Raison D’etre

When in 2006 IRS responded to perceived abuses of the domestic private annuity (widely marketed as the “private annuity trust”), the tax bar largely threw in the towel declaring “game over!” But it is not over.

The private annuity remains important in deferring income tax and avoiding gift, estate, and generation-skipping tax, all while retaining a lifetime stream of income for the annuitant, and keeping the value of those assets in the family.

In 2006, IRS proposed a treasury regulation under which the exchange of appreciated capital assets for a private annuity would be denied ratable recognition of gain over the life expectancy of the annuitant, instead requiring full recognition in the year of exchange. The proposed regulation is to be retroactive to 2006 when it becomes final. But (a) several years have now passed, and it is not yet final, (b) the apparent aim was to chill the ardor of the hotel seminar operators who clearly misused the tool, so having achieved its aim, the proposed regulation may never become final, and (c) even if IRS someday declares it final, it is fatally flawed as a matter of law. See Chapter Seven. If all else fails, the annuitant still has the time value of the funds lost to the capital gain tax from the year of exchange to the year the regulation becomes final.

The private annuity protects the assets even after the annuitant loses a lawsuit. This because the courts cannot set aside the purchase . . . it is not voidable by a creditor as a fraudulent transfer, nor by a bankruptcy court as an “executory contract.” The most the creditor may reach are the annuity installments, and may not reach even those if the payor is located in a jurisdiction prohibiting enforcement of the judgment.

By moving the payor to a protective jurisdiction, not only is asset protection enhanced, but the risk of outliving the money is reduced due to non-taxation of retained portfolio earnings.

But it’s complicated. How do you create a foreign non-grantor trust notwithstanding IRC Section 679? What are the effects of foreign trust accounting rules? What about the interplay with the Foreign Investment in Real Property Act? Or the rules for construing governmental regulations?

The private annuity, done properly, is an amazing but complex transaction. The problem is that until now, the information was so fragmented that real clarity was difficult to attain. In An Advisor’s Guide to Private Annuities, veteran trust and estates attorney, F. Bentley Mooney, Jr., presents the most complete treatment of the law, tactics, and concepts on the market today. With it, you may proceed with confidence.

Wealth Transfer Taxes and the Private Annuity

The estate planner’s full employment act is upon us!

On January 1, 2013, estates of only $1 million will subject to federal estate tax with a rate of 55% at the margin.

Review your tools for reducing or avoiding the tax in order to be positioned to act!

Congress will not take action on the estate tax for several practical reasons:

The issue has produced multiplied millions of dollars for campaign contributions over the last 40 years as politicians promise to fight for one side or the other. They are loathe to give up that golden goose by actually solving the problem.

The anticipated Republican takeover in November may give them the House, but the U.S. Senate is less certain.

The purported fight is over a $3.5 million applicable exclusion (Democrats) or $5 million (Republicans). Neither is giving ground.

Even if the Republicans take both houses, they will be unable to overcome a Presidential veto of an enlarged exclusion.

As the tax bomb becomes known, you will be asked by your clients to show them the most painless tactics for avoiding it. One in use for more than a century is the private annuity. But private annuities are complex, and IRS doesn’t like something so good for the taxpayer. You need a comprehensive guide to effectively apply this tool to your clients’ needs.

The Private Annuity for Asset Protection

The recession is in full bloom! Unlike past troubles, this one looks like it will be with us for several more years. Clients who have struggled to this point are starting to give up and look for ways to save what’s left. They need asset protection.

When the client sees the creditors coming down the pike, it is usually too late to transfer assets beyond their reach. The law on such transfers has been with us for more than 400 years. It gives the court the power to void them, imposing liability on the brother-in-law who kindly but foolishly became involved in the deception.

Any transfer made while a claim is pending or threatened and for less than fair value is a voidable fraudulent transfer. In order to get beyond the reach of the court, the client has to buy something at full value. But that alone is not enough. To buy a Rolls Royce is to lose a Rolls Royce when the judgment creditor appears with a writ of execution. Whatever is purchased has to (a) retain value, and (b) be beyond the reach of the court and creditors.

The only transaction matching up all the necessary elements is the foreign private annuity. Getting your hands on the information needed to employ this tactic, however, is problematical. Professional journals deal only in selected aspects of its use. You need a comprehensive guide to effectively apply this tool to your clients’ needs. Until now, there were no books dealing comprehensively with the nature, uses, abuses, and remedies available to make the private annuity a killer solution.

