Planning Fundamentals for Illiquid Assets

By: Martin M. Shenkman, CPA, MBA, PFS, JD

 

1.      Synopsis.

a.       Planning for illiquid assets presents unique and difficult problems for clients, estates, and even the assets/business involved. Practitioners advising clients with substantial liquid assets need to identify the unique problems and provide guidance and solutions to deal with them.

b.      This handout will review a broad range of issues and planning opportunities affecting illiquid assets including both pre- and post death planning. Addressing liquidity issues in buy sell agreements, governing documents, insurance planning in a creative and proactive manner can minimize the difficulties the client’s estate will later face. Post-death planning includes addressing complex valuation issues, taking advantage of tax opportunities to defer estate tax payments, and in some cases reduce them. Fiduciaries will often have to take special steps to protect the trusts and estates they are responsible for as well as to protect themselves from beneficiary challenges. These include properly interpreting will and statutory provisions affecting illiquid assets such as the Prudent Investor Act, tax allocations, etc.

2.      Introduction to planning for illiquid assets

a.       Real estate.

                                                                                       i.      Factors affecting liquidity.

1.      Ownership entity/governing document terms.

2.      Type of property.

3.      Cash flow if any.

4.      Governing documents impact on cash flow certainty.

5.      Ability to sell.

6.      and so on.

b.      Art, jewelry and collectibles.

                                                                                       i.      Distributed in kind versus sale.

                                                                                     ii.      Time period and costs to effectuate appraisals, insurance, transport, sale, etc.

c.       Business interests.

                                                                                       i.      Buy sell agreement terms and funding.

                                                                                     ii.      Transfer in kind to heirs/trusts or liquidate.

                                                                                    iii.      Governing instrument.

d.      Professional practices (including solo practitioners).

                                                                                       i.      Short half-life if not marketed and transitioned quickly.

                                                                                     ii.      Buy out or succession plan if any.

e.       Concentrated stock positions.

3.      Implications of illiquidity

a.       Heirs.

                                                                                       i.      Heirs living expenses.

                                                                                     ii.      Expectations of heirs.

b.      Property, casualty and other insurance issues.

                                                                                       i.      Named insured should be updated to reflect personal representative and trusts.

                                                                                     ii.      How long will insurance company cover vacant property.

c.       Operations of a business.

                                                                                       i.      Succession plan.

                                                                                     ii.      Who will perform. Example, the accountant as executor of the estate of a real estate developer or physician with no succession plan in place.

d.      Payment of estate taxes.

                                                                                       i.      Cash impact.

                                                                                     ii.      See below.

e.       Other.

4.      Cash flow sources to address illiquidity

a.       Loans.

                                                                                       i.      Third party loans.

1.      Viability and cost.

                                                                                     ii.      Related party loans generally.

1.      Respect for tax purposes.

2.      How set collateral and interest rates.

3.      Opposing family members and/or heirs.

                                                                                    iii.      Revolving loan from heir or family entity.

1.      See sample loan document.

b.      Business/real estate ongoing operations.

                                                                                       i.      Impact of death of principal.

c.       Key person insurance.

                                                                                       i.      Adequacy.

                                                                                     ii.      Impact of governing documents, e.g. buy sell agreements.

d.      Insurance outside the business (e.g., ILIT).

                                                                                       i.      Is it available to infuse liquidity to the estate.

                                                                                     ii.      Other constraints.

                                                                                    iii.      Different fiduciaries.

e.       Sale of assets.

                                                                                       i.      Can assets be sold.

                                                                                     ii.      Price at which sale can be realized. Perception of many buyers that estates often must sell at distressed prices.

                                                                                    iii.      Time period and costs to sell.

                                                                                   iv.      Impact of probate issues.

5.      Succession Planning for Illiquid assets

a.       Buy sell agreements.

                                                                                       i.      Lauder. Estate of Joseph H. Lauder, T.C. Memo 1992-736.

1.      Estate sold stock for $4,000/share. IRS claimed value was $13,000/share. The estate used a formula valuation/price. The IRS claimed the value was not reasonable, and that there was no justification for it since no arm’s length bargain for using a book value formula. The IRS stated it was a significant undervaluation. The IRS argued that the value was much greater at the signing and that the advisers never tried to ascertain the FMV of the stock. There was no professional analysis. Then the IRS maintained that the difference was a gift from the estate to the shareholders. Taxpayer’s counsel argued that if there was a gift, that it would qualify for the marital deduction to the extent it inured to the surviving spouse.

2.      The children sold some shares to pay estate tax. Why did a 95 year old woman die with so many assets? She really didn’t it was an $8 billion business so most of the estate value was previously transferred. They only paid tax of $550 million.

3.      Lessons from the Lauder case include:

a.       Importance of a qualified full time professional appraisal.

b.      Incorporate appraiser’s methodology into the documentation.

c.       Enforce the terms of the agreement pre-death. The more times the formula has been used prior to death the more credible that approach will be at death.

d.      Arm’s length bargaining, with different counsel, is important. Document/corroborate that different “sides” (e.g., parents versus children, kids in the business versus those not in the business), etc. You want the appearance and reality of arm’s length bargaining.

e.       It is essential to show a professional attempt to find FMV. In Lauder they taxpayer’s did not use a modicum of effort to do this.

                                                                                     ii.      Estate of Marlin Rudolph v. U.S., U.S. D.C. So. Dis. Indiana, No. 91-151-C, February 5, 1993.

1.      Facts. The brothers were in the asphalt and concrete business. Timing is critical to the ultimate determination of this case. When the buy sell was drafted the attorney documented the purposes of it. These included: Continuity – keep the business in the family; Income for decedent/shareholder’s surviving spouse; separate spouse from the business at the time of the death from the shareholder; and finally the goal of obtaining bid-bonds. If you want to bid on a governmental project you need bonds to prove you can complete the project. You need to show corporate responsibility. The taxpayers used the corporate buy sell agreement to help corroborate their responsibility and ability to complete a job they started. The agreement was included in the packages for the bid-bond applications. This was an important independent use of the appraisal that affected the final determination of this case.

