 15, 2005 )

Restrictions of Buy-Sell Agreement Disregarded for Estate Tax Purposes – (Space limitations prevented this newsletter item edited by Stephen Silverberg & Lisa Hunter of Certilman, et. A.L. from being printed last month.)

In 1981, George Blount and his brother-in-law, Mr. Jennings, each owned one-half of the shares of BCC, a construction company. They entered into a buy-sell agreement restricting transfers of stock during the shareholders’ lifetimes and at death. Lifetime transfers required the consent of all parties to the agreement. At death, the deceased shareholder’s estate was required to sell, and BCC was to buy, the decedent’s shares either at predetermined price or at the company’s book value at the end of the preceding fiscal year. The agreement could only be modified by the written consent of all “parties,” which initially included Blount, Jennings, and BCC.

Blount and Jennings later transferred shares to an employee stock ownership plan (ESOP) that BCC established. Jennings died in 1996, and the business redeemed his shares for almost $3 million, leaving Blount and the ESOP as the only remaining shareholders. However, Blount owned 83.2% of the outstanding stock, making him the controlling shareholder of BCC. As such, he was effectively the only remaining party to the buy-sell agreement.

Later that year, Blount learned he had terminal cancer and began setting his affairs in order. He wanted to ensure the company would survive after his death. Taking into account $3 million in life insurance the company would receive, he determined that the maximum amount BCC could pay to purchase his shares upon his death was $4 million, or $92.85 per share, far less than the $155.32 per share based on the most recent appraisal.

Blount drafted a new agreement with BCC that, upon his death, the company would pay his estate $4 million for his shares. Blount signed both in his individual capacity and as the company’s president. He did not obtain the consent of the ESOP, nor did he consult an attorney regarding the consequences. After Blount’s death, BCC redeemed his shares for the $4 million amount set forth in the modified agreement, and his estate also reported that as the stock’s value for estate tax purposes.

Unfortunately, the IRS determined an estate tax deficiency of $2.4 million, and the Tax Court agreed. The Court ruled that since Blount could unilaterally modify the buy-sell agreement without obtaining the consent of the other shareholder (the ESOP), the restrictions in the modified agreement were not binding on him during his life, and the agreement must be disregarded for estate tax purposes. Even if the agreement had been binding on Blount, the Court reasoned, it would have fallen under § 2703, which provides that an agreement to acquire property for less than fair market value will be disregarded in valuing the property for estate tax purposes, unless the agreement meets certain conditions, which Blount’s did not.

Also the Court determined that the $3 million in life insurance proceeds should be added to the company’s value, bringing the taxable value of Blount’s shares to $8.2 million.

Estate of Blount v.Commissioner

(T.C.Memo.2004-116, 5-12-04 )

Cell Phones – On about September 6, 2005, cell phone numbers are being released to telemarketing companies and you will start to receive sale calls. YOU WILL BE CHARGED FOR THESE CALLS…..

To prevent this, you can call the following number from your cell phone: 888/382-1222. It is the National DO NOT CALL LIST. It will only take a minute of your time. It blocks your number for five (5) years.

Ed Slott’s IRA Advisor- These quoted articles appeared in our chapter member’s monthly newsletters. (Ed Slott can be reached at (516) 536-8282.

Should You Ever Name Your Estate As Your IRA Beneficiary? – Does it ever make sense to name your estate as your IRA beneficiary? Sometimes, but only in exceptional circumstances.

Your Estate Has No Life Expectancy

“As a general rule, naming your estate as IRA beneficiary does not make sense if tax deferral after your death is important to you.” An estate has no life expectancy and estate beneficiaries will not be able to stretch payments over their lifetime. Similar results will occur if you name no IRA beneficiary, in which case the account will generally be paid out to your estate after your death, depending on the default provision in your IRA Custodial Agreement.

“The final regulations on minimum required distributions, issued in 2002, eased up on payouts to your estate, if you die after the required beginning date (RBD) for required minimum distributions (RMDs)”.

Say you have to take RMDs; then you die, leaving your IRA to your estate. Going forward, IRA distributions can be stretched out over your hypothetical remaining life expectancy, as of the year of your death. Subsequently, that life expectancy would be reduced by one, year after year, to calculate the required minimum payout.

(With your estate as beneficiary, the IRA will be passed on under the terms of your will. Ongoing distributions would go to the beneficiaries of your estate, who wind up with the IRA.)

Thus, your IRA might be stretched out by 5 to 10 years or so, in this situation. If you die at age 80, for example you’d have a remaining life expectancy of about 10 years.

That’s not bad, but it may not compare to the benefit of leaving your IRA to a named beneficiary. Your 50-year-old daughter, for example, would have a 34.2 year stretch out, while your 20 year-old grandson could enjoy 63 years of tax deferred compounding.

The potential loss of tax deferral is even greater, though, if you die before your RBD. “In that situation, what is known as the ‘five year rule’ takes effect.” That is, the IRA would have to be paid out to your estate by December 31 of the fifth year following your death. Therefore, leaving your IRA to your estate might turn 63 years (or more) of tax deferral into five years.

There is another disadvantage to naming your estate as IRA beneficiary. “If the money goes into your estate, it’s subject to the time and expense of probate.”

On the other hand, an IRA passing to a specified beneficiary skirts probate.

When it Pays to Name your Estate as IRA Beneficiary

Considering the potential loss of wealth building and the intrusion of probate, does it ever make sense to name your estate as IRA beneficiary?

Perhaps, if you consider tax-deferred IRA payouts to be uncertain of relatively little value. “This type of ‘Stretch IRA’ is up to the beneficiary.” The deceased owner generally can’t guarantee it. Just because the option exists doesn’t mean the beneficiary will implement such a strategy.

A stretch may be meaningless, if both the amount of the IRA and the tax brackets of the beneficiaries are fairly low. “Fiduciary accounting allows the estate to determine who will pay tax on the IRA.” “For example, if you have a $100,000 IRA and ten of the beneficiaries are between the ages of 18 and 25, in the 10% tax bracket, the IRA portion of the estate can be distributed to them without a major tax hit.”

Charitable Intentions

If you are willing to give up on a stretch IRA, for various reasons, other goals may be considered more important. “Although naming the estate as beneficiary is usually not a good idea, it may be the best alternative in some situations and is not always as detrimental as it first appears.”

A client wanted to make specific bequests to several charities, totaling $70,000. “He had a small IRA,” and IRAs typically are a good source for these types of bequests.’ If an IRA is bequeathed to charity, the deferred income tax can be avoided.

However, the custodian of this particular IRA was not willing to comply with the IRA owner’s wishes. “For beneficiaries, it would accept percentages but not specific dollar amounts.”

That is, the custodian would agree to a beneficiary designation of, say, “15% to the local community foundation” but not $10,000 to the foundation.” What would happen, for

example, if there were $70,000 worth of bequests but only $50,000 in the IRA at the owner’s death?

“The only way to do what the client wanted to do was to have the estate inherit the IRA. Then the $70,000 could be paid to the named charities, under the will. Any excess in the IRA will go into the estate while the estate will be responsible for making up any shortfall.”

Estate vs. Trust Beneficiary Strategies

Other scenarios for naming an estate as IRA beneficiary could result from a desire to use a trust. “There might be a case, where you want a son or daughter to inherit your IRA but you know that person is a total spendthrift. The money will be spent rapidly and there won’t be any stretch out if you name him or her as a beneficiary.”

In this situation, your first choice normally would be to name a trust as your IRA beneficiary; then your son or daughter can be the trust beneficiary. Handled properly, long-term tax deferral will be possible, under the direction of the trustee.