Estate Planning for Deferred Compensation

Many executives receive, as part of their compensation packages, arrangements that provide compensation at a later date, often dependent on achieving corporate goals, such as income or sales levels.  Payments may be made after a few years or at retirement or termination of employment.  Funding may be from the employer’s general funds, through a fund set aside or through life insurance.

Most executives receive their payments during life and treat them as ordinary income or capital gains, depending on the structure used.  But deferred compensation arrangements often have a provision for payment in the event of the executive’s death.  Depending on the particular arrangement, the deferred compensation arrangement can be a significant portion of the executive’s estate.

In most deferred compensation arrangements, there will be a provision for naming a beneficiary to receive deferred compensation after the executive has died.  Like qualified retirement plans, IRAs and life insurance, the determination of who receives the benefits is made pursuant to the beneficiary designation rather than the executive’s will (unless the executive has named the estate as the beneficiary).  The beneficiary designation is really a form of will, because it governs the disposition of assets at death.  It should be planned as another element of the executive’s overall estate plan.  Questions of tax deferral and disposition of assets must be viewed by looking at the will as well as the various beneficiary designations.  Many people forget to combine these documents when planning their estates, and most people can’t find their beneficiary designations and have forgotten what they say.  In fact, if a lawyer keeps a copy or the original of a client’s will, the same file should contain a copy of all beneficiary designations.

Speaking of deferred compensation, a new and extensive regulatory framework was enacted in 2004, providing rules for deferred compensation arrangements of all types and including significant penalties if those rules are not followed.  Because of the extensive nature of those rules, and the hundreds of pages of regulations issued to interpret the new statute, the Treasury and IRS gave several extensions of the time period to bring arrangements into compliance with the new law.  That extension of time to assure compliance, which includes a grace period to make changes in arrangements, will come to an end on December 31, 2008.  That means that there are only a very few months before all deferred compensation arrangements must be brought into compliance.  In doing so, it’s first necessary to decide what arrangements exist, and then to decide whether and how they should be changed.  This is a big task, and lawyers whose clients have deferred compensation arrangements need to check now to see that the compliance process is under way

Robert H. Louis
Saul Ewing

http://www.saul.com/

Battle Over Fox Chase Expansion Continues

Amy B. Ginensky argued in Philadelphia Court of Common Pleas’ Orphans’ Court Thursday that the Fox Chase neighborhood in Northeast Philadelphia is doubly blessed to have both Fox Chase Cancer Center and Burholme Park within its environs, and a proposed plan to lease part of the 70-acre park to Fox Chase for an expansion of its medical campus will allow the neighborhood to continue to reap its dual blessings.

But during a hearing held Thursday in front of Philadelphia Common Pleas Judge John W. Herron about the city’s plan to sublease part of the park to the cancer center, counsel for a group of taxpayers and neighbors opposing the plan argued that the city undertook a public trust when it agreed to accept the park when Robert W. Ryerss willed his country seat to the city to be used as a public-access park for perpetuity.

Samuel C. Stretton, a West Chester solo practitioner, said that Herron must consider what the park means as a public trust and what it means as a preserved green space in this day and age.

Ginensky is of Pepper Hamilton and represents Fox Chase in Estate of Robert W. Ryerss. Co-counsels from Pepper are Charles S. Marion, Kathleen H. Stephenson and Alison Altman Gross.

The city of Philadelphia and Fox Chase are seeking Herron’s approval of deviation of Ryerss’ will giving 48 acres to the city to be used as a public park and the public trust created when the city accepted Ryerss’ 1895 bequest, expanded the park to 70 acres with a later purchase and maintained the park with city funds.

City Council passed an ordinance March 6 in support of the plan to sublease 19.4 acres of the park to Fox Chase.

Much of the bulk of Thursday’s hearing was taken up with testimony of John K. Binswanger, a Fairmount Park Commissioner and president of the Fairmount Park Conservancy.

Binswanger was the witness of Gerald E. Wallerstein, a senior attorney with the Philadelphia Law Department. Wallerstein’s co-counsels were Robert Aversa and Larry Copeland.

Under questioning, Binswanger noted that most of the area that would be given to Fox Chase is a golf driving range.

Stretton argued in his opening remarks that the current golf driving range will bring the city more money from concessions than from the millions of dollars in proposed, staggered payments from Fox Chase.

According to court papers, Fox Chase could pay up to $12.25 million in development fees, base rent and additional consideration.