2.      Discounts. Lack of marketability. Tough times. This case occurred during the oil crisis in the 1980s. Why would asphalt be in tough shape? Because asphalt is made from oil products and supplies were difficult to obtain. A discount for “additional competition” was taken. How can you prove to the IRS that there is new, additional or different competition? Take the yellow pages and look by year. Evaluate the map of the area code.

3.      The estate won the valuation argument because it did not discuss tax savings when the buy sell price was set. The only documented discussions were economic related. The price was set before discovery.  Both parties had cancer and the price was negotiated. There was no imminent danger to the business because they each were able to have life insurance. The shareholders were healthy when the buy out price was set. This demonstrated that it was not intended as an estate tax valuation ploy. The predicted sales slump in their valuation analysis actually occurred (hindsight).

4.      Note that the life insurance payable to the corporation was factored into the sales price under the buy sell agreement. No matter how this is done, it  must be addressed.

5.      It was not certain whether the formula used self-adjusted for changes in economic conditions but it appears that it may have.

6.      Lessons from the case:  The facts governing discounts may apply during the current economic turmoil. Discount arguments may apply today. Be careful to periodically update all buy sell valuations and agreements.

7.      The following factors helped support the taxpayer victory in this case: The agreement was binding during life or death. It was not testamentary in nature. Comparable terms and conditions. This is the tough part of many buy sell agreements. How do you find a comparable paving company? The IRS and courts will always look at comparability. IRS is aware that a few accounting tricks here or there can manipulate result. You therefore want advisers who have worked with similar companies. The court measured reasonableness of the formula used. The date of signing is the date that is important. Practitioners need to do a better job documenting the facts at the date of the signing. How was the state of the corporation, the economy and the industry at the date of signing?

8.      Other lessons to glean from this case include: There were two deaths within a short time. Consider simultaneous deaths. Give buy sells the importance and urgency of wills. They should be kept current and revisited frequently. “Very few” buy sells address multiple events. Time is of the essence in funding buy sell agreements.

                                                                                    iii.      PLR 9315005.

1.      Facts: Father and brother-in-law owned business 50/50. Father, son and brother-in-law entered into a buy sell agreement.  If brother-in-law died son was required to buy as much as possible with proceeds of life insurance he purchased on the life of the brother in law. If the proceeds were insufficient then son had an option to buy the rest of the stock, but if he did not the corporation had to buy it. Brother-in-law committed suicide during the contestable period for the insurance. So no funds (other than return of premium) so son purchased only three shares of stock. The estate lowered the price after the initial purchase and the corporation purchased the shares at a bargain price, and son purchased the balance of the shares.

2.      IRS said by not exercising the corporation’s right to redeem the father indirectly, because he controlled the corporation, made a taxable gift to the son. In other words because father did not exercise option there was a gift.

3.      Lessons to learn from this PLR. Be wary of unexercised options. Inaction (i.e., not exercising options) can create a gift. Never draft a buy sell to base the obligation to buy on the amount of life insurance someone owns because that insurance may not be there (e.g., failure to pay premiums, suicide, false application etc.). There a many reasons the insurance might fail. The buy sell agreement should provide a safety valve to pay over time in case the amount of life insurance is insufficient (e.g., installment provision).

                                                                                   iv.      Estate of Gordon B. McLendon v. Comm’r, T.C. Memo. 1993-459, Sept. 30, 1993.

1.      This case involved a “big” name in radio broadcasting who started to purchase radio stations. Then he purchased chain of radio stations, then television stations. Many medical problems developed. Cancer in 1985. This was followed by an apparent suicide attempt at the end if 1985, etc.

2.      Buy sell provided that son is manager of the FLPs on his death or disability. The taxpayer set up private annuity to purchase business interests. The children were to buy his FLP interests for $250,000 plus income for life for their interest in the business.

3.      Background on Private annuities. Nothing is included in the parent/seller’s estate since there is no transmission of wealth on death because the private annuity payment ends on death. The use of the private annuity technique in the correct circumstances is an effective tool. You use to be able to spread out gain over lifetime but cannot do this any longer. So now sales are structured to grantor trusts. However, if you have an asset with a high basis (e.g. assets inherited from deceased first spouse) you can do a private annuity. If party is ill but not in imminent danger of dying you can use IRS tables and in effect turn the tables against the IRS. There is a rebuttable presumption if you survive for 18 months after you sign the agreement that you would have not had a fifty percent or greater likelihood of dying within a year.

4.      Obtain a physician letter stating likelihood of surviving two years (not 18 months). Another clever approach is to apply for life insurance. If you get approved it will demonstrate survivability beyond one year period. There are also life expectancy reporting companies you can hire to perform an analysis. If two year survival is likely but client is in poor health private annuities make sense.

5.      In this case Mr. McClendon was “circling the drain.”  Therefore, the IRS argued that the difference between what was paid and what should have been paid was a gift. Gift within one year was likely. Court held Mr. McClendon’s actual life expectancy, not the 7520 tables, had to be used since there was a 50% or greater probability that he would die within one year.

6.      A savings clauses may be void as against public policy. Some practitioners puts these in his private annuities anyhow, others avoid them intentionally in this context.

7.      Lessons from this case include: Death bed private annuities are problematic. See Rev. Rul. 96-3 and 96-12.  Poor health, but likely to live more than 2 years is viable. McClendon wanted to have his cake and eat it too. Economic control and benefit of assets inside FLP increased in value. He could have removed it from his estate but he retained controls over it causing estate tax inclusion. You cannot base annuity payments solely on the income of the property transferred or the IRS will argue that this was a retained income interest.

                                                                                     v.      PLR 9349002.

1.      If the corporation owns an insurance policy and you give the insured the right to buy the policy back, if the insured retains the option to buy the policy back, this is an incident of ownership over as policy on the insured’s own life.

