Tax exile

Rock star David Bowie died of cancer in January at age 69. According to a recent account in TaxNotes, Bowie became a tax exile in 1972. At that time he had accumulated U.S. and California tax debts of some $300,000. As England then had a top marginal income tax rate of 83%, that also was not very inviting. Bowie’s wife at that time, Angela, had been educated in private schools in Switzerland, so she suggested that they explore relocating there.

The couple flew to Switzerland, hired a local lawyer, and negotiated Swiss legal residency in Blonay, a village near Lake Geneva. Bowie was required to spend significant amounts of time in Switzerland to maintain that status, but in exchange his income was taxed at only 10%.

Reportedly Bowie later changed his legal residency to Ireland by purchasing a 640-acre estate near Dublin. This could have been an even better tax deal than that offered by Switzerland. After 1969 the Irish tax code exempted royalty earnings of musicians, writers and other artists from income tax. The exemption was capped in 2007, leading some artists to relocate to The Netherlands.

Another savvy move by Bowie in the financial realm was the creation of Bowie Bonds in 1997. $55 million worth of bonds were sold, secured by Bowie’s back catalog. The interest and principal payments for the bonds came from the royalties from some 300 songs that he wrote and still owned. When the bonds were fully paid off, the intellectual property rights reverted back to Bowie. This model for securitization of royalty rights has since been emulated by other artists.

Press reports pegged Bowie’s estate at about $230 million. No word yet on which nation or nations expect to impose an estate tax on it.

(February 2016)
© 2016 M.A. Co. All rights reserved.

Digital Estate Planning

ID-100278678Last year, Facebook announced a change in its policy for managing profiles after death. Earlier, the family of a deceased user could ask Facebook to “memorialize” the user’s profile. Now users can designate a “legacy contact” who will have access to the account after the user’s death. The legacy contact will be permitted to post a death notice on the profile, and more importantly, will be able to download the archive and all associated photos. Alternatively, one can request that the account be deleted upon death.

One odd detail, the legacy contact won’t be notified by Facebook of the status until after the user dies. Seems like the user should take the initiative and discuss the situation with the legacy contact first. Imagine that a friend has died unexpectedly, and then you get a Facebook notification that you are now responsible for his or her profile! Not a happy surprise.

Planning for digital assets is emerging as an important area in estate planning, for several reasons. One aspect is that digital assets, such as Facebook accounts, may have sentimental value for the family, and some assets might have monetary value. Another aspect is avoiding identity theft of the deceased person. Finally, with more and more commerce being transacted digitally, access to passwords and electronic accounts may prove very helpful in estate settlement.

For a more detailed discussion of the ins and outs of planning the digital estate, law professor Gerry Beyer has an excellent short article here.

One may be forgiven for assuming that planning for digital assets isn’t really important. However, having an estate plan is very important, even for someone with modest assets. If you haven’t had your will drafted yet, we suggest that you see your attorney soon. Even if you have a will, check it every few years to make certain it still matches your desires.

Image courtesy of Stuart Miles at

Jumbo Gift Tax Exclusions

Every taxpayer has two shields from the federal gift tax: a $14,000 annual exclusion and a $5.43 million lifetime exemption.  Each of these is indexed for inflation.  To the extent the gift tax exemption is used, one’s estate tax exemption is reduced, dollar for dollar.

The purpose of the annual exclusion is to eliminate the necessity of gift tax returns until the total of gifts made to one person exceeds $14,000 in a single year.  Note that the annual exclusion is not per taxpayer, it is per donee. A grandfather with six grandchildren may give each of them $14,000 this year without needing to file a gift tax return to report the gifts to the government.

One couple recently leveraged the gift tax exemption and exclusion to avoid all gift taxes on a transfer of property worth $3.2 million to a trust.  They each claimed $720,000 in gift tax annual exclusions, and their lifetime gift tax exemption covered the rest.

How is that possible?  The trust was a so-called Crummey trust, named for a taxpayer victory many years ago.  That case held that the annual gift tax exclusion must be allowed if a beneficiary has a power, even a temporary power, to withdraw trust assets when they are contributed to the trust.  In the new case, the couple had named 60 different beneficiaries for their trust, each with a Crummey power of withdrawal.

It’s important to note that the withdrawal power must not be illusory.  The beneficiaries must be advised of the power as well as the contributions to the trust, and they must have a reasonable time to exercise the power, typically 30 days. If the power is not exercised, the property remains in the trust for future distribution to the beneficiaries.

The IRS challenged the annual exclusions for the 60-beneficiary trust, but lost in the Tax Court.  The Service did not base its arguments on the large number of beneficiaries, or the practical limitations on satisfying a withdrawal demand when the trust held illiquid assets.  Rather, the IRS focused on a clause in the trust that had the potential to disinherit any beneficiary who objected to a trustee’s distribution decision.  The Tax Court held that the clause in question did not apply to withdrawal demands, which are different from distribution decisions.

The moral of the story is that one can leverage the two gift tax shields considerably. However, excellent legal advice will be a must, because an IRS objection to such arrangements will be likely.

The tax value of fine art

Bernice Newberger died in July 2009. Her estate included three valuable pieces of art, for which it obtained appraisals from Sotheby’s and Christie’s. The valuation was complicated by the fact that the market for fine art took a steep dive in 2008, as the economy slipped into recession. For example, in October 2008 some 44% of pieces put up for auction failed to attract minimum bids, double the rate of a year earlier. They had to be returned to their owners. In 2009 Sotheby’s revenue declined by 53% and Christie’s by 46%. Bernice’s death came at the trough of the slump.