Binswanger said that the deal requires Fox Chase to buy 19 substitute acres for another park, but it has been difficult to find another suitable open space in 10th City Council District, which is represented by city Councilman Brian J. O’Neill and is home to Burholme Park.

Binswanger also said that Fox Chase’s original request to obtain 39 acres of the park was unacceptable to the park commissioners.

The city argues in court papers that city residents would benefit from Fox Chase’s ability to “continue to be at the forefront of cancer treatment and research,” from the creation of temporary construction jobs and permanent jobs if Fox Chase’s campus expands, and the expansion of the city’s tax base. The city and Fox Chase say the plan is necessary because Fox Chase is bursting at the seems in its current campus, has nowhere else to expand its campus within its residential neighborhood, and may have to move out of the city if it can’t expand at its current locale.

“It’s a fair deal for the city. It’s a fair deal for Fox Chase … the fact they can keep their complex together … is a very advantageous position for Fox Chase to be in,” Binswanger said after he was allowed by Herron to speak to the reasoning he had for supporting the proposed sublease.

Binswanger was a member along with Deborah Goldstein, the ex officio mayor’s representative to the commission, and Commissioner Robert Nix, of a committee that negotiated with Fox Chase about the proposal ultimately approved by the commission and by City Council.

During Stretton’s cross-examination of Binswanger, Stretton hit home repeatedly on the suggestion that there might be conflicts in Binswanger’s involvement because Binswanger’s brother used to serve on Fox Chase’s board, and the conservancy he leads may receive a significant administrative fee in order to hold funds Fox Chase would give toward Burholme Park.

Binswanger said that he didn’t believe he had a conflict of interest.

Stretton’s 13 clients were given standing to intervene in the case and present their opposition to the plan.

The hearing was expected to continue Friday, Aug. 29, and perhaps into a third day on Wednesday, Sept. 10.

– Amaris Elliott-Engel, staff reporter

This Doesn’t Sound Good

Suppose you were a corporate executive and your employer offered you a golden coffin. Would you be happy or sad?

There are a variety of ways of compensating corporate executives, ranging from incentive bonuses and stock options to various forms of nonqualified deferred compensation and “perks.” Some of these benefits are designed to encourage employees to stay with the company. If you stay a certain period of time and achieve certain goals, you’ll be handsomely rewarded; but if you leave early, nothing. These types of arrangements are often referred to as golden handcuffs. Another method of encouraging employees to stay is to assure them that if the business is sold or undergoes a substantial change in control, something good will happen. That something might be immediate vesting in stock options or a cash payment if employment ends shortly after the change. This is referred to as a golden parachute. If more modest benefits are promised to employees at lower echelons of the business, the phrase tin parachute is used. There are restrictions on the use of golden parachutes that are too generous, and that can lead to the imposition of an excise tax by the IRS.

An article on the Human Resource Executive Online Web site notes evidence of so-called golden coffin payments, based on examination of filings made with the SEC. Executives may become entitled to salary continuation payments for several years after their deaths, or their families might be given the right to continue the use of executive perks, such as private jets and country clubs. I suppose the theory is that the executive has been given so much compensation during life that any further increases can’t be justified to shareholders. So, as an alternative to paying more, the idea is to pay it longer, even after death. Still, golden coffin? It doesn’t sound like something nice.

As an alternative to this desire, like General Bullmoose from Li’l Abner, to have all the money in the world, some executives have opted to create a golden legacy. If the executive or his family has a particular charitable interest, the employer might arrange that life insurance proceeds on the executive’s life, or a large severance payment, be paid to a favorite charity or to a foundation set up by the executive during life. There shouldn’t be any tax consequence to the executive or his or her family from such payments, even though there are at least some indirect benefits to the family that might be generated. This enables the executive to do estate planning that is solely focused on providing for the family after the executive has passed on or, as they would say several generations ago, joined the silent majority (a phrase having nothing to do with the Nixon administration).

Robert H. Louis
Saul Ewing

http://www.saul.com/

‘The Dean is Furious! He’s Waxing Wroth!’

This was the only quote I could think of to introduce a discussion of planning with Roth IRA and retirement plan benefits. In response to this statement, Groucho Marx said: “Is Roth here too? Tell Roth to wax the Dean for a while.”

Delaware Sen. William Roth gave his name to this type of retirement benefit. It’s simple, sort of. You don’t get a tax deduction when the contributions are made, but you don’t pay taxes when the account is distributed at retirement. You give up a current tax saving in exchange for a greater one later. Is this a good deal? The answer is definitely, sometimes.

