Weathering the Economic Storm - Handouts from our recent breakfast seminar
June 17, 2008
HEROLD AND HAINES, P.A.
presents
"Weathering the Economic Storm"
Somerset Hills Hotel - June 5, 2008
www.heroldhaines.com
WEATHERING THE ECONOMIC STORM
Speakers:
Joseph M. Lemond - Estate Planning
Estate Tax Savings Techniques In Declining Markets
Robert B. Haines - Tax
Tax Benefits From Residential Real Estate
John W. McGowan, III - Corporate
Material Adverse Change Clauses -
Are Your Existing Agreements At Risk?
Craig S. Provorny - Labor/Employment
New Jersey Paid Family Leave Act
Gary S. Jacobson - Bankruptcy
How Not To Get Tangled Up In Someone
Else's Bankruptcy
Estate Tax Savings Techniques In Declining Markets
Joseph M. Lemond, Esq.
Herold and Haines, P.A.
The precipitous decline in the real estate and equity markets coupled with historically low interest rates create unique estate planning opportunities. The planning techniques involve utilizing an individual's $1 million lifetime gift tax exemption (and $12,000 annual exclusions) to transfer depressed assets to children or grandchildren so that future appreciation passes free of transfer taxes. Note that the federal estate tax exemption (as opposed to the gift tax exemption) is currently $2 million and is scheduled to increase to $3.5 million in 2009.
Outright Gifts
A straightforward technique involves making an outright gift of a depressed asset. For example, if you own a summer home currently worth $1 million which you purchased in 2005 for $1.3 million, you could transfer the home to your children without a current gift tax by utilizing your $1 million gift tax exemption. If the property's value returns to $1.3 million, the $300,000 would have escaped the transfer tax system. Note that it is generally counter-productive to give assets with a low tax basis, since that would transfer the built in tax liability to your children, effectively reducing the value of the gift.
Gifts to Grantor Trusts
A properly drafted grantor trust's assets are treated as owned by the individual who created the trust for income tax purposes, but by the trust for transfer tax purposes. If you make a gift of low basis assets to such a trust for the benefit of your children, you would pay the income tax on any subsequent sale by the trust, but the trust keeps all of the economic gain, giving the children the benefit of the trust's pre-tax rather than after-tax earnings. This would work well for an asset with a built in tax gain which is currently depressed. An example would be if you transferred to a grantor trust stock in Continental Airlines currently priced in the $13.50 range (which is a recent low point) but purchased by you for $5/share in 2003. If the stock returns to its January price (about $25) and is then sold by the trust, the trust retains the entire $25/share, and you pay tax on the gain ($20/share). Thus, you utilized only $13.50 of your gift tax exemption, the trust received a share of stock eventually worth $25, and you (not the trust) were responsible for the income tax generated by the sale.
Loans
The IRS's minimum interest rate for a three year loan made in June 2008, is 2.08%. This means you can loan a child $1 million for three years at 2.08%, and he/she would pay you $20,800 in annual interest ($62,400 total). If he/she invests the money and earns 5% during the same period ($50,000 annually, $150,000 total), the aggregate difference between the interest he/she paid you and what he/she earned ($87,500) passes transfer-tax free to the child.
Grantor Retained Annuity Trust
A grantor retained annuity trust ("GRAT") is an irrevocable trust which you create during your life. You reserve the right to receive a fixed dollar amount for a certain number of years, with the trust balance then being handed over to your children. The value of the children's remainder interest is a taxable gift, using up part of your $1 million gift tax exemption. The effectiveness of this gift depends entirely on the GRAT's investments earning more than the Treasury valuation rate used to project and value what the children will receive when the GRAT ends. The rate for June 2008 is 3.8%. You may establish a GRAT with the payout rate to you set so high that the remainder gift to the children is worth almost zero for gift tax purposes. This is called a "zeroed out" GRAT. If the assets of a zeroed out GRAT created in June 2008 appreciate significantly more than 3.8%, the excess would pass to your children without utilizing any of your gift/estate tax exemption.
Tax Benefits From Residential Real Estate
Robert B. Haines, Esq.
Herold and Haines, P.A.
