Four Reasons to Own Life Insurance

Posted by David E. Peterson, Esq. on January 20, 2015 under Estate Planning | Be the First to Comment


Let’s face it: most people are averse to life insurance. For permanent policies, the premiums are high, and the payouts typically don’t happen until you die. Couple that with the fact that many life insurance agents are overly aggressive, promising that life insurance will bring peace to the Middle East.

Still, I’ve noticed a few scenarios where life insurance makes sense. If you fall into one of these categories below, then you should talk with an estate planning attorney, because life insurance is best used as a component of an overall estate plan.

Reason #1: Term life insurance protects young families, and is pretty cheap.

While children are still young, the death of a parent can be financial crippling. This is especially true in today’s financial environment, where is typically takes two incomes to provide a quality upbringing for your children.

Thankfully, term life insurance can provide a high level of coverage for relatively cheap premiums. If you have young children, you absolutely must have term life insurance. It’s part of being a responsible parent.

Reason #2: Life insurance is a better alternative to long-term care insurance.

People ask me all the time whether they should get long-term care insurance. Here is what I tell them:

If you end up in a nursing home for an extended stay, long-term care insurance will be the best thing you ever bought. But if you don’t go into a nursing home, then you will have squandered tens, or even hundreds, of thousands of dollars for nothing.

A better alternative is to use permanent life insurance that allows for the acceleration of the death benefit to pay for long-term care expenses. Here’s how it works:

Scenario 1:

You purchase permanent life insurance with a death benefit of $300,000. You stay healthy until you die, and incur no long-term care expenses. Your family receives $300,000.

Scenario 2:

You purchase permanent life insurance with a death benefit of $300,000. Your health declines and you incur long-term care expenses of $200,000. The insurance company pays the long-term care expenses, but reduces the death benefit by that amount. When you die, your family receives the remaining $100,000.

Whether you remain healthy or not, you’re going to get $300,000 out of the insurance policy. This type of life insurance costs only slightly more than long-term care insurance, but it guarantees that you’ll get a return on your investment. It’s all of the benefit with none of the risk.

Reason #3: The tax advantages of life insurance increase the children’s inheritance.

When you invest money, and earn a return during your lifetime, you pay income taxes to your state and federal government. Then when you die, if your net worth is above certain thresholds, both Massachusetts and the IRS levy a tax on your estate. Even if your investments go through the roof, these taxes take a huge chunk of it, and your family winds up with much less.

Life insurance is treated differently than most investments. Even though you invest money into a life insurance policy, the death benefit is not considered taxable income. Further, when done correctly in trust, the death benefit is not subject to the estate tax.

The result of these tax advantages is that life insurance can provide a great return on investment for a very small amount of risk, especially for those in high tax brackets. This is a great strategy for families that can afford to invest in insurance without impacting their quality of life. If you can easily afford it, then you should do it.

Reason #4: Life insurance can protect a business and it’s owners.

Aside from its normal uses, life insurance is a component of several business planning strategies. The most common uses are to protect the business from the death of key employees, to fund a buy out of the company if one of the owners dies, and to equalize the inheritance of children that are not active in the business.

The first of these strategies is fairly simple. If one of the key employees of a business dies, then the business will likely suffer a financial loss. If the business maintains a life insurance policy on that employee, then the death benefit would offset the financial loss, and allow the business to continue during the transition period.

The second strategy is used when more than one partner owns a business. When one of the owners dies, the other owner will receive a life insurance death benefit, which is used to buy out the deceased owner’s share of the business. That way the decedent’s family receives cash, and the remaining owner keeps the business. You can read more about this strategy here.

The third strategy is useful in situations where the business is the family’s largest asset. Often times some children are active in the business, but others are not. In the ideal situation, the active children would inherit the business, and the non-active children would inherit other assets. If there aren’t enough other assets to equalize the shares, then life insurance can provide the liquidity needed to do so.

To recap, these life insurance strategies are geared towards: 1) young families, 2) those worried about future long-term care expenses, 3) families in high tax brackets that want to leave an inheritance, and 4) business owners. If you fit into any of these categories, then you may benefit from a closer analysis of your estate planning. Remember, while these strategies fit neatly into a blog post, it takes trusted professionals to implement them properly.

How Wealthy People Avoid Estate Taxes

Posted by David E. Peterson, Esq. on January 6, 2014 under Estate Planning | Be the First to Comment

The Basics

The estate and gift tax is a tax on the transfer of wealth from one generation to the next. The tax is levied when a transfer occurs, which by lifetime gift, or upon death.

The estate and gift tax rates start low. The Massachusetts estate tax affects estates worth more than $1 million. The marginal rates start at 4%, and rise gradually to 16%. Federal estate taxes kick in at $5.34 million, but the marginal rate is 40%. The top marginal rate for combined federal and Massachusetts estate taxes is 49.6%.

What People of Moderate Wealth Do

People of moderate wealth can greatly reduce, and often eliminate, their estate tax burden through fairly common estate planning techniques. Marital deduction/credit shelter planning can double the amount that a couple can pass free of the Massachusetts estate tax. Annual exclusion gifting can simply and easily reduce future estate taxes. Charitable giving also reduces estate taxes

With proper planning, a couple worth $2 million can reduce their tax bill from around $100,000 to zero. A couple worth $10 million can reduce their estate tax from around 25% to around 5%.

What Very Wealthy People Do

Individuals and families with more than $10 million can take advantage of a variety of sophisticated estate planning techniques. One of the most common techniques is called a “zeroed-out grantor retained annuity trust” or “GRAT” for short. Here’s how it works.

The person setting up the GRAT is called the Grantor. The Grantor puts money into the GRAT. The GRAT then provides an annual payment to the Grantor for a predetermined number of years.

The present value of these future payments can be calculated based on interest rates set by actuaries at the IRS. Currently, these interest rates are very low. They change each month, but have been hovering around 2%. The Trustee of the GRAT invests the GRAT’s money. If the investments earn more than the predetermined interest rate, then the GRAT will still have some money left, even after it makes its final annual payment to the Grantor. The money that is left over passes to the Grantor’s children (or anyone else specified) free of estate and gift taxes.