2.      The woman who ran the corporation had an inactive right to buy back the policy on her own life. Provisions in the buy sell agreement provided that if certain things happened she would have the right to buy the policy back. At the time of her death these conditions were not met, so the right was inactive. Still, the IRS attempted to include the policy in her estate in its entirety.

3.      Lesson. Any meaningful chance of insured buying policy back could trigger an IRS attack.

                                                                                   vi.      PLR 9347016.

1.      The corporation in this Ruling owned a life insurance policy on all three of its shareholders. They wanted to implement a cross purchase buy sell. The sons paid their father the amount equal to policies cash value. Policy on dad’s life was the transferred to the sons as co-owners. There was a co-ownership is a problem. If two sons are co-owners of policy and may become co-owners with a divorced spouse, or co-owners with children. This is a complicated and unwieldy situation. You probably never want co-ownership of a life insurance contract.

2.      Using the cash value of the policy as the measurement of the value of property was not adequate. Difference between cash value and real value of the policies is a gift. The real value of life insurance policy is a very difficult question today in light of secondary markets, etc. Certainly the minimum value is likely to be argued to be the interpolated terminal reserve plus unearned premium. Eventually the IRS will look at life settlement values for policies since there is a market for life insurance. Thus, the value of many life insurance policies will be found to be greater than the interpolated terminal reserve plus unamortized premium. At this point the IRS has not taken this position. It may.

3.      The transfer for value rules were not triggered only because of a safe harbor. If partners, even if not transferred inside the partnership, so long as transferred to a partner or the partnership the safe harbor applies. However, don’t assume that you can form a partnership for no reason other than to avoid the transfer for value rules as its only purpose and win. If the partnership has no valid business purpose the anti-abuse regulations will cause the disregard of the partnership for this purpose. What if the parties each purchase an interest in a public partnership (e.g., co-shareholders purchase interests in public limited partnership)? This sounds like an IRC Section 101 safe-harbor, but it is not the intent of the law and the conclusion is not certain.

                                                                                  vii.      Estate of George C. Blount.

1.      This case involved IRC Section 2703. October 8, 1990 is a key date for buy sell agreements. From this date onward, if a buy sell does not meet the requirements of Chapter 14, the IRS will disregard the terms and conditions that depress the value if 2703 applies (i.e., is violated). These restrictions will be ignored and IRS and courts will then be free to determine a value even if the parties are bound by the terms of the now disregarded (for tax purposes) buy sell agreement.

2.      Facts: Buy sell required about $7.6 million but did not have the cash to affect this purchase. The taxpayer drew up his own buy sell agreement that was a page long. He considered the amount of cash and life insurance and changed the price to $4 million. He did not add lifetime restrictions because he did not anticipate living that long. One of the shareholders’ was an ESOP and taxpayer did not even discuss with them his unilateral change. The taxpayer argued that the proceeds of the life insurance should be offset for valuation purposes by the obligation to pay for the shares. In Blount, the $4 million obligation to pay the decedent/shareholder’s estate should offset the $3 million life insurance. Lower court said that the $3 million of life insurance is a non-operating asset so that the company value was the $4 million value plus a dollar for dollar increase for the life insurance of $3 million.

3.      Here are the approximate numbers: $6,750,000 +3,146,134 = 9,896,134. Problem. The stock is according to the above calculation worth about $10 million. The estate tax was about $5 million at a 50% tax rate, on the estate’s interest in the stock. However, the estate was only paid about $4 million. The tax exceeded amount received by the estate!

4.      The agreement must be comparable in terms of price so value was $6.7 million. 11th circuit reversed and said you don’t have to add the insurance proceeds. Is the 11th circuit right?

5.      Court held that: Decedent’s unilateral ability to change the agreement alone invoked the IRC 2703 provisions. The taxpayer modified a pre 1990 grandfathered agreement by substantially modifying it, so IRC Section 2703 rules now apply. What is a substantial modification? When you change value, quality or timing of rights. Taxpayer in Blount changed all of these. The buy sell agreement in Blount was not comparable to other agreements.

6.      Lessons to learn from Blount: IRC Sec. 2703 applies to buy sells, options, to almost anything you put in writing to depress the purchase price if changed after October 1990. The agreement must be reasonable with a determinable price at the time it is signed.  The estate must be bound to sell under the buy sell agreement. The buy sell arrangement cannot be a device to transfer the stock at a depressed price. It cannot be a testamentary device to transfer wealth from parent to child, etc. It cannot be a substitute for a will. The buy sell pricing must represent a bona fide arm’s length business agreement. A lifetime price cannot be higher than the death-time price.

7.      Remember that a higher level of scrutiny applies to all of these points if the parties to the buy sell are related. There must be a bona fide business agreement at arm’s length but closer scrutiny is assured with related parties. The terms of the agreement must be comparable to similar businesses. Can you demonstrate that non-related parties would have entered into a similar agreement? It cannot be a d device to transfer the interests at a reduced value.

8.      Problem or warning signs include: The client is old or in poor health; there were no negotiations of terms with independent lawyers; the provisions of buy sell agreement were not consistently enforced, e.g., different results during lifetime than at death-time; the client won’t obtain professional advice from a full time professional appraiser in setting a valuation formula. If significant assets, such as life insurance, are excluded from the formula, the buy sell is less credible. If there is no periodic review of the terms of the agreement, the terms will be suspect. (e.g., 8-10 years go buy since buy sell last updated or reviewed). If the transfers were really based on family relationships instead of business relationships the agreement will be more suspect.

b.      Charitable bail out.

                                                                                       i.      Gift to CRT so gain is partially sheltered and contribution deduction received pre-death.

                                                                                     ii.      Issue 2511(c).

c.       Insurance arrangements.

                                                                                       i.      Life insurance generally.

                                                                                     ii.      Buy sell.

                                                                                    iii.      Key person.