A qualified personal residence trust ("QPRT") is an irrevocable trust, except that the only asset it holds is a personal residence (it can be a condominium or co-op). You put a residence (primary or secondary i.e. the "summer place"), into the QPRT, reserving the right to live there for a fixed number of years; at the end of that time, the QPRT turns the residence over to the children. Since you have retained the right to use the residence for a fixed number of years, the gift is discounted. For example, a QPRT by a 60-year-old of a $1,000,000 residence with a 15-year retained term, is a gift of $404,000. If the retained term is reduced to 10 years, the gift amount increases to $574,500 because the value of the retained interest has decreased from $596,000 to $425,000.
With current depressed values of real estate, a QPRT may be even more advantageous. If the same $1,000,000 house now has a value of $900,000, the gift amount for a 15-year QPRT is reduced from $404,000 to $364,000.
I should point out, however, that since interest rates are now so low, the IRS currently assumes a 3.8% interest factor. One year ago, that interest rate was 5.6% and a QPRT of a $1,000,000 house by a 60-year-old in May 2007, would have been a gift of $312,000 - less than the QPRT of the $900,000 house in May 2008.
With a QPRT, you take advantage of a special IRS valuation assumption that says a house never changes in value while it's owned by a QPRT. The IRS views the taxable gift to the children as the present value of their right to get the house at the end of the QPRT term, with the house presumed to be worth exactly what it's worth today.
Aside from the "frozen value" assumption, QPRTs get a unique valuation break that makes them especially attractive for those who have reached their golden years. This wrinkle - involving a "reversionary interest" - is pretty technical, but the net effect is to greatly reduce the amount of the taxable gift when someone in their 70's or 80's decides to utilize a QPRT for some last-minute estate reduction.
To those cautious souls who aren't sure they want to give up their home when the QPRT ends, we offer two suggestions:
While you can't buy back the house, you can lease it from the children at prevailing market rates. In that case, either you need trustworthy children, or the house should pass from the QPRT into another trust with a dependable trustee. In any event, the lease rental must be tied to market value as of the termination of the QPRT, perhaps by appraisal.
Exclusion of Gain from Sale of Principal Residence. Married couples have a $500,000 exclusion from the gain of the sale of a principal residence. The Mortgage Forgiveness Act of 2007 passed by Congress on December 18, 2007, provides that the $500,000 exclusion of gain from the sale of a principal residence will be available to a surviving spouse. This new law is effective for sales after December 31, 2007. The sale by the surviving spouse must occur within two years after the deceased spouse's death. Without this law change, a surviving spouse would have the $250,000 gain exclusion allowed to single taxpayers.
Since the residence is likely to get a new cost basis as an asset of the deceased spouse, this additional exclusion can provide a real additional tax benefit. Spouses A & B jointly own their primary residence with a cost basis of $300,000; if Spouse A dies when the house is worth $900,000, Spouse B will be sole owner as surviving joint tenant and will own the house with a cost basis of $600,000 (50% of the pre-death cost basis plus 50% of the value on the date of Spouse A's death). If Spouse B sells the house within two years after Spouse A's death, she will not pay any capital gains unless she sells the house for more than $1,100,000. Prior to the 2007 change, Spouse B would have had a taxable gain if the sale was for more than $850,000 so that if the house were sold for its appraised value on the date of Spouse A's death, there would have been a $50,000 taxable gain to Spouse B.
Material Adverse Change Clauses -
Are Your Existing Agreements At Risk?
John W. McGowan III, Esq.
Herold and Haines, P.A.
What is a material adverse change clause, commonly known as a MAC?
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In a transactional document, a MAC is an all-purpose out for a buyer whose target has become, by the time the deal is to close, an entity that looks different than it did when the deal was signed.
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In a lending document, a MAC allows the lender to accelerate debt, call for more collateral, impose a lien on additional collateral (a springing lien), or exercise a remedy. This is also sometimes called a "general insecurity clause".
Typical MACs
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MAC used in a transactional document, such as a merger agreement or an agreement for the purchase and sale of a business
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"Material Adverse Change" means any material adverse change, individual or in the aggregate, since the date of this Agreement in the condition (financial or other), business, results of operations, prospects, assets, liabilities or operations of Seller or on the ability of Seller to consummate the transactions contemplated hereby or to perform any of its material obligations under this Agreement or any event or condition which would, with the passage of time, constitute, individually or in the aggregate, a "material adverse change."
