Estates, Trusts & Gifts
Beneath some of the most beautiful areas of the United States lies wealth beyond some people’s wildest dreams. States such as New York, Ohio, Pennsylvania, and West Virginia have regions that contain Marcellus shale, a sedimentary rock that contains natural gas. This rock is now being sought in order to extract that valuable resource. Many believe that the highest production potential can be found in the northeastern and north-central regions of Pennsylvania.
Many in the Marcellus shale areas are being faced with difficult financial decisions due to the newfound wealth associated with the sudden interest in the Marcellus formation. Because of new drilling techniques, the natural gas industry has struck deals with many landowners in order to obtain drilling and mineral rights to their property. Landowners who signed the lease agreements, as well as those who are contemplating signing a lease, need to look ahead for ways to keep these benefits continuing into the future. With proper planning now, future generations will still be reaping today’s rewards.
Key Items to Consider
Many people avoid estate planning because of the complexities involved, and also because of the difficulty in facing their own mortality. But there are some basic steps individuals can take to lessen the various types of pain associated with these issues.
Make Sure a Will Is in Place
Like many individuals in the United States, those who have signed gas leases may never have thought that they needed a will. However, these individuals worked for their assets and now would probably like to dictate where their assets go after their death. Without a will, the intestacy laws of the resident state will generally determine how the assets will be distributed. Further, if any of these individuals have young children, a will can name the guardian(s) of those children should the individual pass away while the children are still minors.
Use Time Wisely
One of the most important things for taxpayers to remember about estate planning is to use their time wisely. As each year passes they will lose valuable planning opportunities. One example that demonstrates the importance of proper timing is the use of annual exclusion gifts to individuals. For 2010, the exclusion amount is $13,000—a taxpayer can gift up to $13,000 to an individual without incurring gift tax. When 2011 comes around, he or she can gift the annual exclusion amount again to the same person. Over time, proper gifting of the annual exclusion amounts can significantly reduce an estate’s value. For example, a married couple with three children can reduce the value of their estate by more than $750,000 with proper planning over the next 10 years [($13,000 × 3 children × 10 years) × 2 = $780,000]. An added benefit is that the appreciation of these annual gifts is removed from the estate.
Don’t Forget the Basics
Payments made directly to educational or medical providers are not considered taxable gifts. For example, if a grandparent pays a grandchild’s tuition directly to a college or university, this is not considered a taxable gift and does not get included in the grandparent’s annual exclusion gifts for the year. If someone pays for braces for a nephew, as long he or she makes the payment directly to the medical provider, it is not considered a taxable gift. And generally any medical costs that an individual could deduct for income tax purposes would qualify for this exclusion.
Due to the various types of lease agreements that the Marcellus shale individuals may be involved with, liquidity could become an issue because of estate or even inheritance taxes that may arise upon death. The creation of an irrevocable life insurance trust would help with any liquidity problems. This trust, if properly created and administered, would provide the necessary cash that would be needed at death, and the life insurance proceeds would not be taxable for estate tax purposes.
Sec. 529 plans allow individuals to make payments to an account that will be used in the future for a designated beneficiary’s educational expenses. Gifts under the annual exclusion amount could be used to fund contributions to these plans.
In order to fund the Sec. 529 plan with a larger up-front contribution, an individual can elect to take a contribution to the plan in the current year into account over five years. However, the individual then cannot make a contribution to the same plan for the next four years.
For example, in 2010 a grandmother could contribute $65,000 to a Sec. 529 plan for the benefit of her granddaughter. This gift would utilize the annual exclusion associated with this granddaughter for the current year as well as the next four years. For more on this, see Zook and Zook, “Tax Benefits for Education,” 41 The Tax Adviser 464 (July 2010).
Individuals should ask themselves whether, if something unexpected happens to them, they have a plan in place to ensure that their business will continue successfully. In most cases, the answer is no.
In order to guarantee the future success of a business, the successor individual must be given the proper tools to be able to continue successfully. The individual needs to understand the business and the responsibilities. He or she must be given the opportunity to ask questions. Most of all, the chosen individual must be willing to be the successor.
Many of the Marcellus shale landowners have created limited liability companies (LLCs) to hold the mineral rights. With the use of valuations and applicable discounts, gifting can be used to transfer limited liability ownership to future generations. This is the easy part. What becomes more difficult is for the original owners to decide who should control the LLC in years to come.
It is never too early to start having these conversations. Also, given low natural gas prices, which would equate to lower values of the limited liability interests, now may be a good time to be considering gifts of this type.
Planning for Uncertainty
Currently there is no estate tax for the year 2010, but that could change at any time. Congress could decide to institute some form of the estate tax retroactively to January 1, 2010; it could choose a date in 2010 for the estate tax to take effect; or the estate tax could remain repealed for the entire year. No matter what the outcome, on January 1, 2011, there will be an estate tax. For this reason alone, estate planning cannot be forgotten.
Estate plans must remain flexible, and they must be closely monitored. Individuals must be proactive about planning in order to achieve their goals.
The families affected by the Marcellus shale boom, as well as many others across the country, can benefit from proper and timely estate planning. Although estate and gift planning is not the most pleasant topic of conversation, it is extremely important and should not be ignored. Individuals who are proactive and seek tax advice can save tremendous amounts, not only in terms of tax dollars but also in time and frustration.
Editor: Anthony S. Bakale, CPA, M. Tax.
Anthony Bakale is with Cohen & Company, Ltd., Baker Tilly International, Cleveland, OH.
For additional information about these items, contact Mr. Bakale at (216) 579-1040 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Baker Tilly International.