Here’s how it looks with actual numbers. The Grantor puts $5 million in the GRAT for a term of five years, when the IRS interest rate is at 2%. The Trustee invests the money, and earns 8% return per annum. The Trustee pays the Grantor $1,061,000 per year. At the end of five years, the GRAT still has $1,123,000, which goes to the next generation free of taxes.

It’s not uncommon for very wealthy families to have multiple GRATs going at the same time, or to roll over new two-year GRATs each year indefinitely. If the GRAT’s investments appreciate in value during its term (think family business stock), then the tax savings can be astounding.

Bloomberg recently published an article on this strategy, using Las Vegas Sands Corp. owner, Sheldon Adelson, as a case study.

The Lesson

The lesson to be learned is that families of moderate wealth face steep taxes, and very wealthy families face even steeper taxes. Fortunately, there are plenty of ways to mitigate these taxes through proper planning. Don’t give your wealth to the government. Give it to your family.

Your New Year’s Resolution Starts with a Phone Call (or email).

Posted by David E. Peterson, Esq. on December 26, 2013 under Estate Planning | Be the First to Comment

The holiday season is a time of great religious and economic significance. And even in our busy lives, it is a time for reflection. For many of us, the fruits of our reflection are our annual resolutions: to become healthier, to spend more time with family, to finally watch “The Wire” (or “The Walking Dead” or “Breaking Bad”).

As I reflect on this holiday season, I come to understand the symbiotic relationship of stress and merriment. Undoubtedly, it is stressful to balance the competing demands for your time and money. To decide which relatives to visit and which gifts to purchase. But that stress exists because we have people that cherish our company, and with whom we share tokens of our affection. Stress and love cannot be separated, but they can be tempered.

There are many ways to reduce this Christmas reflection to a New Year’s Resolution. Allow me to suggest one. Take the steps necessary to protect your family after you are gone. Now is the time to consider how your death or incapacity would impact your loved ones, both financially and emotionally. If you’ve been avoiding the issue, now is the time, now is the opportunity.

Of course, many New Year’s Resolutions can be daunting. Lifestyle changes and serious issues are not always easy to handle.

Here’s a bit of advice: It starts with a phone call (or even an email).

Don’t spend time obsessing over the details, or worrying about failure. Just pick up the phone or send a quick email. Ask to setup an appointment to talk to someone about your goals.

Want to exercise more? Call a local gym. Want to learn the guitar? Call a music shop. Want to be healthier? Email a doctor/dietitian/acupuncturist. Want to read more? Call a well read friend and ask for a book suggestion.

If you want to protect your family in case something happens to you (and someday something will happen to all of us), call an estate planning attorney. If you’re in Massachusetts, you can call me. The first step is a phone call (or email). The second step is a conversation. It’s easy and pain free. So why wait?

Top Five Methods of Charitable Giving

Posted by David E. Peterson, Esq. on September 17, 2013 under Estate Planning | Be the First to Comment

A colleague and I have recently devoted some time to developing a new facet of estate planning that we call “Zero Tax Planning.” The idea is simple. First, we use traditional estate planning techniques to reduce estate taxes as much as possible, while keeping assets within the family. Then, once traditional methods are exhausted, we make charitable gifts of any remaining taxable estate. Because there is an unlimited estate and gift tax deduction for charitable gifts, this method will work for any estate, no matter how large or small.

Of course, eliminating estate taxes is only one goal of estate planning. Clients often have many competing needs and goals that we must address. Fortunately, the non-profit and financial industries have developed several sophisticated charitable giving methods, that allow clients to achieve their family, financial, tax, and philanthropic goals simultaneously.

So without further ado, here are the Top Five Methods of Charitable Giving, ranked from simplest to most sophisticated:

1) Outright Gifts (Lifetime, Bequests, Devises, and Legacies)

The simplest way of giving to charity is to just do it. You can make an outright gift by handing over cash or writing a check. You can donate a car, a house, stocks, bonds, mutual funds… you name it. You can gift during your lifetime, or upon your death.

(aside: the term bequest and legacy traditionally referred to a gift of personal property in a will; devise to real estate. Today they commonly used interchangeably, and can be made via will or trust.)

When making outright gifts, make sure to keep records so that you can authenticate the transaction to the taxing authorities.

2) Charitable Gift Annuities

For donors looking to retain an income stream, while removing property from their taxable estates, a charitable gift annuity is a worthwhile option. With a gift annuity, the donor transfers property to a charitable organization, and the charity makes periodic payments back to the annuitant. Then, when the annuitant dies, the remainder of the property vests in the charity. The property transferred to the annuity is immediately removed from the donor’s taxable estate, reducing his or her estate tax. Further, the donor receives an immediate partial income tax deduction for the present value of the annuity’s remainder interest. The annuity payments to the grantor are partially taxable income, and partially non-taxable return of principal.

3) Pooled Income Funds

A pooled income fund is similar to a gift annuity, in that the donor receives an income stream, and the charity receives a remainder interest. However, with a pooled income fund the donation is invested into a professionally managed fund, and the donor receives periodic payments of the income generated by the investments. Because the income generated by the fund varies with the market, the periodic payments will vary. Conversely, with a charitable gift annuity, the annuity payments would be predetermined based on actuarial rates.

Tax-wise, the donor receives an immediate partial income tax deduction. However, because payments to the donor consist solely of fund income, they will be taxable on the donor’s 1040 in their entirety. Fortunately, the entirety of the gift will be removed from the donor’s taxable estate.

Because they are so similar, it can be difficult to determine whether a charitable gift annuity or pooled income fund is the right solution for a family. Although individual circumstances vary, typically, a pooled income fund is typically more appropriate for larger gifts, especially when the immediate income tax deduction is desirable.

4) Charitable Remainder Trusts

A charitable remainder trust is essentially a do-it-yourself version of a charitable gift annuity. With a CRT, the donor establishes a trust, and funds it with money or other assets. The trustee then invests the trust’s property, and makes periodic payments to the donor, or other income beneficiary. Finally, when the income beneficiaries pass away, the remainder passes to one or more charitable organizations.