6.      Estate Tax Considerations of illiquid assets

a.        Carry over basis considerations.

                                                                                       i.      Wills should also have express language authorizing the executor to allocate the $1.3 million general basis adjustment and the additional $3 million spousal basis adjustment. This power perhaps should be exercised by an independent person, not a beneficiary who would benefit. This is far from a simple matter to address as the possibilities are endless.

                                                                                      ii.      What is the expected holding period for the property? If property, such as a family cottage, is intended to remain for generations in the family it is less in need of an allocation to increase basis than are other assets which are more likely to be sold.

                                                                                    iii.      Are other avenues to avoid, defer or minimize the potential future capital gains tax available and how does their availability compare to other assets in the estate if the maximum basis adjustment has to be rationed to the various assets?

                                                                                    iv.      CRT Example: I the estate holds raw land that is likely to be donated to the local church for an expansion project the basis adjustment is less important as compared to other assets if a charitable remainder trust could be used.

                                                                                     v.      1031 Exchange Example: If the estate owns a shopping center and rather than sell it a tax deferred Code Section 1031 exchange is a likely possibility, then the allocation of basis to the shopping center may be less advantageous than an allocation to other assets.

                                                                                    vi.      Principal Residence: If the decedent’s principal residence can be sold and exclude gain under the home sale exclusion rules then to the extent that that exclusion will avoid taxable gain, basis adjustment should not favor the residence.

                                                                                  vii.      What will the capital gains tax rates be?

                                                                                 viii.      What will the tax bracket and status of the beneficiaries receiving the property be?

                                                                                   ix.      The myriad of factors and competing interests of different beneficiaries will also make it difficult for advisers to evaluate and weigh the many options. How will counsel to the executor advise on the allocations? If there are no directives in the will (and how should those be drafted?) as to how the basis adjustment should be allocated, what framework can be used to make a determination? Clients might consider carving out specific assets that should or should not receive an allocation. This might include a direction not to favor a family business in the basis adjustment allocation because the testator’s intent is that it not be sold.

b.      Will clause for carryover basis.

                                                                                       i.      If at the time of my death the tax laws provide for a basis adjustment, similar to that provided under Code Section 1022, then I give my Executor the authority to allocate such basis adjustment to assets over which my Executor has authority under applicable tax laws to make such allocation, wherever such property is located, to and among such assets as my Executor may direct and appoint by a written instrument delivered to each beneficiary or heir with respect to the specific article or articles to which an allocation is or is not made.  The provision of such a written instrument to any beneficiary, heir or other appointee if adult, or if a minor of his or her parent or the person with whom he or she resides, shall be a full and sufficient discharge to the Executor from all liabilities with respect to the allocations so made. I request, but do not direct, that the Executor consider the following factors in making such an allocation:

1.        Possible future income tax rates.

2.        Anticipated holding periods for assets.

3.        Tax incentives that could minimize or defer the income tax consequences on selling assets.

4.        My intent that a particular asset be held for a short or long time period.

5.        Any wishes as I may have expressed to such Executor.

c.       6161 Extension of time to pay estate tax for reasonable cause.

                                                                                       i.      The Secretary can extend the time for payment of the amount of the tax shown or required to be shown, on any return or declaration required under authority of this title (or any installment thereof), for a reasonable period not to exceed 12 months for an estate tax, from the date fixed for payment of the estate tax.

                                                                                     ii.      The regulations provide reasonable cause with respect to the estate will support an extension of time beyond the due date to pay any part of the tax shown on the estate tax return for a reasonable period of time, not to exceed 12 months if approved by the district director or the director of a service center, at the request of the executor, if an examination of all the facts and circumstances discloses that such request is based upon reasonable cause. Treas. Reg. Sec. 1.6161-1(a)

d.      Estate tax deferral 6166.

                                                                                       i.      Estate taxes have long been a major bane of the family business. On death, heirs must obtain sufficient cash to pay the estate tax within nine months of death. This financial pressure can ruin a family business. The tax code has long provided some flexibility to the closely held business through the mechanism of deferring estate tax payments. Although, the federal estate tax is due nine months from the date of your death, if certain requirements are met, the estate tax attributable to interest in closely held business can be paid in 2-10 installments and can be deferred for up to four years after the date the tax is due. This is a 14 year deferral.  In order to qualify for the deferral numerous requirements have to be met. IRC §6166(a)(1).

e.       Graegin loans.

                                                                                       i.      See sample form attached.

                                                                                      ii.      Proposed Regulation Section 20.2053-1 states as follows:

  (a) General rule. In determining the taxable estate of a decedent who was a citizen or resident of the United States at death, there are allowed as deductions under section 2053(a) and (b) amounts falling within the following two categories(subject to the limitations contained in this section and ….20.2053-2 through 20.2053-10):

(1)First category. Amounts which are payable out of property subject to claims and which are allowable by the law of the jurisdiction, whether within or without the United States, under which the estate is being administered for – …

(ii) Administration expenses;

(iii) Claims against the estate (including taxes to the extent set forth in section 20.2053-6.

(iv) Unpaid mortgages or, or any indebtedness in respect of, property, the value of the decedent’s interest in which is included in the value of the gross estate undiminished by the mortgage or indebtedness.  …

5. Provisions applicable to both categories

 (1) In general.  ….In order to properly take into account events occurring after the date of a decedent’s death when determining the amount deductible against a decedent’s estate, the deduction for any item described in paragraph (a) of this section is limited to the total amount actually paid (subject to any time requirement under paragraph (a) of this section) in settlement or satisfaction of that item. (See however, Section 20.2053-1(b)(4) for a special rule for deducting certain estimated amounts.) …(underlining added to show changes added by the proposed regulations)