If you knew that you would pay a higher tax rate in retirement, Roth tax treatment would clearly be better. Conversely, if you knew that your tax rate would be much lower in retirement, it might be better to stay with the traditional method of planning: a deduction up front and taxation later. Opinions vary on this subject, and studies have been made to try to determine when and whether one method is superior to the other. There are some unknown elements: not only your own tax rate but tax rates in general. Who can predict what income tax rates will be 10 or 20 years from now? Or that Roth treatment will still be in effect?

For now, here are two situations in which Roth treatment makes sense. First, if you have a child who has a summer job, it makes sense that the child have a Roth IRA. In most cases, kids with summer jobs have little or no income tax liability anyway, so a deduction for an IRA contribution is of no value to them. Then, they will have many years in which the Roth IRA can grow tax-free. When the funds are distributed, perhaps 50 years later, the small contributions from summer jobs could be a large amount.

Here’s another possible benefit: Roth IRAs do not have minimum distribution rules, unlike standard IRAs and qualified plans. If an individual has other assets such that he or she won’t need the Roth money, the balance can be left in for the rest of the individual’s life and be paid out only in the next generation. This extremely long-term accumulation period, followed by no tax on distribution, can make Roth a valuable planning benefit.

People with standard benefits can convert them to Roth benefits by paying taxes on them now. After that, any distributions will be free of tax. The ability to convert is limited to those with income below certain levels, but that restriction will end by 2010. At that time, anyone will be able to convert to Roth treatment. This opens up the possibility of interesting estate planning with Roth benefits, which we’ll discuss in another blog.

Robert H. Louis
Saul Ewing

http://saul.com

Sign Here, My Dear

This was the title of a series of lectures to help spouses, mostly wives, understand financial matters. It addressed a very real problem that families face when the “financial spouse” passes on.

What bills do I have to pay? Will I have enough income to cover my expenses now that my spouse is gone? Will I have to sell my home? Or, will I have enough to make gifts to children and grandchildren during my life? These kinds of questions, which arise frequently in estate planning and administration, demonstrate the need for a kind of planning that incorporates knowledge of retirement plans, financial planning, elder law and estate-planning concepts. Lawyers practicing trusts and estates have most of these skills and need to understand the importance of having a wider view of the planning client’s requirements.

I have discussed with clients the preparation of a template during the lifetime of the financial spouse, setting forth what expenses need to be met and how they are paid:

• Bills paid every month, such as telephone, other utilities, car payments.
• Bills paid on a regular but not monthly basis, such as auto and homeowners insurance, life and disability insurance premiums.
• Bills paid as expenses are incurred or are chosen to be paid, such as credit cards, contributions, medical and dental expenses, veterinarian (if you live at my house), car repair, home repairs.

A second part of the template is things to do during the course of the year:

• Car inspections.
• Home inspections.
• Medical and dental checkups.
• Memberships in various organizations, such as ambulance services, that are useful to families.
• Required distributions from retirement plans, depending on the survivor’s age.
• Filing tax returns and paying any required estimated taxes.

A third part of the template is a list of the people to contact for assistance:

• Lawyer (always the top of the list).
• Accountant.
• Insurance agents.
• Home service and repair people.
• Car repair services.
• Other specialized assistance.

And, finally, it’s important to have good organization of the information. There’s no point in assembling information if the survivor can’t find it. I’ve had some clients who went a little overboard on this (“walk three paces to the left”), but it is important that the survivor know where things are. As the large Baby Boom Generation moves toward retirement and beyond, it will be important to help them plan these practical aspects of the balance of their lives.

Robert H. Louis
Saul Ewing

http://www.saul.com

The Wisdom of Dagwood Bumstead

Dagwood Bumstead, featured in the long-running comic strip Blondie, has worked for more than 70 years for J. C. Dithers, the model for many a law firm senior partner. But that was not the way he started out comic strip life. His saga tells an interesting story about family business succession.

Dagwood began as the heir to an industrial empire, the Bumstead Locomotive Works. He fell in love with Blondie Boopadoop, whom his family considered beneath him socially. When he insisted on marrying Blondie anyway, his father disinherited him. Thus ended his future of becoming an executive in a large industrial concern, and he turned instead to more than 70 years of wage slavery, carpools, running into the mailman, etc. He seems to have become stuck as the equivalent of a third year associate. Meanwhile, Blondie started her own business, and the Bumstead Locomotive Works has disappeared. Perhaps Dagwood could have saved the company and redirected its business to defense contracting or microchips.