So what is the benefit of a CRT? Flexibility. The donor of a CRT can name multiple charitable beneficiaries, while gift annuities and pooled income funds are specific to each charity. The CRT can have multiple income beneficiaries. The donor can reserve the right to change the charitable remainder beneficiaries. The income stream to the donor can be structured in a variety of ways (percentage of trust assets, set dollar amount, limited to net trust income, etc.). Each allowable arrangement has its requisite legal acronym, so we have CRATs, CRUTs, NICRUTs, NIMCRUTs, and FLIPCRUTs. Confused yet? That’s okay. If you’re considering this type of planning, you need to speak with an attorney who can walk you through it.

Finally, charitable remainder trusts allow the donor, if they are also the trustee, to handle all of the investment decisions for the trust. This control is forfeited with a gift annuity or pooled income fund, and is attractive for many donors.

5) Establishing a Private Foundation

For donors who want to take complete control of their philanthropic endeavors, establishing a private foundation may be the answer. A private foundation essentially operates on an ongoing basis towards the furtherance of a stated charitable purpose. Typically, the private foundation is endowed by one or more wealthy individuals, or a wealthy family, or corporation. The foundation then invests and manages its endowment, and makes disbursements to other organizations with direct charitable or educational operations. These disbursements are often determined through a grant-making process.

While a private foundation may come into existence through a wealth person’s estate planning, the foundation could continue long after the founder’s death.

Of course the pathways to establishing and funding a private foundation are numerous, and the tax implications labyrinthine. However, for wealthy individuals that want to leave an ongoing philanthropic legacy, they are a powerful tool.

The largest, and perhaps the most famous, private foundation is the Bill & Melinda Gates Foundation.


So there you have it, my Top Five Methods of Charitable Giving. Of course, these aren’t the only way to give to charity. For those not in a position to make financial gifts, consider making a gift of your time and volunteering for a local charity. If you are interested in learning more about integrating philanthropy with your estate plan, please feel free to contact me.

Does Having A Will Avoid Probate?

Posted by David E. Peterson, Esq. on September 9, 2013 under Estate Planning, Probate and Trust Administration | Be the First to Comment

Does Having A Will Avoid Probate?

There is a common misconception that having a valid will allows a decedent to avoid probate. This is completely false.

When someone dies without a will, they are considered “intestate”. The Massachusetts Uniform Probate Code includes several formulas for determining the division of assets when someone dies intestate. These formulas are based on the assets of the estate, and whether the decedent left a surviving spouse, children, grandchildren, parents, distant relatives, etc.

The primary benefit of a will is that it avoids using these intestacy formulas. Instead of a formula determining who inherits an estate, the will states who will inherit. This is a huge advantage over intestacy, because it allows the decedent to set forth their intended beneficiaries.

However, whether someone dies intestate (without a will) or testate (with a will), their estate still has to go through probate.

What is Probate?

Originally, the term probate referred to the legal process for determining the validity of a will presented to the court. This led to the courts tasked with jurisdiction over the administration of decedents’ estate to be called probate courts”. In Massachusetts the court probate court also has jurisdiction over domestic relations cases, and is called the Probate and Family Court. Now, the term probate refers to the process of administering an estate in the probate court.

The process for probating an intestate estate and a testate estate are essentially the same. Someone, usually a close family member, must submit a Petition to the Probate and Family Court. The Petition will typically request that the Court determine the proper beneficiaries of the estate (by applying the will, or the intestacy formulas), and officially appoint someone as the Personal Representative (formerly called Executor or Administrator) of the estate. Depending on the complexity of the estate, the remainder of the administration may be relatively simple or complex.

So What’s the Matter with Probate?

If you listen to talk radio, you’ve probably heard advertisements proclaiming the horrors of the probate process. While these commercials are somewhat hyperbolic, probate does exert a cost, in time, energy, and money.

First, probate is slow. Even if a decedent’s family is prompt about administering an estate, it’s probably going to be a few weeks before they can file a probate petition. Then once the petition is filed, it could be a few more weeks before the Probate Court issues a Citation. A citation is the Court’s written instructions for serving notice on interested parties. It involves sending copies of the citation in the mail, and publishing the citation in a local newspaper. The citation typically allows a period of time for interested parties to object to the petition, usually around a month. Then, once the objection period has expired, it could take the Court several more weeks to approve the petition.

As you can see, just getting permission to administer an estate can easily take three months, or more. Then, creditors of an estate have one year from the decedent’s date of death to file claims against the probated estate. That means that the Personal Representative cannot safely make distributions until a year has passed.

And this illustration is for an estate that goes smoothly, which seldom happens. Ensuring a snag free probate will require either a considerable amount of the family’s energy in researching the process, or hiring an estate attorney at considerable expense.

The fees for probating an estate run into the hundreds, even without hiring an attorney. The court fees in Massachusetts are around $400, and the newspaper publication fees are around $200, depending on the specific paper.

The good news is that probate can be avoided with relative ease.

How Can I Avoid Probate?

The best method for avoiding probate is to establish a revocable trust during your lifetime. Think of a revocable trust as a “will substitute”. It essentially allows you to designate the beneficiaries of your estate, but is not subject to the probate process. Instead, your trust will nominate someone to take over as trustee upon your death, so that they can immediately manage and administer your legacy for your loved ones.

In addition to avoiding probate, revocable trusts have a multitude of other estate planning advantages over simple wills. When done correctly, revocable trusts can double the amount of assets that a married couple can pass free of estate taxes, and can protect the beneficiaries’ inheritances from their future lawsuits, creditors, divorces, etc.

If you are interested in revocable trusts, avoiding probate, or estate planning in general, please contact an specialized estate planning attorney. A bit of planning now will safe a lot of money and frustration in the future.

Why I Like Our Current Estate Tax System

Posted by David E. Peterson, Esq. on August 14, 2013 under Uncategorized | Be the First to Comment

Warning: This article is very long.

It feels weird to write a post in favor of taxes, but hear me out. After my last post about ways to avoid the estate tax, some friends indicated that the estate tax should be abolished altogether. While I’m no fan of taxes, they are a certainty of life, and I believe the estate tax reforms over the last 12 years have been a great success.