An Advisor’s Guide to Private Annuities is the only complete collection of everything you need to know in order to quickly evaluate and design a tax avoidance or asset protection strategy. Compare the private annuity to the other planning options and your clients will call you blessed!

Harold and Winifred

Harold started a magazine publishing company in 1970. Winifred is not involved in the business, nor are their three children. Harold and Winifred are now 61, love to travel, but publishing deadlines make italmost impossible to take that dream trip. Harold believes the company would sell for about $10 million. They have abou $3 million in homes, automobiles, and other assets; no debt. Both Harold and Winifred are in good health.

They obtained an appraisal of the company and transferred 63% of the stock to a trust (Payor) in exchange for its promise to pay annuity installments to them for life. The present value of that promise is $6.3 million.

The Payor will market and sell the company, and Harold will continue to manage it for a salary until the sale is closed. Following the closing, the Payor will begin paying Harold and Winifred an annuity of $400,000 per year, payable for as long as either of them lives, and spreading the capital gain reporting over their joint life expectancy of 25 years. If the Payor’s portfolio manager earns 8% net average annual return on investment, it pays the annuity entirely from income and capital gains, leaving a nominal amount to add to principal. At the end (death of the survivor), they will have received more than $19 million over their joint life expectancy, and the assets backing up the annuity will wind up in a $13.9 million trust for the children and more remote issue. As much as $4.9 million in estate tax is avoided, and no gift or generation-skipping transfer tax will ever be incurred.

Jack and Jill

Jack and Jill were married for a number of years, the second marriage for each, and they have two children each from the prior marriages.

Jack built a successful medical practice in southern California. Jill was one of two children of a reckless, dishonest, trust fund baby who envisioned himself a player in the business world.

Jill’s father one day found himself broke, after a lifetime of high living and losing lawsuits brought by those he endeavored to cheat. Jill had served as an officer for several of his corporations, signing papers put before her and, trusting that all was proper.

Then she began receiving dun notices from banks and finance companies for defaults on airplane loans, automobile leases, and personal guarantees. She quickly realized that she had signed some papers without reading them, and that her name was forged on others, leaving her on the wrong end of several lawsuits for almost $3 million.

Around the same time, Jack was diagnosed with a rare form of bone cancer, and given fi ve years to live. Th e only medical facility
specializing in his form of cancer was located in Texas.

Jack and Jill entered into a prenuptial agreement when they were married. Under it, Jack’s home and medical practice were characterized as his separate property, unavailable by statute to Jill’s creditors. They had also accumulated about $300,000 in savings. Jack’s life also was insured for $500,000 under an association group term life insurance certificate.

Jack and Jill sought legal advice on how to protect their separate and community assets from her creditors, taking into consideration the need to move to Texas for clinical trials. The attorney advised them that both California and Texas law protects the separate property of Jack from lawsuits against Jill. He also advised them that Texas has an unlimited homestead exemption from the claims of judgment creditors. The homestead law requires that a certain amount of time pass before the exemption applies, but estimated that they had time to make it work.

The separate property practice and home were exchanged for a $2 million foreign private annuity, the attorney arranged for a life settlement sale of the term policy for $375,000, Jack put in a claim on his disability income insurance policy, and they moved to Austin.

There, they purchased a beautiful home with the community property cash, and Jack began treatments at the clinic. At bottom, his medical insurance paid the treatment costs, his disability policy pays $6,000 per month, his Social Security Disability payments are $2,000 per month, the private annuity pays $9,000 per month for as long as either Jack or Jill lives, and Texas’ unlimited homestead exemption fully protected the home.

The transfers of separate and community property were not voidable under fraudulent transfer law because the transfers were purchases, not transfers for less than fair value.

All this served to remove financial pressure on Jack while he fought for his life. Jill was able to settle with the creditors on the basis that their community property is exempt from claims under the homestead exemption, and Jack’s separate property was protected
by the state exemption, not to mention that it is located 8,000 miles away in the form of a foreign private annuity. Their affairs are stable, Jill’s private annuity income over her 38-year life expectancy will be approximately $4.5 million, and ultimately the children come into a trust estate on the order of $8.8 million.