By Christopher Westman.

On August 26, 2020, the Securities and Exchange Commission (SEC) adopted new final rules intended to modernize the existing rules, and provide additional flexibility for certain entities and individuals the SEC deems financially sophisticated enough to understand the risks of participating in private offerings.

These additions to the definition of accredited investor, particularly those changes regarding professional certifications, designations, or credentials and to qualifying family offices, are positive changes that will expand investment opportunities for certain entities and sophisticated individuals who previously did not qualify as accredited investors, and increase the private fundraising capabilities of corporations.

The accredited investor definition in Rule 215 and Rule 501(a) of Regulation D promulgated under the Securities Act of 1933, as amended, has been amended to make the following additions:

• Individuals Holding Professional Certifications: Individuals holding certain professional certifications, designations or other credentials issued by an accredited educational institution, as designated by the SEC from time to time, may qualify as accredited investors.  When the new final rules take effect, holders in good standing of FINRA Series 7, Series 65, and Series 82 licenses will now qualify, and the SEC retained discretion to add additional professional certifications, designations, and credentials at a later date.
• Knowledgeable Employees: Individuals who are “knowledgeable employees” of a private fund may now qualify as accredited investors for the purposes only of investing in that fund. This list of “knowledgeable employees” includes, among others: (i) executive officers, directors, trustees, general partners, advisory board members, and others who oversee the fund’s investments, and (ii) employees or affiliated persons of the fund that have regularly participated in the fund’s investment activities over the past year.
• Certain Investment Advisers & Rural Business Investment Companies: SEC- and state-registered investment advisers, exempt reporting investment advisers, and rural business investment companies (RBICs) that are so licensed by the United States Department of Agriculture may qualify as accredited investors.
• Entities With $5 Million or More in Investments: Any entity, including Indian tribes, governmental bodies, funds, and those organized under the laws of foreign countries, that owns investments in excess of $5 million may qualify as an accredited investor.
• Family Offices and Family Clients: Family offices (i.e., entities established by families to manage the family’s wealth and provide other services to family members, such as tax and estate planning services) with at least $5 million in assets under management and their family clients may qualify as accredited investors if they are not specifically formed for the purpose of acquiring the securities offered, and are directed by a person capable of evaluating the merits and risks of the prospective investment.
• Limited Liability Companies: The new definition clarifies that limited liability companies with $5 million in assets may qualify as accredited investors.
• Spousal Equivalents: The term “spousal equivalent” has been added to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors just as spouses may do under the old rules.

Notably, the SEC did not revisit the accredited investor financial criteria for natural persons, which remain largely unchanged since 1982 despite not having been indexed for inflation.

These amendments were announced on August 26, 2020, and will become effective 60 days after publication in the Federal Register.

For more information or to discuss how this may impact the structure of your future investments, please contact Coblentz’s Corporate attorneys Sara Finigan at sfinigan@coblentzlaw.com or Christopher Westman at cwestman@coblentzlaw.com.

By Kit Driscoll.

Please note: Coblentz is not taking on new clients for Proposition 19 matters at this time.

Proposition 19, which will be on California’s November 2020 ballot, dramatically changes the property tax rules exempting certain intra-family transfers and primary residence transactions for certain individuals such as those over age 55 or severely disabled.[1] This memo illustrates the impact of the proposed change for properties transferred between parents and children, which could significantly increase the cost to future generations of keeping legacy properties within the family.[2]

California property tax is assessed based on the property’s purchase price and the cost of any improvements to the property. Unless a “change of ownership” occurs, the assessed value of real property increases by no more than 2% annually. Because average appreciation of California real property has far exceeded the 2% annual adjustment since the enactment of Proposition 13 in 1978, long time owners of California real estate generally enjoy a very low property tax burden relative to owners of newly acquired property. California currently provides two valuable exemptions from reassessment, which allow the continuation of this benefit after transfers of qualifying property interests between parents and children.[3] First, a transfer of parent’s principal residence to a child is completely exempted from reassessment. The child succeeds to the parent’s assessed value regardless of the value of the property or its assessed value at the time of transfer. Second, transfers of real property interests which are not the parent’s primary residence (residential or commercial) are exempted from reassessment to the extent of $1 million of assessed value, regardless of the fair market value of the property.