Let me begin by explaining the current estate tax system, and how it’s evolved over the last 12 years.

Current Estate Tax System

Rates and Thresholds

Just like income taxes, there is a federal estate tax, and a Massachusetts estate tax. Currently, the federal estate tax is a flat 40% of anything over $5.25 million (the calculations are a bit more complicated, but this is basically how it works). For example, if you die with $6.25 million, you’re $1 million over he limit, and will owe $400,000. Massachusetts taxes estates over $1 million, a much lower threshold, but the rates are also lower, on a scale from 0 to 16%. A $5 million estate would owe a Massachusetts estate tax of $391,600, which is an effective rate of 7.8%. That same estate would owe no federal estate tax, because it’s under 5.25 million.

Treatment of Married Couples

While the rates described above are for individuals, married couples can essentially double their threshold, and defer any remaining estate tax to the death of the second spouse. For the federal estate tax, this can be done with almost no planning, due to new “portability” rules. In Massachusetts, achieving this favored treatment usually requires some advanced estate planning, which is fairly common. Here is an article about estate tax planning for married couples.

Evolution Over Time

The current estate tax rates are fairly low, and the thresholds fairly high, but this wasn’t always the case. In 2001, the federal estate tax was up to 55% on the value of the estate over $675,000. From 2001 to the present, the estate tax went through a series of periodic changes. Essentially, the rates went down and the thresholds went up until we reached our current $5.25 million/40% system. Strangely enough, there was no federal estate tax in 2010.

While the federal estate tax underwent massive changes, the Massachusetts rates remained the same.

Capital Gains Avoidance

Typically, if you buy and asset, then sell it later for a profit, you will owe a tax on the increase. This is called a capital gain, and is taxed at rates slightly to significantly lower than normal earned income. To calculate the gain you subtract your purchase price (cost basis) from your sale price. If you paid $15 (basis) and sell for $25, your gain is $10. Therefore, even though there are favorable tax rates for capital gains, it can still be expensive to sell highly appreciated property.

Fortunately, there is a provision in the Internal Revenue Code that states that any asset included in calculating the value of a persons estate for estate tax purposes receives a “step up” in cost basis for income tax purposes, upon the death of the owner. For example, if you buy a house in 1980 for $50,00o, and it is worth $300,000 upon your death in 2013, then your next of kin would owe no capital gains tax when they sell it for fair market value in 2013, because of the step up in basis. If there were no estate tax, then there would be a capital gain of $250,000, which would likely result in an income tax liability of $37,500 (assuming a 15% capital gains rate). This is a huge benefit, and undercuts the impact of the estate tax for many taxpayers.

The Hypothetical $5 Million Estate

Let’s take a look at a hypothetical estate worth $5 million. Assume that the pre-step up basis in the estate’s assets is $2.5 million. We know that there will be no federal estate tax due, because it’s under the $5.25 million threshold. We also know, from above, that the Massachusetts estate tax will be $391,600. Assuming a capital gain rate of 15% (it’s probably going to be higher due to the Obamacare surtax), there would have been an income tax of $375,000 if no estate tax were in effect (($5M value -$2.5M basis) x 15% rate). Of course, the heirs could always hang onto the property instead of selling it, but the gain would be realized eventually.

So the estate tax due was $391,600, and the capital gain savings was $375,000. That’s a net tax liability of $16,600, which is only 0.3% of the $ 5 million estate. Even without considering the capital gains treatment, the effective rate is only 7.8%. This is a drop in the bucket, especially compared with the 2001 estate tax system.

Now let’s consider the merits of the estate tax in comparison to other common taxes.

Comparison to Other Taxes

I posit that the estate tax is economically and morally superior to other types of taxes.

Estate Tax vs. Income Tax

The federal and Massachusetts income tax systems are truly marvels to behold. While simple in concept, intended to skim off a portion of each taxpayer’s income, they are replete with rules, regulations, loopholes and perverse calculations. When you boil it down, you’ve essentially got a graduated tax on earned and unearned income, so that the most income you have the higher your rate, and the more taxes you pay.

The Mitt Romneys of the world make their money from buying and selling investments, and therefore pay lower capital gains rates on their income. Other fortunate folks have significant unearned income, for which they are taxed. But for the vast majority of taxpayers, the income tax is a tax on their earned income. It is a tax on their paycheck. It reduces the reward for their labor. This has major negative macroeconomic implications.

Of course everyone expects to send some money to our friends at the IRS and DOR. When a teenage kid gets his first paycheck for bagging groceries, and sees that $10 a week goes towards taxes, he’s probably not going to quit and go home. But that same kid may respond differently ten years later, when he’s beginning a professional career, and he’s in a 38% tax bracket (or ten years after that, when he’s a self-employed consultant in a 45% bracket).

A little aside about income tax brackets: Your bracket determines your “marginal rate,” which is the percentage of taxes that you pay on each additional dollar earned. Brackets are graduated, so that you pay a lower rate on the first dollar earned, than you do on the last dollar earned. While FICA and self employment taxes are technically different from the “income tax,” they are taxes on income, and should be considered in calculating your marginal rate, at least in the context of personal/family finance. Therefore, a Massachusetts resident earning from $36,250 to $87,850 per year is in a 25% federal income tax bracket, and pays a 5.25% Massachusetts income tax rate, and 7.65% FICA rate. That’s a combined marginal rate of 37.9%. So if this person receives a $1,000 raise, then $379 dollars goes towards taxes. The FICA rate is doubled for self-employed taxpayers.

As you can see, with rates approaching, and even exceeding 50%, income taxes provide a huge disincentive to further one’s career. And with higher rates for the self-employed, they make building a successful business nearly impossible. One might find it easier to just bag groceries. The ripple effect through the economy is dramatic.

The estate tax system, on the other hand, taxes wealth at the moment of its transfer via inheritance, not at the moment of its payment as compensation. If you work harder and earn more money, you will have the full benefit of that money during your lifetime. If you save that money, then you may increase the estate taxes payable upon your death. But it is the persons inheriting your wealth that will lose the benefit of that money, and they never had control over it to begin with. So unlike the income tax, the estate tax does not disincentivize work. Conversely, if a wealthy person’s heirs know that they’ll lose part of their inheritance to estate taxes, then that may actually encourage them to work harder to earn their own wealth.

