Glossary and Helpful Planning Tips and Explanations For The Year 2000 and Beyond

Note: Terms in BOLD are explained in this Glossary.
Updated materials and tips will appear on our website at www.monbar.com.
You may click on underlined terms in italics for easy cross reference in this document.

See Table of Contents at the beginning of
“Lifetime Business, Financial, Retirement,
And Estate Planning And A Will --
All Five Benefit You And Your Loved Ones
In The Year 2000 And Beyond”
By:
Patrick J. Browne, Albert Mintz,
Omer F. Kuebel, Jr., Edmond C. Haasé, III, Stephen P. Schott, and J. Scott Loeb

Ability, Eligibility, and Deadline Ages and Dates Affecting Your Estate and Your Lifetime Financial, Retirement, and Estate Plan

The following is a list of ages and dates at which you are able or eligible to take or required to take various actions explained in this Glossary as of this writing:

ABCs of Your Lifetime Financial, Retirement and Estate Plan

Your financial, retirement, and estate plan should take into consideration at least the following elements which are described in more detail in this Glossary:

Phase I

• A will, possibly with trusts and providing for the appointment of an Executor or Executrix and a tutor or tutrix of your children
• Appropriate ownership of life insurance and appropriate beneficiary designations for life insurance, IRAs, retirement plans and pensions, annuities, and death benefits
• Appropriate ownership of property and business interests
• Durable power of attorney including a health care provision
• Living will
• Anatomical gift
• Letters instructing your spouse, heirs, business colleagues, and employees

Phase II (alphabetically listed)

• Asset protection
• “Cashing out” assets
• Charitable deductions limitations
• Critical illness insurance
• Death benefits
• Disability income insurance
• Education funding
• Establishment and periodic adjustments of retirement plans and pensions, IRAs, and tax deferred variable annuities
• Estate liquidity life insurance
• Income shifting among family members
• Irrevocable life insurance trusts
• Life insurance and buy/sell life insurance
• Lifetime gifts to your loved ones and charities
• Long term care insurance
• Marital deductions
• Matrimonial agreements
• Medicare
• Reverse mortgages
• Rollovers
• Sale and purchase of a business
• Sale of depreciated property
• Sale of residence
• Social Security benefits and taxation
• Tax-free exchanges

Abusive Tax Shelter

Investment that could result in a high ratio of deductions and credits to the investment which must be registered with the IRS and is subject to penalties.

Accelerated Death Benefit

A life insurance death benefit paid to the insured after the insured has been diagnosed as either chronically or terminally ill.

>>> Tip: Such benefits may be excluded from federal income taxation under certain conditions.

See “Cashing Out” Assets references and see Critical Illness Insurance, Long Term Care Insurance, Medicaid, Medicare, and Medigap Insurance.

Accumulated Earnings Tax

An extra penalty tax imposed on corporations (other than a personal holding company, for example) if earnings are permitted to accumulate instead of being distributed and the earnings exceed certain amounts unless the corporation justifies a reasonable business need.

Adjusted Basis (Real Estate)

The original purchase price plus certain capital costs (the basis) of a property less certain deductions such as depreciation plus capital improvements.

>>> Tip: Income taxes are deferred in each current year but the owner’s tax liability increases when the property is sold; the owner is then taxed on the difference between the adjusted basis and the net sales price. See Sale of Depreciated Property and see Stepped-Up Basis.

See Real Estate Investments references.

Adjusted Gross Income (AGI)

Gross income minus deductions.

Alternative Minimum Tax (AMT)

An additional federal income tax of up to 28% which reduces some of the tax savings which would otherwise result from some deductions, exclusions, credits, and tax liability computation methods. The AMT mainly aims at tax preference items, including depletion in excess of a property’s adjusted basis, certain excess intangible drilling costs, interest on certain private activity bonds, excess of accelerated depreciation over straight-line depreciation on certain property placed in service before 1987, and 50% exclusion from gross income associated with gains on the sale of certain small business stock.