Proposition 19 revises the Parent-to-Child Exemptions to limit (1) the types of transfers between parents and children that can be exempted from reassessment, and (2) the property tax benefit available. First, only a transfer of the parent’s principal residence to the child where the property continues as the child’s principal residence qualifies. Second, provided the transfer meets the principal residence requirements, the child’s assessed value is then determined based on whether the property’s value at the time of transfer is greater than the parent’s assessed value by more than $1 million. If the value of the property at the time of the transfer exceeds the parent’s assessed value by less than $1 million, then the child takes the parent’s assessed value. If the value of the property at the time of the transfer exceeds the parent’s assessed value by more than $1 million, then the child’s assessed value is the current value of the property less $1 million. The following hypotheticals illustrate the consequences under current law versus Proposition 19

Hypothetical No. 1 – Prop 19 Increases Taxes 10x

Facts:

• Property #1 is Mom’s principal residence: $10M FMV, $500,000 assessed value
• Property #2 is Mom’s secondary residence: $5M FMV, $1M assessed value
• Mom’s total assessed values that she pays property tax on is $1.5M
• Property tax rate is 1.25% (estimated)
• Mom’s estimated total property taxes are $18,750
• Mom gives Property #1 and Property #2 to Child and claims exemption
• Child does not use either property as principal residence

Child’s Assessed Values and Property Tax Consequences:

Current Law	Proposition 19
Property #1 assessed value $500,000 (exempt under R&T Code Section 63.1(a)(1)(A)) Property #2 assessed value $1M (exempt under R&T Code Section 63.1(a)(1)(B))	Properties #1 and #2 are both reassessed to their fair market value because of the requirement the property be both Mom and Child’s principal residence before and after transfer, respectively
Assessed value is $1.5M, total, same as Mom’s	Assessed value is $15M, total
Property tax is $18,750, total, same as Mom’s	Property tax is $187,500, total

 

Hypothetical No. 2 – Prop 19 Increases Taxes 9.3x

Facts:

• Same facts as Hypothetical No. 1, except that Child maintains Property #1 as Child’s principal residence after the transfer.

Child’s Assessed Values and Property Tax Consequences:

Current Law	Proposition 19
Same result as Hypothetical No. 1 Property #1 assessed value $500,000 (exempt under R&T Code Section 63.1(a)(1)(A)) Property #2 assessed value $1M (exempt under R&T Code Section 63.1(a)(1)(B))	Property #1 receives a limited exemption from reassessment of the fair market value, less $1M ($10M – $1M = $9M) If Property #1 FMV were instead $1M then the assessed value would remain $500,000 and Child would have same property tax as Mom for Property #1 Property #2 is reassessed to its fair market value because of the requirement the property be both Mom and Child’s principal residence
Assessed value is $1.5M, total, same as Mom’s	Assessed value is $14M, total
Property tax is $18,750, total, same as Mom’s	Property tax is $175,000, total

 

 

[1]           Note that Prop 19, if passed, would expand the ability of certain homeowners, such as those over age 55 or severely disabled, to transfer the assessed value of their principal residence to a replacement residence and likely provide property tax savings to such homeowners.  In particular, Prop 19 would allow such a transfer of assessed value to a replacement residence in any California county.

[2]              R & T Code Section 63.1 provides the “Parent-to-Child” exemptions. The Parent-to-Child exemptions are for transfers “between” parents and children. The Parent-to-Child exemptions are also available for transfers between grandparents and grandchildren in certain circumstances. For purposes of this illustration, “parent” is the transferor and “child” is the transferee.

[3]              Note that certain procedural requirements must be satisfied to benefit from these exemptions and that other types of exemptions exist other than the Parent-to-Child transfers.

By Kit Driscoll

Now may be an opportune time to gift assets out of your estate, particularly through an estate planning technique known as the Grantor Retained Annuity Trust (“GRAT“)—a small silver lining of the alarming pandemic and down economy. As you undoubtedly noticed, the stock market and other economic indicators declined significantly in reaction to the COVID-19 pandemic, and the federal interest rates declined in tandem. The federal interest rates remain exceptionally low and many asset values are still generally depressed despite some gains and volatility in the stock market since its initial downturn. A GRAT is a highly efficient wealth transfer vehicle in low interest rate environments when funded with assets that are expected to appreciate considerably after the gifting date. It uses virtually none of your lifetime gift and estate tax exemption amount (currently $11.58 million per person) and has practically no downside risk, which is key in this volatile environment.

GRAT Structure

A GRAT is an irrevocable trust that is generally structured with a short term to which you gift property that is expected to appreciate over that term—you may consider contributing a concentrated position or securities in one asset class. The GRAT pays an annuity to you during the trust term equal to 100% of the value of the assets at the time you transfer them into the GRAT plus a small amount of interest. The amount of interest included in the annuity (also known as the “hurdle rate”) is based on the Internal Revenue Code Section 7520 rate, which is tied to the applicable federal rate (“AFR”). The GRAT then transfers all remaining appreciation to your beneficiaries, either outright or often to a continuing irrevocable grantor trust (“IDGT”) at the end of the term. Click here to view a flowchart for a simple example of a GRAT structure.