Furthermore, from an ethical standpoint, it is more justifiable for government actors to take money that you did not earn, than to take money for which you actually worked.

Estate Tax vs. Sales Tax

The second most visible tax that most of us pay is the sales tax. In Massachusetts we pay a tax of 6.25% of the price of most goods that we purchase. Therefore, the sales tax increases the cost of most items. These higher prices discourage consumer spending spending. And because consumer spending stimulates the economy, the sales tax has a significant negative macroeconomic effect.

This negative economic effect is directed mostly at the middle class. Wealthy people are not going to forgo making a purchase because of the extra 6.25% tax. Poor people do not have the money to spend on discretionary purchases to begin with. However, the middle class has a limited discretionary budget, so the sales tax will  cause them to spend less (or drive to New Hampshire).

While the sales does discourage discretionary spending by the middle class, it does not discourage spending on the household necessities that everyone needs, regardless of class. This causes the regressive application of the sales tax. Taxes can be either progressive, meaning that richer people pay higher rates, or regressive, meaning that poorer people pay higher rates. A tax could also be flat, meaning that everyone pays the same rate, regardless of wealth. The sales tax doesn’t have brackets; it’s the same 6.25% for everyone. While this may seem like a flat tax, it is regressive in application.

The sales tax is regressive, because poorer people spend a higher proportion of their money on necessary household goods. Without considering luxury purchases, most families have the same expenses for essentials. A family of four making $300,000 per year, and a family of four making $40,000 per year, each spend the same amount of money on toilet paper, or dish soap, or laundry detergent. Therefore, each family pays the same sales tax on these goods. However, that sales tax represents a much higher percentage of the poorer family’s income than the richer family’s income.

Regressive taxes are particularly burdensome in today’s economy, where 76% of Americans are living paycheck-to-paycheck.

Looking at both the discouragement of spending, and the regressive nature of the sales tax, the estate tax stands in sharp contrast. The estate tax actually encourages spending, because money spent during life is no longer part of the taxable estate at death. Furthermore, the estate tax is the ultimate progressive tax. It only kicks in for Massachusetts residents with over $1 million, and the rates stay relatively low until the federal threshold of $5.25 million. The vast majority of individuals will never have to pay an estate tax, and only the very wealthy will pay a significantly high percentage of their wealth towards estate taxes.

Effect on Small Businesses

Critics of the estate tax often cite the “devastating effect on family businesses” as justification for its repeal. In actuality, however, the estate tax does not devastate family businesses. The first step in engaging in this discussion is to define the term family business. Sure there are a few families that have $100 million businesses. Even after a 50% estate tax, these families will still walk away with over $50 million. They aren’t the sympathetic characters that we’re referring to.

Instead, let’s define “family business” as a company worth between $1 million and $20 million. By the time a business gets to $20 million, the ownership has usually spread out to include more people, so that the entire value will not be included in one owner’s taxable estate. Often time a business owner will sell their business to a public company, or private equity firm, before it gets that large. Still, let’s take a look at the hypothetical $20 million family business.

The Hypothetical $20 Million Family Business

First of all, no one is likely to build a $20 million business without the support of a loving spouse. So assume that the business owner is married (it is a family business after all). Well, the unlimited marital deduction for both federal and Massachusetts estate taxes ensures that estate taxes need not be paid until the second spouse dies. Furthermore, portability rules dictate that the couple can pass $10.5 million free from federal estate taxes. Simple marital estate planning can double the Massachusetts threshold to $2 million. These results requires a fairly simple amount of estate planning.

Based on a $20 million estate, the Massachusetts estate tax will be around $2.5 million. This state level estate tax is deductible from the federal gross estate, which results in a federal tax liability of around $2.8 million. I won’t bore you with all of the calculations, because they are a bit complicated, but you can see that the total estate tax liability is around $5.3 million, which is 26.5% of the estate.

Under the 2001 estate tax system, the estate tax would be substantially higher. The calculations were a bit different back then, but even using the marital planning described above, the total estate tax due would be around $10.26 million, or 51.3%.

Paying the Tax

The challenge for our family is to come up with $5.3 million of cash to pay the tax. Well, they’ve got a business worth $20 million, so they probably have some liquid assets lying around as well. If those liquid assets are not enough, they could borrow money from a bank, using the business as collateral, in order to pay the tax. They could then repay the loan over a period of years, using excess cash flow from the business. With today’s low interest rates, this option could make sense even if there was an extra $5 million lying around. Suppose they couldn’t get a bank to loan them the money. Well, the Internal Revenue Code has special provisions that allow business owners to pay their estate tax in annual installments.

Of course, the best way to deal with this estate tax liability is to plan for it in advance. The only time that the estate tax devastates a family business is when that family fails to properly plan for the succession of their business. This brings us to the last topic.

Easily Avoided with Estate Planning

The best aspect of our current estate tax system is that the taxes can be so easily reduced or avoided. With a fairly simple level of estate planning, the family in our example above was able to reduce the tax on a $20 million estate to only $5.3 million.

With more sophisticated planning, they could reduce this tax even more. For example, an annual gifting program to the next of kin could easily pass on $2 million worth of business stock over a ten year period. The gifts could be of non-voting stock, with valuation discounts, so that ownership and control of the business can be addressed separately. The gifts could be made in trust to protect the beneficiaries from their own financial woes.

Interest rate arbitrage strategies, using grantor retained annuity trusts (GRATs), or installment sales to intentionally defective grantor trusts (IDGTs), can pass wealth outside of the estate.

Those with the intelligence to build a $20 million business must also understand their own mortality. Allocating a small amount of the business’s profits to pay premiums on life insurance policies would provide liquidity at the moment of death, which could cover estate taxes.

Perhaps there was a college or university that set the family on the path to success, or perhaps the family’s faith was instrumental in building their business. Charitable gifts are deductible from the estate and lower estate taxes.