Alternative Valuation Date (AVD)

Allows an executor or executrix of a will to value for federal estate tax purposes all probate and non-probate assets as of six months after the decedent’s death for undistributed or undisposed of assets or the value on the date of distribution or other disposition of other assets; assets sold between the date of death and the six-month date are valued at the date of sale; there must be a decrease in the value of all estate assets and a decrease in the federal estate tax paid.

Similar relief permits real estate used in the decedent’s business to be valued on the basis of its actual business use if it constitutes a requisite portion of the decedent’s adjusted value of the decedent’s gross estate; accordingly, interests in such real estate can be timely transferred to the decedent three years before death to increase the percentage of the decedent’s estate which the value of such real estate constitutes, or this can be accomplished by “backing” the decedent into the same situation by transferring non-business assets to others.

>>> Tip: The AVD election can reduce estate taxes when assets have lost value and increase the income tax basis of estate assets and thus reduce the income taxes that will be owed on a subsequent sale of the assets. See Qualified Family-Owned Business. A similar AVD may also be elected under the Louisiana inheritance tax law, that is, a date up to six months from the date of death.

Anatomical Gift

The gift of one or more organs upon your death.

Annuities

An insurance company contract which provides income.

è Immediate Annuities

A single premium annuity contract which pays installments immediately.

è Deferred Annuities

Pays installments in the future; they can be single payment or multiple premium payment annuities.

è Variable Annuities

Are deferred annuities which pay installments in varying amounts, depending on the performance of the underlying investments which may be stocks, bonds, and so forth.

èTax Deferred Variable Annuities

Provide growth and accumulations which are tax-deferred (unlike mutual funds) prior to the annuity starting date (that is, prior to the date when you begin to receive distribution payments). Individuals who have placed maximum amounts in their 401(k)s and other tax-deferred retirement savings plans may want to invest in deferred variable annuities.

>>> Tip: Transfers of assets between accounts may be made free of current income taxes (also unlike mutual funds). See Retirement Plans and Benefits.

>>> Tip: Drawbacks include high costs which may require you to leave earnings in the annuity for ten years or more, and you lose the right to take capital gains rates (usually 20%) on investment earnings because annuity earnings are taxed as ordinary income. Surrender charges for early withdrawal can apply. There is a 10% tax penalty on taxable withdrawals unless the withdrawals are made after age 59½, because of disability, or in certain other circumstances. You cannot take a tax deduction on capital losses, unlike assets in taxable accounts. With taxable accounts, you can deduct up to $3,000 of the excess loss from other income.

>>> Tip: It may be more prudent to invest in mutual funds and stock after you have maxed out on your 401(k) and other tax-deferred retirement savings plans and upon retirement, sell them, pay capital gains, and invest the net proceeds in an immediate fixed or immediate variable annuity.

>>> Tip: Such annuities can also present problems for heirs.

>>> Tip: One way to set up an annuity is to transfer a life insurance policy to a deferred or immediate annuity without a tax by using a Sec. 1035 exchange. See Tax-Free Exchange.

See Retirement Plans and Benefits.

Appropriate Ownership of Property and Business Interests

Property including real estate, vehicles, vessels, and leases may be owned by one individual (a sole proprietorship) or by more than one individual or by a legal entity such as a corporation, partnership, limited liability company (LLC), or trust. See also Family Holding Company, Family Limited Partnership, Qualified Family Owned Business, Qualified Small Business Stock, S Corporation, Sale and Purchase of a Business, Trusts, and Real Estate Investments references.

The selection of the form of appropriate ownership should be made only after taking into consideration a number of legal consequences and characteristics such as your personal liability, various tax consequences, and the applicability of federal Securities and Exchange Commission (SEC), state securities, and “Blue Sky” laws.

>>> Tip: The property which you own individually in your own name (a sole proprietorship) or which you own with other individuals or legal entities is called in Louisiana ownership in indivision and each owner has an undivided interest; ownership should always be covered by appropriate insurance, including liability and “umbrella” coverage for all owners. Such ownership should also be subject to a co-ownership agreement in which the owners agree to such matters as the allocation of income and expenses, restrictions on the rights of co-owners to sell or mortgage their interests, assignment of duties to the various owners to manage the property (for example, which owner will be responsible for paying bills, tending to maintenance and repairs, preparing tax returns, finding tenants, collecting rents, and so forth).