The current Internal Revenue Code Section 7520 rate is exceptionally low in September (0.4%). Gifting certain stocks or interests in assets currently depressed but expected to rebound will shift that relatively significant appreciation out of your estate while using almost none of your lifetime gift and estate tax exemption. If the gifted assets do not appreciate, then the downside is only lost transaction costs because all assets transferred to the GRAT are ultimately distributed back to you. The beneficiaries or IDGT that receives the GRAT appreciation can mirror the provisions of your existing estate plan or you can provide for additional beneficiaries or changed terms, which we can discuss in more detail.

You can also “roll” these GRATs, meaning that when the annuity is paid to you on the applicable anniversaries of the GRATs, you can fund those annuities into new GRATs and continue the process. Click here to view the flowchart for an example of a rolling GRAT structure.

Further, if the GRATs fail from the start because of an immediate downturn, the GRATs are structured so that you can swap the assets back to yourself in exchange for assets of an equal fair market value and then you can fund new GRATs right away to take advantage of the immediate downturn.

Income Tax Consequences of GRATs

The GRAT and IDGT are “grantor trusts” for income tax purposes. You, as an individual, are taxed on the income and realized gains of the GRAT and IDGT. Instead of the trusts bearing their own tax liabilities at the compressed trust tax rates, your payment of the taxes will be a tax-efficient wealth transfer as it will not utilize any of your lifetime gift and estate tax exemption. Grantor trust status may be switched off for the IDGT at any time, in which case the IDGT will bear its own tax liabilities at all times in the future.

A tradeoff between making the gifts discussed herein and retaining them until your death is that assets held at death receive a full step-up in basis for income tax purposes. The income tax basis of assets transferred to the IDGT generally has a “carryover basis” as your basis attaches to the property when gifted to the GRAT. (Note that in certain circumstances this planning could foreclose recognition of losses on gifted assets.) Once the IDGT receives the assets, you may reacquire the assets by substituting other assets with an equal fair market value at the time of the reacquisition. In particular, you may swap assets of the IDGT for other assets that have a relatively high basis to minimize capital gains consequences upon a sale by the IDGT.

Gift Tax Consequences of GRATs

A small “adjusted taxable gift” (e.g., typically less than $100) is made upon the transfer of property to the GRAT. There is no gift tax due in connection with the transfer, assuming you have remaining lifetime exemption from gift and estate tax.

Gift Tax Return Due

Although there is no gift tax due, you need to file a gift tax return (Form 709) reporting the transfer of property to the GRAT at the same time you file your 2020 income tax return. Either we or your accountant will prepare the gift tax return.

Estate Tax Consequences of GRATs

Once the property is transferred from the GRAT to the remainder beneficiaries of the IDGT at the end of the GRAT term, the property is not considered part of your taxable estate and will not be taxed at your death. Your lifetime exemption from gift and estate tax will be reduced by the amount of the “adjusted taxable gift” discussed in Paragraph III above. If you do not survive the GRAT term, however, any remaining GRAT property is includable in your taxable estate and may be subject to estate tax depending on your remaining gift and estate tax exemption just as if you never implemented the GRAT planning.

Please reach out to Coblentz Family Wealth attorneys if you would like to further discuss the GRAT technique and why this may be an opportune time to implement a GRAT gifting strategy.

By Kit Driscoll

Major tax reform discussions are ongoing in Washington and Sacramento while everyone at home is busy navigating the pandemic. Many commentators are predicting that budgetary pressures resulting from the COVID-19 stimulus measures will necessitate a near-term reversal of some of the 2017 federal tax cuts and provide further rationale for the passage of significant California property tax propositions. We encourage you to revisit your estate plan and consider gifting strategies in light of the potential legislative changes and unprecedented economic environment as highlighted below.

Estate, Gift, and GST Tax Increases Under Biden’s Proposal

In 2020, the lifetime exemption allows individuals to transfer up to $11.58 million free of estate and gift tax and generation-skipping transfer (“GST”) tax either by gift during life or upon death. Transfers in excess of those exemption amounts, other than to charity or to or for the benefit of a spouse, are taxed at a 40% rate. Biden and Sanders published 110 pages of policy reforms that would restore the estate tax regime to the “historical norm.” Many commentators are speculating this proposal means reducing the estate and gift tax and GST tax exemptions from $11.58 million per person to $3.5 million per person. However, “historical norm” could also mean even lower exemption amounts and a higher tax rate.[1] If not sooner amended, the estate and gift tax and GST tax exemptions are slated to revert to pre-2017 levels effective January 1, 2026, absent Congressional action.