Sure, all of these techniques require the guidance of a competent estate planning professional. But the return on investment for this advice is immense. Legal fees are relatively small compared with the millions of dollars saved by proper planning.

Then vs. Now

Under the 2001 rates, estate planning could only go so far in reducing estate taxes on large estates. Now, under the 2013 system, estate tax rates are much lower, and the thresholds are much higher. This results in lower overall taxes for everyone, which helps family businesses. It also makes the estate tax more progressive, and contains the impact to those who can truly afford it.

My Professional Pledge

While this article lays out my beliefs on the propriety of our current estate tax system, it is my duty to explain this system to my clients, and to reduce or eliminate their future estate taxes. Many people never plan for estate taxes, and those are exactly the people that should be paying them. When a client comes to me, it is my goal to ensure that they do everything within the law, and within their comfort level, to pay as little an estate tax as possible.

In our complicated world, people have many competing interests, and taxes are only one of them. My goal is to review a client’s situation holistically, taking many factors into consideration, taxes included, to craft the plan that is best for them.

If you found this article informative, and would like to discuss how these topics impact you or your family, please contact me to schedule a consultation. My office is in Danvers, Massachusetts. I would love to hear from you.

The Three Easiest Ways to Avoid The Massachusetts Estate Tax

Posted by David E. Peterson, Esq. on August 8, 2013 under Estate Planning | Be the First to Comment

If you are a resident of Massachusetts, and you die with more than $1 million in your “taxable estate,” then you owe a Massachusetts estate tax. The tax rate is based on a sliding scale from 0% to 16%. When you add up real estate, retirement accounts, and life insurance death benefits, many Massachusetts residents end up over the $1 million threshold.

Fortunately, there are a variety of estate planning mechanisms that can reduce and often eliminate the estate tax. Here are the top three.

Method One: Marital Deduction and Credit Shelter Planning (sounds complicated, but it isn’t really)

Every person can pass $1 million free of estate taxes. Therefore, a married couple should be able to pass $2 million free of tax. However, achieving this result requires a bit of planning.

Here’s what happens without planning: Husband and Wife have $1.5 million. Husband dies, leaving everything to wife. Wife dies with $1.5 million in her taxable estate (because she got everything when Husband died). Wife is now over the threshold by $500,000, and owes a Massachusetts estate tax of around $64,000.

Here’s what happens with planning: Husband and Wife have $1.5 million. They split their assets evenly, and hold them in revocable trusts with estate tax planning provisions. Husband dies, and leaves his half in a credit shelter trust. His half is under the threshold, so no estate tax is due. Husband’s credit shelter trust is now available for Wife’s benefit, but is not part of her taxable estate when she dies. Wife dies, and her taxable estate consists of the $750,000 in her revocable trust, which is under the threshold. Voila, no estate tax!

Here’s how it works with a larger estate.

Without Planning: Husband and Wife have $3 million. Husband dies, leaving everything to wife. Wife dies with $3 million in her taxable estate. Wife is now over the threshold by $2 million, and owes a Massachusetts estate tax of around $182,000.

With Planning: Husband and Wife have $3 million. They split their assets evenly, and hold them in revocable trusts with estate tax planning provisions. Husband dies, and leaves $1 million in a credit shelter trust, and $500,000 in a marital deduction trust. Because the marital trust is deductible, his taxable estate is only $1 million, and not over the threshold. Both trusts are available for Wife’s benefit. Wife dies. Her estate consists of the $1.5 million in her own trust, and the $500,000 in the marital trust, for a total estate of $2 million. She is $1 million over the threshold, and owes a Massachusetts estate tax of around $100,000. That’s an estate tax savings of $82,000!

This type of planning is the most common method of reducing or eliminating estate taxes. The only prerequisite is that you are married.

Method Two: Annual Exclusion Gifting

If the estate tax is based on your net worth when you die, then why not just give your money away while you’re still alive? Well, the smart folks at the federal IRS and Massachusetts Department of Revenue have already thought of that. Therefore, there are rules in place that cause large gifts to count as part of your taxable estate, even though you no longer have the money/property. Fortunately, there is an exclusion from these rules for gifts of up to $14,000 per person per year. That means if you give me $14,000 today, you will lower your future estate taxes. Even better, married couples can give $28,000 per year.

Here’s how this plays out:

Husband and Wife have over $2 million, so they’ll owe an estate tax even with the marital planning discussed above. They also have three children, who are all married. Therefore, Husband and Wife can give each of their children, and each of their children’s spouses, $28,000 per year. That equals out to $168,000 per year ($28,000 x 6). Husband and Wife decided that they would like to keep their money within the family, and reduce their eventual estate tax, so they make these gifts every year for six years. This reduces their taxable estate by over $1 million, and saves them around $100,000 in estate taxes. Imagine how much they could save by gifting to their grandchildren too!

Method Three: Charitable Giving

When you give money (or property) to charity, you reduce your taxable estate. And for charitable gifts, there is no $14,000 limit. You could theoretically eliminate your estate tax by giving everything to charity. It is more common, however, for people to pass their wealth to their families, while making some charitable gifts for tax planning purposes.

Like other types of estate planning, there are many ways to make charitable gifts. You can gift outright, by writing a check. You can leave gifts when you die, by putting them in your will, or in a trust. You can set up a Charitable Remainder Trust, which preserves a stream of income while you are alive, but goes to charity when you die. You can even set up a Private Foundation that serves an ongoing charitable purpose long after your death.

Some clients favor a Zero-Tax Planning approach. This consists of utilizing all three methods with the ultimate goal of paying no estate tax. First, we set up the credit shelter/marital deduction trusts to double the amount that will pass tax free. If they’re still over the threshold, we incorporate annual gifts to family members to gradually reduce their estates. And if they’re still over the threshold at death, we make a charitable gift to reduce their taxable estate to the threshold, ensuring no estate tax is due.

So there you have it, three three easiest and most effective ways to reduce or eliminate estate taxes in Massachusetts. Of course there are plenty of more sophisticated methods as well, but for most of us, these three are the ones to discuss with your Massachusetts estate planning attorney.