What’s the lesson for those thinking about family business succession, which is one of the most difficult goals to achieve but one of the most satisfying when it is achieved? It’s a better course of action for the family members to discuss each of their goals and plans. Bumstead Senior should have realized the consequences of leaving no one to follow him in the business. Dagwood could have suggested that he come into the business on a lower level so that he could prove himself. Senior’s lawyer could have explained how disinheriting his son would probably put an end to the plans to have the business remain in the family and successful. But I suppose that wouldn’t make for a good comic strip; better to feature big sandwiches and funny bowties.

Here are two sources of learning on the process of business succession, very different but both helpful. One is a book titled “Estate & Business Succession Planning,” by Russell J. Fishkind and Robert C. Kautz. The second is a series of programs on succession planning that feature a theatrical performance of vignettes in the story of family businesses. These programs have been arranged by a psychologist, Dr. Scott Budge, who has spoken for PBI on business succession planning. They are presented in Philadelphia from time to time.

Robert H. Louis
Saul Ewing

http://saul.com

Retirement Havens: Florida, Arizona…Pennsylvania

Part of planning for the future is deciding where to spend the golden years, as marketing types like to call them.  For those people who have an option where to live in retirement, there are the usual suspects: Florida, Arizona, North Carolina and there is the state that is one of the most popular among retirees, Pennsylvania.

By the way, the idea that you need to remain in the city where your law practice is located in order to continue to have an involvement in that practice is fast fading away. Just last week, a lawyer from a suburb of Detroit, who is suing one of my clients, called me from somewhere deep in the heart of North Carolina, from where he is able to be heavily involved in the frivolous litigation he is pursuing. 

Why is Pennsylvania so popular among retirees, especially those in the neighboring states of New York, New Jersey, Delaware and Maryland?  One important reason is the taxation of retirement income, such as Social Security and retirement plan distributions. There is no income tax imposed by Pennsylvania on bona fide retirement income, which is not the case in the neighboring states. If your income in retirement consists only of Social Security benefits and amounts you withdraw from a 401(k) plan, for example, your Pa. income tax will be zero. That is not the case, again for example, in New Jersey.  And if you worked in New Jersey to earn a retirement benefit, New Jersey can’t reach across the river to tax it if you move to Pennsylvania, under federal law.  (But here’s a caveat: Be sure to check the Pennsylvania rules to be certain that your retirement distributions qualify. Nearly all distributions after age 59 1/2 will qualify, but check the rules anyway.)

Yes, we have a sales tax, which Delaware does not have (although there are a large number of “big box” stores suspiciously close to the Pennsylvania border) and yes, we still have the state store system (again, some really good wine stores just across the border in New Jersey and Delaware, I’m told), but Pennsylvania has a big advantage in the taxation of retirement income.  That, combined with reasonable property taxes and access to a world of sports, culture and recreational activities, is why Pennsylvania has one of the largest populations of retirees of any state.

Robert H. Louis
Saul Ewing

http://saul.com/

Send Lawyers, Internal Revenue Codes and Money

Actually, the Warren Zevon song refers to “Lawyers, Guns and Money,” but the Internal Revenue Code can also be a dangerous weapon. Now that the campaign for president has reached the general election stage, it’s time to realize that whoever wins the election; there are massive changes in our federal tax system looming ahead. These changes will affect us and our clients in various ways. In some cases, there will be little that can be done but to accept the changes; in other situations, there may be planning that can be used to reach a better result. Here are a couple of areas where change may occur:

• Federal estate tax: This discussion has been going on for several years, with much misinformation being spread about. (Read “Wealth and Our Commonwealth” by William H. Gates and Chuck Collins for a good review of this debate.) But there will be changes in our federal estate tax system in the future because leaders in both parties agree that the tax must be revised to include only the truly wealthy, not those who bought a home in a good neighborhood. There might be relief for small businesses and farmers, but in general the tax should be one that allows people to pass on some of the fruits of their life’s work without destroying the incentive of the next generation to take part in life’s struggle.
• Federal income tax: The reductions in income tax rates that were enacted in 2001 are scheduled to phase out in a few years. One solution is to extend indefinitely, but this easy answer has to be balanced against the colossal budget deficits that have resulted, in part, from those tax reductions. The view that those budget deficits can go on forever and will somehow be resolved or will disappear as a result of future growth is now classified with bedtime stories.
• Alternative minimum tax: Whose idea was this anyway? In the past few years, we’ve had small bandages applied to this gaping wound in our tax system. Some have suggested just repealing it, which would only result in even larger budget deficits. But reducing its effect to those who are perceived as not paying a fair share of taxes, which was the original intent of the law, will require that some difficult choices be made. Doing nothing (which is a skill of both political parties): not an option.
• Social Security taxes: Someone will have to finally accept that this problem also can’t be ignored or magically wished away with private accounts, and that higher taxes will only be acceptable to a limited degree. As last week’s blog indicated, you can either increase revenues or reduce benefits; there’s no third way.