(4) Estimated Amounts. An item may be entered on the return for deduction though A deduction will be allowed for a claim that satisfies all applicable requirements even though its exact amount is not then known, provided it that the amount is ascertainable with reasonable certainty, and will be paid. No  Under this exception to the rule set forth in paragraph (b)(1) of this section, no deduction may be taken upon the basis of a vague or uncertain estimate. … To the extent that the amount of a liability was otherwise deductible under section 2053 is not ascertainable with reasonable certainty at the time of final audit  the examination of the return by the Commissioner, or to the extent that it is not then clear that the amount will be paid, that amount will not be allowed as a deduction by the Commissioner. .. (underling and strike outs added to show changes made by the proposed regulations)

 

                                                                                    iii.      Regulation Section 20.2053-3 states as follows:

 (a) In general. The amounts deductible from a decedent’s gross estate as “administration expenses” of the first category (see paragraphs (a) and (c) of section 20.2053-1) are limited to such expenses as are actually and necessarily, incurred in the administration of the decedent’s estate, that is, in the collection of assets, payment of debts, and distribution of property to the persons entitled to it. The expenses contemplated in the law are such only as attend the settlement of an estate and the transfer of the property to individual beneficiaries or to a trustee, whether the trustee is the executor some other person.  Expenditures not essential to the proper settlement of the estate, but incurred for the individual benefit of the heirs,.. may not be taken as deductions.  Administration expenses include… (3) miscellaneous expenses.

(d) Miscellaneous administration expenses. (1) Miscellaneous administration expenses include such expenses as court costs, surrogate’s fees, accountants’ fees, appraisers’ fee, clerk time etc. Expenses necessarily incurred in preserving and distribution the estate are deductible, including the const of storing or maintaining property of the estate…

                                                                                   iv.      Estate of Cecil Graegin. The first case to discuss the use of a third party loan and the deduction against the estate tax of the interest on the loan was the case of Estate of Cecil Graegin, 56 TCM 387 (1988).

                                                                                     v.      The Estate of Howard Gilman, 88 TCM 627 (2004) also discussed the deductibility of the interest.

                                                                                   vi.      An estate may claim the entire amount of interest that will be paid on a seven year loan used to pay estate taxes as an administration expense under Code Section 2053(a)(2). However, the expense must be necessary to the administration of the estate. Private Letter Ruling 199903038, 1/25/1999.

f.        Other.

7.      Income tax considerations of illiquid estate assets

a.       IRC Sec. 303.

                                                                                       i.      When stock in a closely held corporation comprises a significant component of the decedent’s estate’s IRC Sec. 303 can provide a valuable tool to address liquidity issues. The mechanism is for the corporation to redeem shares of stock from the deceased shareholder’s estate. This can be done without requiring a forced sale of the business, without triggering ordinary income tax treatment that would accompany a dividend to the deceased shareholder’s estate, and it can be used to infuse cash for the estate to pay the estate taxes and other expenses. This technique has not received significant attention as a result of the shift to limited liability companies as the most common form of entity structure for closely held businesses. Nevertheless, there are millions of closely held businesses that remain organized in corporate solution and with pending tax changes there has for the first time in many years actually been talk of reconsidering the use of C corporations as the tax environment evolves. Also, under current and prior law dividends have been taxed at such a low rate this approach has not been of significant benefit. That too may change.

                                                                                     ii.      The essence of the IRC Sec. 303 technique is that the payments made to redeem a portion or all of the deceased shareholder’s stock is characterized as payments for stock taxed at what historically had been more favorable rates, rather than as dividends which historically had been taxed at higher ordinary income tax rates. Also, as a payment for stock the gain recognition is reduced by the tax basis in the stock, a benefit obviously not available if a distribution were taxed as a dividend. Here too the complexities of estate tax repeal in 2010 weak havoc to traditional planning concepts. Under pre-2010 law assets received a step-up in tax basis on death. IRC Sec. 1014(a). On death the tax basis of the decedent’s stock interest would be stepped up to the fair market value as of the date of death (or the alternate valuation date). The result would be that the only capital gains income likely triggered by application of an IRC Section 303 redemption would be post-death appreciation.

                                                                                    iii.      However, under the carry over basis regime in 2010 whether or not there is a step up in tax basis, and if there is to what extent that step up will eliminate only some or all of the pre-death appreciation will depend on whether and how much of the $1.3 million general, or $3 million spousal basis adjustments the executor allocates to the business interests involved. IRC Sec. 1022. So it is possible that in 2010 a redemption could trigger as much gain under IRC Sec. 303 as a dividend! The entire intent of the statute is undermined.

                                                                                   iv.      In some instances a IRC Sec. 303 redemption can provide a valuable one time opportunity to remove cash from a closely held business in a tax advantaged manner, even if the cash provided is not essential to meet estate expenses. 

                                                                                     v.      Will Section 303 redemption proceeds be subject to the increased Medicare taxes? If you earn a salary from an active business the Medicare tax will apply without limit. If you receive a dividend from a passive business the Medicare tax (once the threshold is passed) will apply without limit. But what about the new Medicate taxes? Starting in 2013 an additional .9% Medicare tax will be imposed on wages and self-employment income over $200,000 for singles and $250,000 for married couples. IRC Sec. 3101(b)(2). That makes the marginal tax rate 2.35% for employees. Self-employed persons will face a 3.8% rate on earnings over the above amounts. Also starting in 2013 a 3.8% Medicare tax will apply to net investment income if your adjusted gross income (AGI) is over the $200,000 (single) or  $250,000 (joint) threshold amounts. IRC Sec. 1411. More specifically, the greater of net investment income or the excess of your modified adjusted gross income (MAGI) over the threshold, will be subject to this new tax. Will Sec. 303 redemption proceeds avoid these taxes?

                                                                                   vi.      Why was this special Sec. 303 rule historically necessary? Absent the IRC Sec. 303 redemption provision the only means an estate would have to minimize the income tax consequence of a redemption would be would be the Code Section 302 provisions which are far less flexible.