>>> Tip: Real estate should be insured by an owner’s title insurance policy even if the mortgage lender has title insurance coverage and even if a competent title examination has been performed because neither lender’s policies nor title examinations protect an owner against certain potential title defects which can surface as “hidden defects”, for example, forgery in the chain of title which could not have been detected by the title examiner. Also the mortgage lender’s policy only covers the current mortgage balance and provides no protection to the owner. See Real Estate Investments references.

The varying characteristics of a legal entity in Louisiana include tax issues, limitations on the number and types of owners (for example, the shareholders, partners, and members), limitations on the liability of the individual owners for the obligations of the legal entities, limitations on management by the owners, and the transferability and heritability of the owners’ interests.

>>> Tip: The Louisiana statutes governing legal entities have numerous default provisions which apply unless the owners agree to override them; as but two examples of such traps for the unwary, each member of a limited liability company (LLC) is entitled to cast a single vote and all decisions are made by majority vote of the members unless otherwise provided in the articles of organization or a written operating agreement, and with a corporation, unless the articles of incorporation provide for them, stockholders do not have preemptive rights; preemptive rights mean each voting stockholder has a right to subscribe for such proportion of new shares to be issued as the number of shares held by each stockholder bears to the total number of voting shares then outstanding.

>>> Tip: Some illustrations of the varying limitations of legal entities to be considered include:

(1) the shareholders of an S corporation may not exceed 75 and all shareholders must be individuals who are U.S. citizens, resident aliens, certain trusts, and tax exempt organizations; the only permitted differences in classification of stock are those relating to voting;

(2) LLCs, S corporations, and C corporations provide limited liability for their owners except in corporate veil piercing situations while a partnership’s limited partners (called in commendam partners) who participate and manage may be (and a general partner is) liable personally for the partner’s virile share of partnership debts (see Asset Protection);

(3) now available in Louisiana is a single-member LLC, while a partnership must have at least two partners;

(4) partners in limited liability partnerships (LLPs) are not liable for partnership debts arising from the misconduct of other partners;

(5) limited liability companies (LLCs), limited liability partnerships (LLPs), partnerships in commendam and general partnerships are generally “pass through” legal entities not subject to federal income taxation unless they elect to be classified as a corporation; as “pass through” legal entities, income, deductions, credits, and so forth are passed through to the partners or members; publicly traded LLCs are treated as corporations; losses can be deducted to the extent of the adjusted basis of the partners’ or members’ interest in the legal entity and can include a share of the legal entity’s liabilities;

(6) S corporations are not subject to federal income taxation; thus income, deductions, credits, and so forth are passed through to the shareholders; losses can be deducted to the extent of the adjusted basis in the debt of the corporation to the stockholders and their shares, but may not include any of the corporation’s liabilities to third parties creditors;

(7) C corporations are subject to income taxes; see Accumulated Earnings Tax, Personal Holding Company tax; stockholders are subject to taxes on distributions to them;

(8) S corporations are not allowed special allocations of income or loss among the shareholders, while LLCs, LLPs, partnerships in commendam, and general partnerships are permitted to have special allocations which are usually allowed provided they have substantial economic effect, except for certain allocations to family members, retroactive allocations, and contributed property;

(9) the assignee of a member’s financial interest in an LLC has no management rights or authority unless the assignee is admitted as a member. Statutory default rules for LLPs, partnerships in commendam, and general partnerships require all partners’ consent to admit new partners, but a partner’s financial interest may be transferred without consent of the other partners. Transferring an S corporation interest is subject to the restrictions imposed by Subchapter S while a C corporation interest is freely transferrable subject to securities law;

(10) the ownership interest in an LLC or partnership is not heritable; stock in a corporation is heritable but an S corporation could lose its “pass through” status if the stock becomes owned by ineligible persons (for example, persons who are not U.S. citizens, resident aliens, or certain trusts) or if the stock becomes owned by more than 75 stockholders;

(11) stock and the ownership interest in an LLC ­or partnership may also be subject to a stock purchase agreement, and so forth effective upon the death or divorce of the stockholder, member or partner, or upon other events such as seizure of an ownership interest by an owner’s creditor;