Based upon the advice of appraisers, the estate valued two lesser pieces at $450,000 and $500,000. The real prize was a Picasso. Sotheby’s offered a $3.5 million guaranteed price. Christie’s offered the estate better guarantees and a professional estimate of date-of-death value of $5 million, which the estate duly included on its estate tax return, timely filed in October 2010.

The IRS challenged all three valuations. Perhaps to create some liquidity for paying taxes, the estate had accepted the terms from Christie’s and put the Picasso up for auction in February 2010. The expected sale price was $4.7 million to $6.3 million, consistent with the appraisal. In the event, including the buyer’s premium, the painting fetched over $12 million. The IRS cited that fact as it claimed that the Picasso had been undervalued by the estate.

Although events occurring after death are not to be taken into account to determine date-of-death values, the Tax Court held that the later sale may be used as evidence of value. The estate’s argument that the high price was “a fluke” that was unforeseeable at the date of death was rejected. The Court accepted the IRS’ downward adjustment to $10 million to reflect the changing market conditions. The estate’s values for the two lesser pieces were sustained.

Had Newberger lived another seven months, her estate would have avoided all estate taxes, as 2010 was the year when the federal estate tax was optional. In the absence of estate tax, carryover basis would apply. In that event the heirs would have been exposed to a very large capital gains tax upon the sale of the art, as Newberger had acquired the Picasso for just $195,000 in 1981.

(February 2016)
© 2016 M.A. Co. All rights reserved.

I need protection for my 401(k) distribution


When I retire in about a year, I’m expecting a six-figure distribution from my employer’s 401(k) plan. The success of my retirement turns on what I do with this money, and I’m more than a little unsettled by the prospect. What should I do to keep my all my options open?


DEAR LOOKING: I have two words for you: IRA Rollover. With this arrangement you can continue the tax deferral that your 401(k) account has enjoyed so far. Be sure that you use a “trustee-to-trustee” transfer of the funds to avoid the 20% tax withholding that otherwise would apply to your distribution.

Will your distribution include shares of stock in your employer? If so, you should consider not rolling those shares over, but accepting them for your taxable portfolio. Income taxes on “net unrealized appreciation” in those securities may be deferred in this manner—your accountant can give you more details.

You’ll also need an investment plan for your retirement money. When you undertake this plan, consider your taxable and tax-deferred funds as part of one large portfolio. The plan that you or your investment advisors come up with needs to take all of your resources into account, as well as your retirement income needs. You are wise to be looking into these questions a year before you retire. We can help you with all of these questions, if you wish.

Do you have a question concerning wealth management or trusts? Send your inquiry to

(February 2016)
© 2016 M.A. Co. All rights reserved.

Think hard before tapping your 401(k) balance

One of the features that make 401(k) plans so attractive is that your money is not completely out of reach should an emergency need arise. Most plans allow for loans that are completely tax free if repaid as agreed. (Interest payments will be required, but they will be credited to the account.)  In a major emergency, a hardship withdrawal may be permitted, subject to income tax and, usually, a 10% penalty as well.


At first glance 401(k) loans may look particularly appealing. After all, you make those payments of principal and interest to yourself. However, if the interest that you pay is less than your borrowed dollars would have earned in the plan, you will slow the growth of your retirement nest egg. Moreover, you pay with after-tax dollars—replacing your original tax-deferred contributions.

Loans must be repaid in no more that five years. (Fifteen-year terms are allowed for loans to purchase a home.) If you leave your job before a loan is repaid, you’ll have to pay it off, or the open balance will be considered a premature withdrawal subject to income tax and penalty.

Potentially more serious yet, the burden of loan payments may make it impossible to continue your 401(k) contributions.


It’s not easy to make a hardship withdrawal from your 401(k) account. You must show an “immediate and heavy financial need” for: medical expenses not covered by insurance; the purchase of a principal residence; postsecondary tuition; or to avoid eviction from or foreclosure on a principal residence. Many plans also include funeral and child support expenses. You also must show that you have no other resources reasonably available to meet these costs. This means that you first must fail to qualify for a plan loan. Once you take a hardship withdrawal, you will be barred from contributing to your plan for at least 12 months.

Pay now or pay later

To examine the effect of these options, let us compare the long-term results for Nancy Needful, a hypothetical 35-year old worker with a $30,000 balance in her 401(k) plan. Nancy contributes $150 monthly to her account. Faced with a sudden emergency need for $10,000, Nancy has three options.

Nancy can:

  • Take a loan of $10,000 from her plan at an 8% interest rate and cease making contributions until the loan is repaid in five years, making monthly payments of $202.76, and resuming her $150 contribution after five years.
  • Make a hardship withdrawal of $12,500 to provide the cash that she needs and cover her income tax and penalty, resuming her participation in the plan after one year.
  • Obtain a $10,000 advance on an inheritance, continuing her participation in the plan.

Here’s how those choices will play out:

The long-range cost of raising $10,000

Reduced plan accumulations

At age 55 At age 60 At age 65
Loan $199,384 $310,352 $470,186
Withdrawal $166,609 $259,317 $397,437
Advance $236,007 $362,709 $551,476

Source: The Merrill Anderson Company. Assumes a steady 8% return on investment, does not represent any particular investment.

As we see, by taking the advance on her inheritance and continuing plan contributions, earning a moderate 8% return (high today, but average in the long term) on her investments, Nancy ends up at age 65 with 17.4% more than if she had taken the loan and fully 38.8% more than with the withdrawal.

The lesson: tapping into your retirement plan assets should be your very last resort.

(January 2016)

© 2016 M.A. Co. All rights reserved.