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MAC used in a lending document
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"Material Adverse Change" means any material adverse change, as determined in Lender's discretion, in (a) the business, assets, operations, prospects or condition, financial or otherwise, of Borrower; (b) Borrower's ability to pay or perform its obligations in accordance with their terms; (c) the value, collectability or salability of the collateral or the perfection or priority of Lender's liens; (d) the validity or enforceability of any of the Loan Documents; or (e) the practical realization of the benefits, rights and remedies inuring to Lender under the Loan Documents.
Uses of a MAC
- By a strategic buyer - synergies and prospects are most important
- By a financial buyer - define performance criteria
- By a lender - to void a loan commitment, to call an existing loan
But what is a MAC?
Precision in documents
- While the purpose of a contract is to clearly define the parties' obligations, rights, and remedies, a MAC is a consistent exception to that rule
- Specific areas of concern should be addressed up front and apart from the MAC as conditions to obligations to go forward with the transaction
Exceptions to a MAC
- General industry conditions
- Natural disasters
- Macro-economic events
- Dollar amounts on specific events
- Adverse weather, political, economic or general business conditions
- Interest rate or currency exchange rate changes
- Changes in law or accounting conventions
Defenses to the use of a MAC
- Factual defense
- Event that should have been anticipated; e.g. environmental claims in a recent case
- Cyclical nature of earnings
- Forthright negotiation defense - the subjective understanding of one party to a contract may bind the other party when the other party knows or has reason to know of that understanding
Conclusion
- Using a MAC as an excuse to performance and to justify termination is generally risky
- Assertions of MAC are often made to force negotiations in price or other terms
Business Law Department
Howard G. Katz
908-647-1022 Ex 132
hkatz@heroldhaines.com
John W. McGowan III
908-647-1022 Ex 115
jmcgowan@heroldhaines.com
New Jersey Paid Family Leave Act
Craig S. Provorny, Esq.
Herold and Haines, P.A.
Effective dates of legislation
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Signed into law on May 2, 2008 by Governor John Corzine.
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Collection of employee assessment commences January 1, 2009.
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Payment of Family Leave benefits commences July 1, 2009.
Employers Covered
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Applies to all private businesses that employs one or more employees and pays the employee at least $1,000 in the current or preceding calendar year.
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Contrast with the New Jersey unpaid Family Leave Act and the unpaid federal Family and Medical Leave Act which apply to employers with 50 or more employees.
Who is Eligible for Paid Family Leave?
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An individual is covered if he or she is engaged in employment as defined by New Jersey's unemployment compensation law.
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Individual must have had at least 20 calendar weeks in covered New Jersey employment in which he or she earned no less than an amount equal to 20 times the minimum wage (currently $143 per week), or has earned not less than 1,000 times the minimum wage adjusted to the next higher multiple of $100 (currently $7,200 per year) in such employment during the "Base Year" period.
Types of Paid Family Leave
A covered individual is eligible for up to six weeks of paid family leave benefits during a 12- month period if he or she takes leave from work:
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to provide care, as defined by the New Jersey Family Leave Act for a family member who has a serious health condition;
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to be with a child during the first 12-months after birth if either the individual or the domestic partner or civil union partner of the individual, is a biological parent of the child; or
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during the first 12-months after the placement of the child for adoption.
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An employee may also take intermittent leave to care for a family member who has a serious health condition in any 12-month period, if certain conditions are met.
A family member is defined as a child, spouse, domestic partner, civil union partner or parent of a covered individual.
What are Employees' Obligations?
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Employee must provide 30 days notice if leave is for after the birth of a child or placement of the child for adoption.
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If leave is to care for a family member with a serious health condition, the employee must provide prior notice to the employer in a reasonable and practicable manner, unless an emergency or other unforeseen circumstances preclude prior notice.
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The employee must provide a medical certification from the health care provider of the family member.
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A failure of notice penalizes the employee with a two week reduction in benefits.