(12) Cash, property, past services, or a contractual obligation to contribute cash, property, or future services can be contributed as consideration for a membership interest in an LLC; cash, property, past services (but no future obligation of a contributing stockholder) may be contributed as consideration for stock in an S corporation or a C corporation;

(13) The tax treatment of contributions of property to an LLC is generally that there is no gain or loss recognized by either a member or the LLC itself and no control is required after the transfer; any recognition may be triggered by the transfer of property to certain “investment” LLCs;

(14) There is no gain or loss recognized by stockholders of a C corporation on their contribution of property or cash in exchange for stock if the contributing stockholders own at least 80% of the stock and voting power immediately after the transfer and no gain or loss is recognized by the corporation. However, a transfer to an “investment” company may result in gain recognition;

(15) Neither LLCs, LLPs, partnerships in commendam, nor general partners are subject to a Louisiana franchise tax. Corporations are subject to this tax;

(16) The “pass through” of income and loss in an S corporation to its stockholders for Louisiana income tax purposes is only for income and losses allocable to stockholders who are individual Louisiana residents unless a non-resident reports and pays taxes on his or her allocable share of Louisiana income;

>>> Tip: Although income of a C corporation may be taxed twice (once when it is earned by a C corporation, and also when it distributed to stockholders as dividends), in some cases C corporation status can result in better tax savings, for example if the gross income exceeds deductions and the stockholders do not plan distributions, there will be only one tax at the corporate level. The stockholder of a C corporation active in its management may receive corporate profits as salaries provided they are reasonable without triggering tax at the corporate level. Also the maximum tax rate applicable to the gross income of a C corporation in excess of its deductions is 35% while the highest individual income tax rate is 39.6%. It may sometimes therefore be wise to form a C corporation rather than an LLC or S corporation if the owners anticipate being in a high tax bracket and do not anticipate making distributions to the stockholders other than as reasonable salaries or loan payments.

When formed, an S corporation results in greater tax liability than a partnership, LLC, or individual ownership with respect to a gain on appreciated assets which have been contributed or on the receipt of stock as compensation for services. Upon liquidation, an S corporation results in greater tax liability for gain on appreciated corporate assets. During the operation of the S corporation, there is less flexibility in allocation among owners.

An individual shareholder’s income tax rate is lower than corporate income tax rates; tax savings are available.

Members of an LLC or partners of a partnership may be subject to a special “self-employment tax.” Liability depends on whether the member or partner is considered a “general partner” or “managing member” or a “limited partner” or a “non-managing member”. A general partner or managing member is automatically liable for the self-employment tax regardless of the level of the partner’s or member’s involvement it the partnership’s or the LLC’s affairs.

In contrast, a limited partner or non-managing member is not subject to the self-employment tax except to the extent he or she receives “guaranteed payments” for services rendered to the partnership or LLC. A limited partner or non-managing partner is not subject to the self-employment tax on his or her distributive share of partnership or LLC income or loss. Furthermore, a limited partner or non-managing partner may be treated as a general partner or managing member if his or her role in the partnership or LLC more closely resembles that of a general partner or managing member. Factors to consider in such treatment are whether the individual: 1) has personal liability for the debts or claims against the partnership or LLC by reason of being a partner or member, 2) has authority to contract on behalf of the partnership or LLC under the statute or law pursuant to which the partnership or LLC is organized; or 3) participates in the partnership’s or LLC’s trade or business for more than 500 hours during the taxable year.

While the salaries received by an employee of a C corporation are not subject to self-employment taxes, the employee salaries, however, are subject to FICA and SECA employment taxes.

Self-employment tax on LLC income can easily be avoided through restructuring the LLC. The LLC could incorporate and file an S election, or the LLC could “check the box” and elect S corporation status, or the LLC could reorganize as a limited partnership and appoint an S corporation as a general partner.

S corporation shareholders do not pay self-employment taxes. This exemption applies to dividends received and are distinguished from wages paid for services rendered. Wages paid for services rendered are subject to FICA. However, dividends paid to a shareholder who performs services to the S corporation may likely be characterized as wages paid for services rendered.

See Sale and Purchase of a Business.