                                                                                  vii.      Whatever approach is used, if an estate tax exists and has been deferred, consideration should be given to the impact of any distribution or redemption on an election under IRC Sec. 6166 to defer estate tax if one had been made. Generally, a redemption under IRC Sec. 303 should not accelerate payments under IRC Sec. 6166 estate tax deferral. IRC Sec. 6166(g)(1)(B).

                                                                                viii.      The potentially favorable rules for a redemption under IRC Sec. 303 to any class of stock: common, preferred, voting, or non-voting. Treas. Reg. 1.303-2(c)(1).

                                                                                   ix.      What requirements must be met for the IRC Sec. 303 redemption rules to apply:

1.      The stock involved must be included in the decedent’s gross estate for federal estate tax purposes. IRC Sec. 303(a). In 2010 with estate tax repealed, is this requirement possible to meet? If this hurdle is surmounted, which presumably it will be in 2011 if and when the estate tax is again law, there is some flexibility in the ownership of the stock. If the actual stock to qualify for the IRC Sec. 303 redemption is changes as a result of a post-death reorganization or similar transaction the successor stock may still qualify. Treas. Reg. 1.303-2(d). For example, the stock may be recapitalized to preserve relative voting control of different shareholders and post-recapitalization non-voting stock may be redeemed. If the stock is distributed to heirs it may still qualify. However, if the stock is sold to an heir, or received by the heir in satisfaction of a pecuniary bequest, it will not qualify for IRC Sec. 303 treatment. Treas. Reg. 1.303-2(f); Rev. Rul. 87-132.

2.      The value of the stock, of any class in the corporation, included in the decedent’s estate must generally exceed 35% of the excess of decedent’s gross estate reduced by deductions and expenses under IRC Sec. 2053 and 2054. IRC Sec. 303(b)(2)(A). Stock in different corporations can be aggregated for purposes of this test if the decedent owned at least 20% of each corporation. Stock transferred within three years of death can be counted in certain instances for purposes of meeting the 35% test.

3.      The corporate distribution in redemption of the stock which qualifies for this treatment is limited to the sum of the amount of taxes the estate pays and funeral and administrative expenses.

b.       754 basis adjustment.

                                                                                      i.      Under Carryover Basis. Partnership agreements and limited liability company operating agreements frequently include provisions governing a basis adjustment under partnership tax law section 754 of the Internal Revenue Code. If the estate tax is in fact repealed and a carry over basis in place the implementation of a Code Section 754 election may change. The basis of an LLC or partnership interest may not be the same as under prior law. The executor making the allocation of the basis adjustment under the new carry over basis regime, in contrast to prior law, might be held liable for allocating basis adjustment to a partnership or LLC if the general partner, manager, or members have to approve the adjustment. In the past, since the step up in basis was automatic, there was no issue for the executor other than pursuing the adjustment, However, under the new paradigm, since the basis adjustment is limited, if an executor allocates the limited $1.3 or $3 million basis adjustment to a partnership interest and the 754 election is not automatic, the executor might be sued by the beneficiaries for wasting the limited benefit of the basis adjustment. On the other hand, if the partnership or LLC interest is highly appreciated, and the executor does not allocate basis adjustment to this interest, the executor could be held liable for not maximizing the tax benefits.

                                                                                     ii.      General Rules. The basis of partnership property may be adjusted as the result of a transfer of an interest in the partnership by sale or exchange or on the death of a partner if the election provided by IRC §754 is in effect with respect to such partnership.  This result is the same for basis of property held in an LLC, provided the LLC is taxed as a partnership. This provision is not effective for S corporation assets.

                                                                                    iii.      If the election is in effect, the new owner of the partnership or LLC interests may obtain depreciation deductions based on the stepped up basis. IRC §754. A shareholder in an S corporation is limited to his/her pro-rata share of the S corporation's depreciation deduction.

                                                                                   iv.      The partnership agreement and the LLC operating agreements must be reviewed in order to determine whether the agreements address the 754 election.

                                                                                     v.      The election to adjust the LLC's or partnership’s tax basis is made by filing a written statement with the LLC's or partnership’s tax return, Form 1065, for the year in which the transfer occurs, e.g., for the tax year in which a member or partner, dies.

                                                                                   vi.      A valid election must:

1.      Be included in a return filed on time, including extensions.

2.      Include a statement with the following data:

3.      The name and address of the LLC or partnership

4.      The signature of one of the Members or Partners. It should, however, be signed in a manner permitted under the Operating Agreement for the LLC, e.g. by the manager or the Partnership Agreement.

5.      State that the LLC, as a partnership for federal income tax purposes, or the partnership makes an election to adjust tax basis under Code Section 743(b). Treas. Reg. §1.754-1(b)(1).

                                                                                  vii.      The adjustment, in the case of a distribution of property by the partnership will be made under IRC §734.

                                                                                viii.      The adjustment, in the case of a transfer of partnership interests, will be made under IRC §743.

                                                                                   ix.      The adjusted basis of the partnership property will be increased by the excess of the basis to the transferee partner of his interest in the partnership over his proportionate share of the adjusted basis of the partnership property. The adjusted basis of the partnership property will be decreased by the excess of the transferee partner's proportionate share of the adjusted basis of the partnership property over the basis of the interest in the partnership.

                                                                                     x.      The allocation of basis among partnership properties is made in accordance with the rules under IRC §755.

                                                                                   xi.      The following example explains the effect of a 754 election on a partner’s depreciation deduction.  Although the example discusses the sale of partnership interests, the same rules apply to the death of a partner or a member of an LLC, provided the LLC is taxed as a partnership.

1.      A new partner, Sam, pays $400,000 for a 20% interest in a partnership whose sole asset is a building which has appreciated substantially since the partnership bought it many years ago.

2.      The building is on the partnership's books at $500,000, so that Sam's share of it (the inside basis) is $100,000. The partnership is depreciating the building over 15 years on a straight line basis. Sam is only getting depreciation based on the partnership's original purchase price of the building which is much lower.

