Newsletter: June 2010
June 24, 2010
In this issue: Non-domestic Estate Planning; The Importance Of Estate Planning: A Case Study; Business Planning In Difficult Financial Times
NON-DOMESTIC ESTATE PLANNING
Assisting non-citizen clients and citizen clients with foreign assets.
Are your clients U.S. citizens? Are you sure? Do your U.S. citizen clients own real estate or investment assets outside the country? Without asking the critical questions, one may never know the answers until it is too late. Two recent experiences emphasize the importance of knowing the answers.
First, I recently learned that a neighbor I have known for more than 15 years is not a U.S. citizen. He was born in Poland and his family emigrated when he was an infant. He has no accent or other reason to question his citizenship. He was raised here, married here, and has simply never gone through the process of becoming a citizen. He and his wife are in their 60's with a standard Will based estate plan. Will it actually afford them the peace of mind they currently have?
Then, while meeting with other clients, and unbeknownst to the financial advisor or accountant, it was learned that the husband was not a citizen here, although his wife was. The estate plan that they had envisioned and discussed with their advisor was not the estate plan that they would end up with after consulting with Smith and Condeni. The rules for estate planning, estate administration and related legal matters such as gifting are dramatically different when one or more of the parties is a non-U.S. citizen. For example, U.S. citizen couples may gift an unlimited amount to each other during their lifetimes without gift taxation concerns, whereas gifts made from a U.S. citizen to a non-citizen spouse are limited to $133,000 per year before gift tax is levied.
Furthermore, assets passing at death from a U.S. citizen to or for the benefit of a non-citizen spouse are subject to the immediate payment of U.S. estate taxes unless they are held in a specific type of trust with specific requirements for creation and administration. No estate tax marital deduction is allowed unless property passing to a surviving spouse is held in a qualified domestic trust. While transfer tax treaties with certain countries may help ameliorate the results, the marital deduction is denied except under treaties with only three countries, namely Canada, Germany, and France. Meeting with a competent estate planning attorney is essential for developing the proper structure to allow for estate-tax deferral upon the death of the U.S. citizen.
Additional challenges are presented when a U.S. citizen owns property, real or personal, outside the United States. Many, if not most, countries disregard the wishes of property owners and provide a mandatory inheritance to certain relatives, regardless of what the decedent's estate plan may provide. There are ways to avoid that result however, including the formation and capitalization of a U.S.-based LLC. Coordinated planning is required to ensure that the property is treated as the client wishes regarding both its succession and its taxation under U.S. and foreign transfer and income tax regimes. Consulting a knowledgeable attorney is critical so that a plan can be developed to provide the unified treatment and best possible outcomes regarding the taxation and eventual disposition of such property.
Please contact Robin Rose Stiller at Smith and Condeni LLP for more information regarding any of the international estate planning matters discussed in this article.
THE IMPORTANCE OF ESTATE PLANNING: A CASE STUDY
Clients who wait too long to develop their estate plans may sacrifice important planning opportunities.
Recently, we were retained by a husband and wife to do their estate planning. Our first several meetings were with the husband and his Financial Advisor working out the details of the estate plan that he wanted for his family. The advisor made it clear that he had been encouraging his client to get his estate planning done for many years and the client finally accepted the importance of this.
The client spent years building up a substantial portfolio of real estate investments. He also worked closely with his Financial Advisor investing wisely and accumulating a substantial amount of assets in annuity contracts and other financial investments. The total net worth of the client and his wife is about $7,000,000 and represents the results of a lot of hard work and frugal living over many years.
As to tax planning, the client wanted a plan to avoid or reduce estate taxes should something happen to him and his wife. He is age 75 and she was (clue) age 85. They have two children but are disinheriting their son (for reasons that are very understandable) and their daughter does not have any children. There are multiple important issues that needed to be addressed.
Several weeks ago we received a call from our distraught client advising that his wife had unexpectedly passed away. Unfortunately, this was before we could meet with him and his wife and have them sign the estate planning documents we were preparing. Now we are left with administering an estate using a Will that is decades old. The estate tax planning opportunities available to couples has vanished.