Asset Protection

Safeguarding assets from the claims of personal and business creditors, including claims resulting from catastrophic expenses.

Creditors from whom you may want to seek protection include a variety of plaintiffs who may have obtained a court judgment against you in excess of your insurance coverage or in connection with a matter which was not covered by insurance because of a policy exclusion, or because you did not happen to have insurance which provided coverage, and your posting of an appeal bond is not economically feasible.

Life insurance and annuity funds in ERISA pension or profit sharing plans, or funds deposited in individual retirement accounts (IRAs) may not be seized by creditors in many circumstances. The exemption from seizure for life insurance is limited to $35,000 of current value if the policy was issued after September 7, 1990 and within 9 months prior to a creditor’s pursuing a claim in court. Special rules can apply to tax authorities who are creditors.

The term also describes other planning to reduce or eliminate income and estate taxes.

The first step in discussing protection of the assets of a married couple is to give an explanation of the differences between separate and community property in Louisiana and the effect that the categorization of such property as separate or community can have on asset protection (that is, protecting seizeable property from liability and insulating it from the claims of creditors and from possible seizure by creditors of a spouse).

The categorization can also have an effect (perhaps unintended) on inheritances and tax planning because upon the death of one spouse, the estate of the deceased spouse includes not only the separate property of the deceased spouse but also the undivided one-half interest of the deceased spouse in all community property. The inheritance rights of spouses and children vary depending on whether property is separate or community and depending on whether the deceased spouse has a valid will at the time of death. The categorization is also important in the event of divorce, when community property may have to be partitioned (that is, split up or sold).

>>> Tip: Obviously, we do not want to solve one problem (for example, asset protection) and create others (for example, inheritance rights and tax problems).

Community property essentially means in Louisiana that each spouse owns one-half of the property acquired during their marriage in the absence of a matrimonial agreement.

On the other hand, separate property typically includes either spouse’s inherited property, property acquired by either spouse before marriage, and the income from separate property which has been reserved by either spouse by a declaration made in an authentic act or in an act under private signature.

With respect to asset protection (or lack thereof), please note the following outline of some of the consequences of the categorizations, keeping in mind that not all property is seizeable by creditors (for example, certain life insurance and trust proceeds, and so forth):

Both a separate liability or obligation and a community liability or obligation may be satisfied during the community property regime from community property and from the separate property of the spouse who incurred the liability obligation.

When community property is used for the satisfaction of a separate liability or obligation of a spouse, the other spouse may have a claim for reimbursement. Likewise, when separate property of a spouse is used for the satisfaction of a community debt, the other spouse may have a claim for reimbursement.

In general, a liability or obligation incurred by a spouse may be either a community liability or obligation or a separate liability or obligation.

A liability or obligation incurred by a spouse during the existence of a community property regime for the common interest of the spouses or for the interest of the other spouse is a community liability or obligation.

All liabilities or obligations incurred by a spouse during the existence of a community property regime are presumed to be community liabilities or obligations, with certain exceptions: A separate liability or obligation of a spouse is one incurred by that spouse prior to the establishment of a community property regime, or one incurred during the existence of a community property regime, though not for the common interest of the spouses or for the interest of the other spouse. A liability or obligation incurred after termination of a community property regime with certain limited exceptions is a separate liability or obligation.

A liability or obligation resulting from “an intentional wrong not perpetrated for the benefit of the community”, or for a liability or obligation incurred for the separate property of a spouse to the extent that it does not benefit the community, the family, or the other spouse is likewise a separate liability or obligation.

The consequences of categorization on inheritance rights is generally as follows. Note the consequences vary depending on whether or not you have a valid will:

If you have a valid will at the time of death, forced heirship rules apply, but otherwise you may dispose of that portion of your property that is subject to your will as you wish. Forced heirship means that children who are under the age of twenty-four or children of any age, who because of physical infirmity or mental incapacity, are permanently incapable of caring for their persons or administering their estates at the date of the decedent’s death are forced heirs. All children are potentially forced heirs because any child may become disabled after you sign your will. Certain grandchildren are also potentially forced heirs. See Forced Heirship.

See Spendthrift Trust.