Discuss the purpose of estate planning and explain the basic concepts of domestic estate planning, including estates, wills and probate
Will
- aka a testament
- used to transfer estate assets at death
Probate
- legal process to validate and implement the will after death
- can be costly
- and public
Alternatives to transferring assets outside the probate process
- joint ownership with rights of survivorship
- living trusts
- retirement plans
- life insurance
Explain the two principal forms of wealth transfer taxes and discuss effects of important non-tax issues, such as legal system, forced heirship, and marital property regime.
Gifts Bequests Forced heirship Clawback provisions Community property rights regime
Gifts
- without the intent of receiving value in return
- between living individuals
- subject to gift taxes
Bequests
- after death
- estate taxes: paid by the grantor
- inheritance taxes: paid by the recipient
Forced heirship: provide statutory ownership, effectively giving one person the right to the assets of another
Clawback provisions: add value of any offshore assets back to the descendant’s estate before calculating the child’s share
Community property rights regime
- each spouse is entitled to one-half of the estate earned during the marriage
- gifts and inheritances received before or during the marriage may be held separate from marital assets
Separate property rights
- each spouse owns and controls his or her property, separate from the other
Determine a family’s core capital and excess capital, based on mortality probabilities and Monte Carlo analysis
Core capital
- amount necessary to meet all of an individual’s liabilities plus reserve for unexpected needs
- it is the sum of the products of
a) expected spending for each year, and
b) the probability of living that long - an individual has 50% probability of outliving mortality table expected life, so incorporate a safety reserve in core capital
Monte Carlo simulation gives the expected portfolio value and distribution of possible values at retirement.
The probability of running out of money is known as the probability of ruin.
Level of spending and probability of ruin are usually positively correlated
Evaluate the relative after-tax value of lifetime gifts and testamentary bequests
Relative Value ratios (RV) project the future value to the recipient of making the gift now during the giver’s life versus leaving a bequest (gift) at death
An RV > 1
Denominator = FV giving it later
Evaluate the after-tax benefits of basic estate planning strategies:
1) generation skipping
2) spousal exemptions
3) valuation discounts
4) charitable gifts
1) generation skipping
- can avoid the double taxation of assets
2) spousal exemptions
- allowed by many countries
3) valuation discounts
- employed to reduce the taxable value of gifts or the estate e.g. liquidity discount, minority control discount
4) charitable gift
- compound tax saving
Explain the basic structure of a trust and discuss the differences between revocable and irrevocable trusts
Trusts are a means by which a GRANTOR / SETTLOR can transfer assets to beneficiaries outside of the probate process
TRUSTEE holds the assets and manages them in the best interests of the beneficiaries according to the constraints of the trust documents
Revocable trust
- settlor can rescind the trust
- settlor considered legal owner of the assets for tax purposes
Irrevocable trust
- settlor relinquishes ownership
- trustee considered owner of the assets for tax purposes
- protects trust assets from claims against the settlor
Fixed trust
- pattern of distributions to the beneficiaries is predetermined by the settlor and incorporated into the trust documents
Discretionary trust
- trustee determines how the assets are distributed
- beneficiaries have no legal right to either the income or the assets of the discretionary trust, thus the trust assets are protected from claims against the beneficiaries
Spendthrift trust
- used to transfer assets to a beneficiary who is too young or is otherwise unable to manage the assets
Explain how life insurance can be a tax-efficient means of wealth transfer
Premiums paid on life insurance are not usually considered part of the grantor’s estate for tax purposes. In most jurisdictions, life insurance proceeds pass to beneficiaries without tax consequences, and, depending on jurisdiction, the policy might provide tax-free accumulation of wealth and/or loans to the policy holder on beneficial terms.
By establishing a trust on behalf of the beneficiaries and making that trust the direct beneficiary of a life policy, the policy holder transfers assets to young, disabled, et cetera, beneficiaries outside the probate process
Discuss the two principal systems for establishing a country’s tax jurisdiction
1) Source jurisdiction
2) Residence jurisdiction
Source jurisdiction
- a country levies taxes on all income generated within its borders
Residence jurisdiction
- a country taxes the global income of its residents
Discuss the possible income and estate tax consequences of foreign situated and foreign-sourced income
i.e. EXIT TAX
If a citizen renounces their citizenship to avoid taxes, some jurisdictions impost an exit tax, usually based on the gains on assets leaving, as if they were sold.
This could include a tax on income earned for a shadow period
Evaluate a client’s tax liability under each of the three basic methods.
1) credit
2) exemption
3) deduction
Residence-residence conflict: two countries claim residence for the same individual
Source-source conflict: two countries claim authority over the same income
Residence-source conflict: an individual is subject to residence jurisdiction and receives income on assets in a foreign country with source jurisdiction
Tax treaties may partially or fully resolved the double taxation of residence-source conflicts. The income is taxed by the source country and then:
- Exemption method: Not taxed by the residence country
- Credit method: The tax owed to the residence country is computed, and a credit for taxed paid to the source country is applied:
i) if more is owed the residence country, the difference is paid
ii) if less is owed the residence country, the bill is zero - Deduction method: Taxes owed the source country reduce the taxable income in (and thereby partial reduce the tax owed to) the residence country
Discuss how increasing international transparency and information exchange among tax authorities affect international estate planning
Tax avoidance = legal
Tax evasion = hiding, misrepresenting, or otherwise not recognising income so as to illegally avoid taxation
Many countries now enter into global treaties which provide for sharing of information:
QI = qualified intermediaries, banks
- collect all the information required by the United States but provide the information on their US customers only
A similar agreement exists in the EU, by which EU member banks exchange customer information with each other