How to Find an Estate Planning Attorney in Massachusetts

Posted by David E. Peterson, Esq. on July 24, 2013 under Estate Planning | Be the First to Comment

For many people, the prospect of discussing their sensitive family and financial scenarios, in the context of their eventual death, is intimidating. Even so, estate planning is an important undertaking that responsible people should not ignore. The best way to improve the process is to find an estate planning attorney with whom you are comfortable.

So how do you find the right estate planning attorney for you? Let me break it down into three simple steps.

Step One: Identify some attorneys that practice in the estate planning field.

The first step is to identify attorneys that include estate planning in their law practice. Here are some tips.

Ask your professional advisors: Financial advisors and accountants tend to run in the same circles as estate planning attorneys. Ask your other advisors for an introduction.

Ask your current lawyer: If you’ve engaged a lawyer in the past for other issues, he or she may know an estate planning specialist.

Ask your family and friends: Perhaps someone in your family or social circle has done some estate planning. If so, they may be able to recommend someone to you.

Search the internet: If you’re interested in getting the most information in the shortest amount of time from the comfort of your home or office, just hop on Google. Search for estate planning attorneys in your area. Try using a few different search terms (estate, trust, probate, lawyer, attorney, etc.). Unless you truly live in the middle of nowhere, you’ll find many attorneys, mostly located in the commercial areas closest to your home. Pay special attention to the Google Local results (the ones that show up on a map) to see where they are located.

Step Two: Review each attorney’s website for key information and red flags.

The best way to evaluate a potential estate planning attorney early in the process is to check out their website. When reviewing a website, try to answer these questions.

Is this lawyer knowledgable about estate planning?

Estate planning is a multi-disciplinary practice that involves taxes, health care, finance, and business. Because of this complexity, estate planning has become a specialty practice. As such, you should make sure that your lawyer is an estate planning specialist. Check to see that their website discusses estate planning in a thorough and comprehensive manner.

Is this lawyer out of touch, or set in their ways?

Estate planning is a constantly changing area of law. For example, in the last few years, Massachusetts has completely overhauled their probate, estate administration, and guardianship/conservatorship laws, with the adoption of the Massachusetts Uniform Probate Code. Massachusetts has also implemented new changes by adopting a modified version of the Uniform Trust Code. On the federal level, the estate tax laws have changed every few years for more than a decade.

As a result of these constant changes, the best estate planning lawyers tend to be younger, energetic, and enterprising. Just having a website is a good indicator that you’ve found such an attorney. On the other hand, if an attorney has been doing things the same way for the last forty years, they may be slow to adapt to the current state of the industry.

Is this lawyer a general practitioner?

Unfortunately, because of the downturn in the economy and real estate markets over the last five years, many business and real estate lawyers now hold themselves out as estate planners. This makes it more difficult to find a genuine estate planning specialist. When reviewing an attorney’s website, take a close look at their “practice areas.” If they say that they specialize in personal injury, divorce, criminal defense, real estate, business, bankruptcy, and estate planning… that means that they don’t specialize in anything. The “Jack-of-all-Trades, Master-of-None” is not someone to whom you should entrust your family’s legacy.

Please be aware that there are some complementary practice areas to estate planning. For example, genuine estate planners often have subspecialties in probate and guardianship law.

If the attorney seems like a true specialist, with the energy and passion to stay current with the industry, then it’s time to move on to the next step.

Step Three: Schedule a consultation to see if it’s a good fit.

There is no substitute for an actual, sit-down, face-to-face, conversation. Most estate planners offer free consultations to prospective clients. The purpose for this consultation is two-fold. First, it allows the attorney to convey their approach to estate planning in the context of your family’s unique situation. Second, it gives you the opportunity to evaluate your comfort level with the attorney. Did the attorney listen to and understand my goals? Did he or she appear well informed? Most importantly: Would I feel comfortable working with them?

If you’ve made it this far in the article, I invite you to use my website as a starting point.

I hope that my website (, and this blog, portray me as an energetic and knowledgable estate planning specialist. But that’s for you to decide. If so, I would love to hear from you. My office is in Danvers, on the North Shore of Massachusetts.

What Aaron Hernandez Should Do.

Posted by David E. Peterson, Esq. on July 2, 2013 under Uncategorized | Be the First to Comment

Aaron Hernandez needs some serious legal help, but not from a criminal lawyer, from an estate planner. It’s become increasingly clear that Hernandez is guilty of at least one murder, possibly more. Although he’s got an experienced and high priced legal defense team, odds are that he’s going to jail for the rest of his life.

Let’s take a closer look at the situation. Hernandez was towards the beginning of a $40 million contract. NFL contracts are complicated, but typically include signing bonuses, guaranteed payouts, and incentive pay. This article says that Aaron Hernandez has received about $10 million thus far from the Patriots. Assuming that he’s got half of it left (he’s probably not investing like Warren Buffet), that’s still $5 million.

Given the overwhelming evidence against him, it’s unlikely that the hundreds of thousands, or millions, of dollars that Hernandez could spend on legal fees will provide him with any benefit. And as we remember from the O.J. Simpson debacle, after the criminal trial, we get to have a civil trial as well. The difference here is that if Hernandez is found guilty in the criminal trial, then the burden of proof will have already been met for the civil trial. Essentially, all of Aaron Hernandez’s money is going to legal fees, and to his victim(s)’ families via a wrongful death judgment/settlement.

So what’s a tight end turned murder defendant to do? For starters, he could swallow his pride, accept his fate, and focus on providing for his family. Aaron Hernandez has an infant daughter. A few weeks ago she was on track for a privileged life. Now, not so much. But Hernandez still has the money to give her that privileged life.

I would suggest that instead of blowing his net worth on legal fees, he establish a trust for the benefit of his daughter, and find a way to get as much money as possible into it. Look at it this way: he’s either going to pay for his kid to go to college, or his lawyer’s kid to go to college.

Unfortunately for baby girl Hernandez, once you commit a major tort, like MURDER for example, you lose much of your ability to disburse assets. If Hernandez places money in trust for his daughter, and is then found civilly liable for his actions and is unable to compensate the victims, then he’s made a fraudulent conveyance, which the court will unwind.