The IRS issued guidance confirming that transfers taking advantage of the current exemption amounts will not be “clawed back” by a change to the law, making 2020 the time to utilize the balance of your exemptions by making gifts before any legislation becomes effective.

Property Tax Increases Under California Propositions 15 and 19

Propositions 15 and 19 will be on California’s November 2020 ballot and, if passed, could significantly change the property tax landscape.

• Proposition 15: Split Roll Tax for Commercial/Industrial Properties. The “split roll” would assess taxes for certain commercial and industrial properties based on their fair market value. Accordingly, Prop 15 removes limitations established under Proposition 13 (1978) that place a 2% cap on increases to the assessed value of these types of properties. Commercial or industrial properties whose fair market value does not exceed $3 million are exempted from Prop 15 reassessment. There is a significant exception to this $3 million threshold: the value of a subject property must be aggregated with the values of any other commercial or industrial properties in California for which a direct or indirect beneficial owner of the subject property shares a direct or indirect ownership interest. Note that the split roll system established under the Prop 15 proposal does not change the overall property tax rate, nor does it apply to residential property or agricultural property.
• Proposition 19: Change Assessed Value Calculations for Residential Property. Proposition 19 would expand exemptions allowing certain homeowners such as those over age 55 to transfer their assessed values to replacement residences in different counties within California, but would significantly narrow or eliminate existing exemptions from reassessment for other intra-family transactions. If you have any California real property with a low assessed value that you hope to pass to future generations, there are several strategies you might consider to take advantage of the current expansive exclusions from reassessment. See a more detailed explanation of Prop 19 here.

Low Interest Rates Favor GRATs, CLATs, and Sales to IDGTs

The current low interest rate environment makes certain wealth transfer vehicles especially attractive. Three of these techniques are briefly described below.

1. GRAT. A grantor retained annuity trust (“GRAT”) is a short-term irrevocable trust to which you transfer property that you expect to appreciate or generate income at a rate greater than that assumed by the IRS. The GRAT pays an annuity back to you during the trust term roughly equal to 100% of the value of the assets at the time you transferred them into the GRAT plus interest at a rate which the IRS publishes on a monthly basis. To the extent that the contributed assets generate income or appreciate at a higher rate than that IRS assumed rate, the excess appreciation passes to your beneficiaries free of tax. See a more detailed explanation of GRATs here.
2. CLAT. A charitable lead annuity trust (“CLAT”) is similar to a GRAT, except that the annuity is paid to a charitable beneficiary. The annuity distributable to the charitable beneficiary can be set at a value of the assets contributed to the trust. The non-charitable beneficiaries receive all appreciation above the contributed amount adjusted for the hurdle rate. A CLAT can be structured either to provide you a charitable income tax deduction in the year of creation or provide the CLAT deductions for the annuities paid to the charitable beneficiary. Please contact us to discuss the many variations on and ways to structure CLATs if you are interested in gifting a portion of your estate to charity.
3. Sales to IDGT. A sale of assets to an irrevocable grantor trust (“IDGT”) is a tax-efficient way to further leverage the use of lifetime estate, gift, and GST tax exemptions. Assets are sold to the IDGT in exchange for a note which bears interest at a rate tied to the IRS assumed “applicable federal rate,” which presently is very low. The IDGT pays you the low interest and principal for the duration of the note. You pay the income taxes on assets owned by the IDGT (for as long as you wish) which is a further tax-free wealth transfer. There are many ways to tailor sales to IDGTs that we are happy to discuss with you in more detail.

Low Income Tax Rates Favor ROTH Conversions

It is unknown what future income tax rates will be, but income tax rates for high-earners may be increased through Biden’s proposal to reverse the 2017 tax cuts or other California and federal proposals to increase tax revenue after the COVID-19 stimulus. Federal and state taxes are owed on the conversion; however, future distributions from the Roth account are then income tax-free. Contact your financial advisor to discuss whether a Roth conversion or partial conversion is advantageous.

Tax Haven States Benefit Trust Planning for Legacy Assets

California’s high state income tax rates are encouraging residents to move out of state, but another option may be to transfer legacy assets to a trust in a favorable tax state. Legacy assets that are expected to be held for future generations and not used for current expenses or distributions might be held in a trust outside of California and accumulate and grow free of state income taxes. We are happy to discuss the optimal structure for legacy assets and advantages of different states with you in more detail.

For more information or to discuss your estate planning and gifting strategies, please contact Coblentz Family Wealth attorneys.

 

[1]           Earlier in his campaign, Biden proposed eliminating the step-up in basis at death so that beneficiaries would have income tax due on the sale of estate assets.