All of these problems will have to be addressed by our next president, either John or Barack. In the course of resolving them, many provisions of our tax laws will be placed on the table: taxation of life insurance, employee benefit taxation, relief for older taxpayers and those with children. Many constituencies will be contending for their interests. It’s important for all of us to know what’s happening, and to plan for change, for us and for our clients.

Robert H. Louis
Saul Ewing

http://saul.com/

Social Security: Did We Solve That Problem Yet?

 

 

I know it was discussed extensively over the past few years, but is it no longer front-page news because the problem has been fixed? Apparently not. It’s more likely that the nation is suffering from attention deficit disorder and can only think about high gas prices right now.

 

But this problem isn’t going away, nor is the Medicare problem on the verge of resolution.  Both of these programs face long-term funding challenges and waiting another few years to think about them again isn’t going to make their solution any easier.

 

An interesting Web site is maintained by the Center for Retirement Research at Boston College, and included on the Web site is a publication called the “Social Security Fix-It Book.”  There are only a certain number of possible solutions to these problems, and the center has summarized them in 52 clearly written and entertaining pages. The publication begins with basic facts about how Social Security works and then makes the following fairly simple statement: The only two ways to fix the problem are to cut benefits or increase revenues. There is no magic formula that will painlessly make Social Security financially solvent for the indefinite future.

 

There are a couple of ways to cut benefits:

 

• An across the board percentage benefits cut that affects everyone, including those now receiving benefits.
• Raising the normal retirement age for full benefits, as has already occurred.
• Freezing the purchasing power of benefits, which means that future benefit amounts would be lower than under the current law.
• Freezing the purchasing power, but to a lesser degree for lower income earners.
• Changing the cost of living adjustment for benefits.
• Doing nothing and cutting benefits all at once in 2040

 

And, there are a couple of ways to increase revenues:

 

• Increasing the payroll tax rate today.
• Raising the cap on earnings subject to Social Security taxes.
• Financing Social Security with revenues from the federal estate tax.
• Transferring Social Security’s startup costs (from benefits paid in the early years of the program) to general revenues.
• Increasing the rate of return on assets held in the Social Security Trust Fund.
• Waiting until 2040 to raise taxes.

 

What to do? The publication ends by asking these three questions, the answers to which will determine how to fix Social Security:

 

• Do we want to keep benefits about where they are now?  If so, how should the burden be shared?
• Do we want to keep taxes about where they are now?  If so, how do we cut benefits?
• Finally, should each generation pay about the same tax and get about the same benefits?

 

Robert H. Louis

Saul Ewing

http://www.saul.com/

‘You Kids Can Work It Out’

This is what a father wrote in a will that was brought to me. It illustrates another fundamental point about estate and retirement planning.

The father had decided to make his estate planning easy. “I’ll just buy CDs in my name and in the names of each of my children. That way, when I die, each of them will have a CD now in his or her sole name.” So, to carry out this idea, the father bought one CD with Child No. 1’s name on it in addition to his, a second in the name of Child No. 2 and the father all the way up to five children. The trouble was, he forgot how much he had purchased for each child, so the amounts were uneven. One child would get $100,000, another $10,000.

But Dad planned how to solve that problem. In his will, he wrote: “If any of the CDs I bought aren’t equal among my children, I ask them to straighten it out.” What do you think happened? Wrong, they did straighten it out. In one of those unusual family situations, the children who got more recognized their obligation to the others and entered into a family settlement. Sometimes it snows in April.

It’s important to remember that a will isn’t the only document that determines how assets are distributed. Life insurance beneficiary forms, retirement plan beneficiary designations and joint title on assets are all forms of testamentary dispositions; that is, they are all wills. Most people don’t know where these forms of wills are, sometimes can’t remember what they say and usually haven’t put them together so that they understand what their estate plan is. But it’s important to do this, because not every family (and, in fact, very few) is as close and understanding as the one described above.

Robert H. Louis
Saul Ewing

http://www.saul.com/