Overzealous asset protection attorneys have found a way around fraudulent conveyance laws, but it’s not for the faint of heart. It would involve Hernandez placing his money into a trust located in an offshore haven, like the Cayman Islands, or the Cook Islands. The terms of the trust would prevent the trustee (an offshore trust company) from ever returning the money, even if an American court determines that it was fraudulently conveyed to the offshore trust.

American courts have responded to these strategies by placing the grantors in prison for contempt of court. For most of us, the threat of incarceration would deter us from committing this fraud. But Aaron Hernandez is going to jail for murder anyways, so it makes no difference to him whether he’s also convicted of fraud, or held in contempt of court.

However, Hernandez doesn’t have the mental capacity to establish an offshore asset protection trust… because they’re very complicated… and he’s very stupid. This is the guy that murdered someone a few blocks from his own home after all. So why doesn’t he just have his fancy lawyers set up his trust? Well, for starters, lawyers can get in big trouble for advising their clients to commit fraud. If he’d asked Ropes and Gray to set up an asset protection trust before committing murder, they probably would have jumped at the chance. Now, not so much.

Which again begs the question, what should Aaron Hernandez do? Here is what I propose.

Aaron should direct his lawyers to negotiate a wrongful death settlement with his victim(s)’ families that compensates them with the majority of his money, but leaves a million or two for his daughter. In exchange for this settlement agreement, Hernandez would plead guilty in his criminal trial, and accept liability in his civil trial. Either way, Aaron is going to spend the rest of his days in Shirley, Massachusetts, which is a beautiful little town with two maximum security penitentiaries. But my approach provides for his family and his victim(s)’ families, while keeping him and his attorneys clear of fraudulent conveyance laws.

Of course this is highly theoretical. We don’t know whether Hernandez has enough money left for this to be feasible. And of course we know he won’t actually do it. He’s got an ego so big that he killed someone over a nightclub dispute, so I don’t think that he’ll put his family ahead of himself. It’s tragic, but fascinating from many different legal perspectives.

Asset Protection: LLCs vs. Irrevocable Trusts

Posted by David E. Peterson, Esq. on June 10, 2013 under Estate Planning | Be the First to Comment

We live in an economically volatile and litigious society. An unexpected lawsuit, or decline in business, can put people’s life savings at risk. Therefore, asset protection planning is of the utmost importance.

According to Massachusetts estate planning attorneys, two of the most common and effective asset protection mechanisms are the Limited Liability Company (LLC) and the Irrevocable Trust. But which one is right for you? Let’s take a look.

Limited Liability Company

Limited Liability Companies are creatures of statutory law. Think of them as Frankenstein’s Monster, patched together with elements of corporate, partnership, and tax law. Only Frankenstein is not a mad scientist, he’s your state’s legislature.

An LLC is an entity that is specifically authorized to provide a liability shield to its owners. So long as the event creating the liability occurs within the LLC, a judgment creditor will be unable to reach the personal (non-LLC) assets of the owner. For example, if you own a vacation home in an LLC, and someone is injured on the premises, then their recovery on the lawsuit would be limited to the assets of the LLC. They couldn’t recover against your bank account, or primary residence, because they’re outside of the LLC.

Furthermore, if the LLC owner is sued due to an event occurring outside of the LLC, then the judgment creditor cannot seize the LLC. For example, if you own a small business inside of an LLC, and you hit someone with your car, they can sue you, but they won’t be able to take your business away if they win.

Because of this protection against inside and outside liability, LLCs are best suited to protect assets that could potential be the source of a lawsuit. Specifically, they are great for holding investment real estate and operating businesses.

Irrevocable Trust

Until recently LLCs have been creatures of common law. That means that they’ve evolved through the decisions of courts in England and the United States over several hundred years. Now however, states often supplement trust law with statutory schemes. For example, the Massachusetts Uniform Trust Code creates a framework for trust law in the Bay State. But to the extent that it is not all encompassing, the common law remains.

When a Grantor puts assets into a trust, they are no longer the owner. Instead, the Trustee becomes the legal owner, and he or she must manage the assets according to the terms of the trust. The terms of the trust typically designate beneficiaries, who are the beneficial owners of the trust.

The asset protection mechanism of an irrevocable trust is a function of control. It works like this: if the Grantor cannot take complete control of the assets in trust, then neither can their creditors. Revocable trusts provide no asset protection to the Grantor, because the Grantor can revoke the trust and take back the assets. However, the Grantor cannot take back the assets in an irrevocable trust, because it is irrevocable, so they are protected.

But what if the Grantor wants to control the trust assets?

The terms of the trust can reserve certain rights to the Grantor. Sometimes the Grantor can also serve as the Trustee. There are many types of irrevocable trusts, but it is usually possible for the Grantor to retain a moderate to high degree of control.

But what if the Grantor wants to benefit from the assets in the trust?

This depends on the distinction between principal and income. The primary assets owned by the trust are the principal, but the income that they generate is the income. For example, a bank account is principal, but the interest that it generates is income. Shares of stock are principal, but dividends are income. Real estate is principal, but the rent paid by tenants is income.

The golden rule of asset protection is that if you can get it, your creditors can too. Therefore, irrevocable asset protection trusts prohibit the Grantor from accessing the trust’s principal. Fortunately, a Grantor can retain the right to income, and creditors will still be unable to reach the underlying assets. In this scenario, the Trustee could reallocate the principal into assets designed to appreciate in value, rather than generate income. Then they could reallocate into income generating property once the asset protection threat has passed.

For these reasons, irrevocable trusts work well for income generating property, or primary residences for older clients.

Why not use both?

A sophisticated estate planner may recommend using both LLCs and irrevocable trusts. You could have an LLC for your business, and a trust for your investments; or an LLC for your vacation home, and a trust for your primary residence. Or, if you want to get really savvy, you could have a trust own an LLC, or an LLC serve as trustee of a trust, or both!

Whether your looking for some simple protection, or you want to create a veritable lasagna (multiple layers, get it?) of LLCs and trusts, the first step is to seek the advice of an attorney that specializes in this type of planning.