3.      Assuming the partnership sells the building for $2 million, the partnerships gain is $1.5 million and Sam’s portion of the gain, absent the election, is $300,000.

4.      If the partnership makes a Code Section 754 election, Sam can get an adjustment to prevent him from getting taxed on the $300,000 gain. Sam can get a depreciation deduction which more closely reflects his actual investment in the building (assuming the passive loss rules don't make the issue moot). The adjustment equals the difference between the $400,000 Sam paid and his $100,000 share of the partnership's basis in the building (the regulations use the selling partner's basis in his partnership interest as allocated to the building instead).

5.      Assuming the only partnership asset is the building, Sam would then depreciate this amount over 31.5 years for an additional $9,524 depreciation deduction on his personal income tax return. This would be in addition to his share of the partnership's depreciation deduction (which is included in the calculation of Sam's share of the partnership's income reported to him on Form K-1).

6.      An important factor governing Sam's depreciation deductions is how the amount he paid is allocated to the partnerships assets (personal property can be depreciated over 7 years, real property improvements over 15 years, buildings over 31.5 years and land not at all). Consider three methods: 

                                                                                  xii.      The 743(b) adjustment is allocated to the various partnership assets in the manner which has the effect of reducing the difference between the fair market value and the adjusted basis of partnership properties. IRC Sec. 755(a). This allocation is a two step process - the adjustment is allocated to one of two categories, depending on which created the adjustment: (1) capital assets and Codes Section 1231(b) property (e.g. buildings) (2) all other assets (e.g. cash, security deposits). The 743(b) adjustment is then allocated to each of the two categories in the ratio which the total net difference for each category bears to the total excess for all assets. If an asset in either category has depreciated in value but the category as a whole has appreciated, the negative adjustment will be factored into this first tier allocation (it will reduce the portion of the 743(b) adjustment allocated to the particular category). It will not affect the second tier allocations described below since no 743(b) adjustment amount is allocate to (or away from) it. This aspect of the required IRC 755 allocation method could result in different allocations then the other methods noted below.  After this first allocation is made, the allocation to specific assets in each category is then made within the category in a manner to reduce the difference between the adjusted basis and fair market value of the assets. IRC Sec. 755(a); Reg. Sec. 1.755-1(a)(1)(i).

                                                                                xiii.      Alternatively the allocation under Code Section 755 may be made in "any manner" permitted by the IRS. To use a method other than that described above a request must be filed with the IRS. There is a 30 day deadline.

1.      Code Section 1060 can require that residual method be used for allocating the purchase price paid for a business to assets when a 743(b) adjustment is made.

2.      The residual method requires the identification of all of the assets purchased. Next, the fair market value of each asset is determined, and assets are categorized into one of four allocation categories: Class I (cash, demand deposits); Class II (CDs, foreign currency, readily marketable securities); Class III (the catchall - any asset which doesn't fit into Class I, II, or IV); Class IV (intangible assets such as goodwill and going concern value).

3.      The next step is to determine the total purchase price which must be allocated to the assets acquired. The total purchase price includes the cash paid, the amount of liabilities assumed, the costs of the acquisition, and the fair market value of any property transferred to the seller (none in this case).

4.      This total purchase price is then allocated sequentially to each asset identified in using the above procedures. The purchase price is allocated to Class I assets first. No allocation can exceed the fair market value of any asset. After Class I assets have been allocated their share of the purchase price allocations are made in a similar fashion through each of the successive Classes. Again, no asset in the first three Classes can be allocated an amount greater than its fair market value. What ever is left, the residual, is allocated to goodwill.

c.       Other.

8.      Probate Considerations of illiquid assets

a.       Valuation issues.

                                                                                       i.      Discounts.

                                                                                     ii.      QTIP Valuation Whipsaw.

                                                                                    iii.      Methodologies.

                                                                                   iv.      Audit issues.

                                                                                     v.      Impact on beneficiaries.

1.      Specific bequests.

2.      Beneficiaries at odds.

b.      Distributions of property in kind.

                                                                                       i.      Costs of shipping, insurance, etc.

1.        General Provisions Governing Disposition of Personal Property.

2.        Property May Be Stored.  My Fiduciary may store any tangible personal property (other than cash) hereby given to any minor or any beneficiary under a disability (as defined in the provision "Beneficiary Under Disability") until such minor shall attain majority or until the disability ceases, and may charge the expenses of such storage to my estate so long as my estate is open, or to such minor or other beneficiary, in my Fiduciary's discretion. My Fiduciary may sell such property, for such price and upon such terms as my Fiduciary shall determine, and dispose of the net proceeds of such sale as if such net proceeds had been given to such minor or disabled beneficiary by the provisions hereof.

3.        Shipping and Related Costs.  All costs, if any, of shipping, packing and insuring any of my personal property transferred under any provision of this Will shall be paid by my estate. In addition, any insurance policy covering personal property, shall, to the extent advantageous to the administration of my estate, be transferred with the property insured. [Comment: Standard and common sounding provision. Issue – when the personal property included a bequest of the piano to the child living on the opposite cost, shipping, insurance and related costs exceeded the value of the piano. What was done? What could be done to avoid this issue?]

                                                                                     ii.      Gain or loss on distributions; DNI.

1.      Generally, when an estate distributes property to a beneficiary, gain or loss normally is not recognized at the fiduciary level unless the distribution is in satisfaction of a pecuniary bequest (a fixed dollar amount).

2.      When property is distributed in kind from an estate, determine whether the estate’s distributable net income (“DNI”) will be carried out to the beneficiary.

3.      Special rules apply during the time period when carryover basis rules apply instead of the estate tax.

4.      Distributions of property by the estate to beneficiaries will generally generate a deduction to the estate equal to DNI. This same amount will generally be taxable to the beneficiaries to the extent of the estate’s DNI for the year. IRC Sec. 661(a)(2); 662(a)(2).