The unexpected happens and in this case, the failure to have an estate plan in place will very probably mean substantial estate taxes on the death of the husband. As an example, if the federal estate tax credit were reinstated at $3,500,000, then our estate plan could potentially have eliminated all federal estate taxes as the use of both of their estate tax credits equals $7,000,000, the approximate size of their estate.
However, we cannot use her estate tax credit. The potential federal estate tax cost assuming a $3,500,000 estate tax credit is about $1,750,000 and Ohio estate taxes are in addition to this.
A disclaimer strategy where the husband disclaims assets to the children (which then uses the estate tax credit of the wife) is not available. A disclaimer of assets would mean that his son receives half of the assets disclaimed and as the husband does not want to leave anything to his son, he will not do that.
Please contact N. Lindsey Smith at Smith and Condeni LLP for more information regarding any of the matters discussed in this article.
BUSINESS PLANNING IN DIFFICULT FINANCIAL TIMES
In this turbulent economic climate, the time is right for businesses to review their debt obligations and loan documents.
With the current state of the economy, businesses need to understand the details of their business loans. In particular, business owners need to review their loan documents, whether they are lines of credit, mortgages on their buildings, etc., to make sure they understand all of the requirements and so that they do not unknowingly default on any of the provisions contained in the loans. What many business owners fail to realize is that a business can continue to make all of their payments on their business loan, but be in default because they did not meet all of the other requirements that were imposed on them within the loan documents. Some of the more common examples of these requirements are:
- EBITDA/Debt ratio (EBITDA is Earnings before interest, taxes, depreciation and amortization and is also called operating income);
- Required Net Income per month;
- Asset to Debt ratio; and
- Occupancy percentage (when the loan is a mortgage for a building).
These are just a few of the provisions that exist in loan documents. Every company should review their own documents for their specific requirements. If a particular business determines that the business is struggling with meeting these requirements, then the business needs to take such action to prevent a default on the loan from occurring. It is crucial that businesses do not default on these requirements because if they do, then there are several problematic events that could potentially happen:
- The financial institution may call the loan, and now when banks have been very selective in providing loans to businesses, a business may face having their loan called (and be required to immediately make payment in full, which may occur when they do not have the resources to pay off the loan and also not be able to find another financial institution who is willing to fund the payment).
- Agree to forebear from foreclosing on the loan and enforcing the default, but may make significant demands to be met for them to not foreclose. Examples of the demands that financial institutions sometimes require for them to forebear on foreclosure are:
- Large injection of cash into the business;
- Shareholders/owners from taking cash withdrawals or loans from the business or limited compensation;
- Prohibition of any additional purchases of assets (other than inventory) such as furniture, fixtures or equipment without the financial institution's prior review and written consent;
- Refinance through the same financial institution at a higher interest rate and with more restrictions;
- Require personal guarantees of all of the owners or key employees of the business;
- cross-collateralization between line of credit and business buildings;
- require that debt be secured with owners' personal assets.
- The financial institution may demand that the business payoff the loan or refinance with another financial institution as the financial institution may want to end their business relationship with the business.
- The financial institution may insist that if refinancing or pay-off are not feasible then the business be sold or liquidated to pay off the loan.
The reality of the situation is that financial institutions generally do not want customers to default on their loans. Nevertheless, with the problems that they have been facing, financial institutions are trying to clean up some of the bad debts that they have had regarding the residential home market collapse and if they can increase fees to their business clients, or restructure their existing loans with business clients, it may help them improve their own balance sheets and financial positions.
Unfortunately, we find that businesses that have a long standing relationship with a particular financial institution, when they default on their loans, do not always have a friendly contact at the bank. Typically, when these situations occur, the business is reassigned to a special department in the bank that deals with defaulting business clients and the business is forced to deal with persons whom they do not have a long term relationship. The demands placed on the business client by the financial institution may be very demanding or seemingly nearly impossible to meet. Careful negotiations sometimes may result in successfully achieving agreement on the terms of a forbearance agreement with the financial institution.
We believe in these current economic times that businesses truly need to be proactive to prevent the occurrence of a default on a loan. If a business finds itself in these circumstances, we suggest that they contact their legal counsel and accounting advisors to address the issues and take whatever steps are necessary to prevent the default, or if a default has occurred to limit liability and prevent a financing disaster.