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To qualify for paid family leave, employees must first exhaust availability maternity and disability leave. Employers may also require workers to use any paid sick leave, vacation time and other leave at full pay for up to two weeks before using paid family leave time.
Cost to Employees and Amount Eligible to Receive
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Beginning January 1, 2009, employees must begin paying an additional tax of 0.09% on the portion of wages, approximately $27,700, subject to temporary disability insurance, or $24.93 per year, about $0.48 per week.
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In 2010, the tax rate will be increased to 0.12% of wages, or $33.24 per year, about $0.64 per week.
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Employee may receive two-thirds of his or her weekly compensation up to $524 per week, for up to six weeks, during any 12-month period.
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If the employee takes intermittent leave, the employee will be eligible to receive up to $74.85 per day, for up to 42 days, during any 12-month period.
Job Protection
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For employers who employ fewer than 50 employees the failure or refusal to restore an employee to employment following paid family leave will not be a wrongful discharge in violation of a clear mandate of public policy.
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An employee of such an employer will not have a cause of action against the employer, in tort, or for breach of an implied provision of employment, or under common law, for refusing or failing to restore the employee to employment.
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Employers who are covered under the New Jersey Family Leave Act and the federal Family and Medical Leave Act (50 or more employees) are still subject to the reinstatement obligations pursuant to those Acts.
Labor and Employment Practice
Craig S. Provorny
908-647-1022 Ex 135
cprovorny@heroldhaines.com
Charles F. Waskevich
908-647-1022 Ex 129
cwaskevich@heroldhaines.com
How Not To Get Tangled Up In Someone Else's Bankruptcy
Gary S. Jacobson, Esq.
Herold and Haines, P.A.
1. Dealing with contractors and placing special orders of goods.
a. Cash deposits for future goods and services have little protection if the contractor or vendor becomes insolvent.
i. The risk is that the job will not be completed, the goods will not be delivered, and you will not get your money back.
b. Buy supplies directly rather than advancing funds to the contractor to purchase them.
c. Protect money you advance through a true escrow arrangement that places funds with a third party and releases money upon discrete, objective milestones.
2. Helping family and friends who are in financial trouble.
a. Avoid signing guarantees; if you must provide them, limit guarantees to specific amounts and time periods.
b. If you are loaning money or guaranteeing debt, obtain collateral from the borrower.
i. To be valid against other creditors, a mortgage or security agreement must be promptly and properly perfected by recording in a government office.
c. To help someone pay off a specific debt, pay it directly or make sure that the payment is made directly and immediately from your loan so that your funds are "earmarked".
d. Be wary of having assets transferred to your name to protect them from someone else's creditors.
3. Extending business credit to customers.
a. Protect yourself by closely monitoring customer credit lines to prevent run-ups.
b. Don't let receivables age beyond your customer's customary payment history.
i. Cut off additional credit or put the customer on C.O.D. terms for additional orders.
c. Securing your goods as collateral requires careful documentation and notice to other creditors.
d. If you believe that the customer is insolvent or learn that it files for bankruptcy, immediately send a written demand for reclamation of goods that have been delivered within the preceding 45 days.
4. Glossary of key bankruptcy terms.
a. Avoidance Power: The right of a bankruptcy trustee to sue to recover a payment that is a preference or a fraudulent transfer; or to invalidate a lien on collateral because it was not perfected.
b. Fraudulent transfer: Movement of property or money made either (I) with intent to hinder, delay, or defraud creditors; or (II) by an insolvent party who does not receive fair value in exchange.
c. Insider: A relative or business associate of a debtor.
d. Lien: The right of a creditor to have first claim to collateral or its value, such as a mortgage on real estate or a security interest in other types of property.
e. Perfection: Public recording or other formal steps necessary to make a lien valid against other creditors and a bankruptcy trustee.
f. Preference: A payment made by the debtor to an unsecured creditor within 90 days before bankruptcy is commenced. Payment made to an insider within one year before the bankruptcy is a preference.
g. Unsecured creditor: A creditor who does not have a lien on any particular property of the debtor.
Bankruptcy Practice
Gary S. Jacobson
908-647-1022 Ex 117
Direct Dial - 908-484-1117
gjacobson@heroldhaines.com