5.      IRC Sec. 661 provides a deduction for estates and trusts that accumulate income, or distribute corpus. The deduction is the sum of income for such taxable year which is required to be distributed currently, and any other amounts properly paid or credited or required to be distributed for the taxable year.  The amount of the deduction cannot exceed the distributable net income of the estate or trust. The income is treated as if it consists of the same proportion of each class of items entering into the computation of distributable net income of the estate or trust as the total of each class bears to the total distributable net income of the estate or trust. If, however, there is an allocation to different classes of income under the specific terms of the governing instrument, such as the will, then that allocation will control.

6.      An election can be made to recognize gain. IRC Sec. 643(e)(3). Gain or loss shall be recognized by the estate or trust in the same manner as if such property had been sold to the distributee at its fair market value, and the amount taken into account under sections 661(a)(2) and 662(a)(2) shall be the fair market value of such property. An election under this provision applies to all distributions made by the estate or trusts during a taxable year, and shall be made on the return of such estate or trust for such taxable year.  Any such election, once made, may be revoked only with the consent of the Secretary.

                                                                                    iii.      Basis of property distributed in kind.

1.      Consider carryover basis rules.

2.      The tax basis to a beneficiary in property distributed in kind from an estate is generally the adjusted basis of the property in the hands of the estate or trust immediately before the distribution, adjusted for  any gain or loss recognized to the estate or trust on the distribution. IRC Sec. 643(e).

                                                                                   iv.      Receipts and releases.

1.      Acknowledge valuation decisions.

2.      Consider provision of appraisals.

c.       Prudent Investor Act.

                                                                                       i.      Can the personal representative continue to hold the illiquid asset or is diversification required.

1.      State law.

2.      Governing instrument.

3.      Factors to consider.

                                                                                     ii.      For a dynasty trust Prudent Investor Act standards are likely to be inappropriate unless a marketable securities sub-trust is established. Most dynasty trusts own interest in a single LLC or FLP, or family business interests, or an IDIT note sale transaction, and should not be constrained by diversification requirements. The investment goals should generally be growth for a very long term time horizon. While some investment standards could be specified a preferable alternative may be to leave all investment decisions to the complete discretion of the trustee in order to assure the maximum flexibility to address future uncertainties.

9.      Drafting considerations to mitigate issues created by illiquid assets

a.       Tax allocation clause.

                                                                                       i.      Illiquid asset beneficiaries may not have cash/liquidity to bear tax burden.

b.      Specific bequests.

                                                                                       i.      If testator made a specific bequest of the property there is no need for liquidity.

                                                                                     ii.      Insurance, taxes, carrying charges, however, still must be funded.

c.       Direction to retain house for minor children.

                                                                                       i.      Residence Bequest for Minor children. Real Property Distribution. [Comment: A divorced parent wished to name the older children as guardians and to assure that the family home would be available as a home for the minor children. While somewhat unusual the provision illustrates how many different drafting issues, such as guardianship, life estate, personal tangible property, etc. can be integrated and coordinated to endeavor to accomplish a specific personal goal. Focus on the ancillary issues that are raised and dealt with in an attempt to make the provision workable. What issues exist that were not raised? What other approaches might you have recommended to the client?]

1.        I currently own a residence located at 123 Big Avenue, City, State. At the time of the execution of this Will, my parents are currently residing in such residence. For purposes of this Will, the term "Residence" shall refer to either this residence or, any other residence in the Area-Name metropolitan area which is considered my primary residence at the time of my death. I recognize that there is potential for confusion if I own more than one residence on my death, but I to not believe this to be a practical issue and have not endeavored to address risk in my Will. [Comment: Review last sentence. When a decision is made that could be problematic, confirming the client was aware of the issue can protect the attorney and avoid incurring considerable costs dealing with a possibility the client deems remote.]

2.        If, following my death, any Younger Child [Definition provided elsewhere in Will this clause was extracted from.] has not reached majority and if either of my Older Children shall be the Guardian of any Younger Child, then the following shall apply:

a.        The Residence shall be added to the Client-Name Family Trust, established hereunder, to be administered as a part thereof.  In administering the portion of the Trust Estate which shall consist of the Residence, the Trustee shall take the following into account:

                                                                                                                                                               i.      The Residence is intended to be for the primary benefit of any of my children who are minors and the Guardian of the minor child who is either of my Older Children. I also intend that during such time as the Guardian of the minor child is either of my Older Children (the "Guardianship Period") (i) if my Relative-Names are living in the Residence, and wish to remain in the Residence, they be able to do so, without the payment of rent or other carrying charges and (ii) any of my other children may reside and/or use the Residence as their residence.

                                                                                                                                                              ii.      Neither of my Relatives and no child of mine or trust established for the benefit of any child of mine, or the guardian of such child, shall be required to pay any rent or other compensation for the use of the Residence. 

                                                                                                                                                            iii.      My intent in this provision is to allow my children to remain in the house so long as there is a minor child and the guardian of the minor child is another child of mine. [Explanations of an intent or objective that is not obvious, if done carefully to avoid interpretive issues, can be helpful if there is a later challenge or action concerning the provision. It can also put a “face” on the provision to facilitate it accomplishing its personal objectives].

b.       I request, but do not direct, that the Residence be sold upon the following conditions:

                                                                                                                                                               i.      If any of my Younger Children are under age of majority and the Guardians of all Younger Children who are Older Children advise the Trustee that such Guardians no longer wish to reside in the Residence.

                                                                                                                                                              ii.      Upon the youngest of my then living minor children reaching majority.

                                                                                                                                                            iii.      Upon the determination by the Trustee that the Residence be sold, if either of my parents are then living and are using the Residence as his or her primary residence, the Trustee shall allow my Relatives a reasonable period of time to relocate to a new residence. I suggest, but do not direct that the reasonable period of time shall be Nine (9) months.

                                                                                                                                                            iv.      Upon the sale of the Residence, the net proceeds of the sale shall be held as a part of the Trust Estate.

c.        If, following my death, all of my Younger Children have reached majority or if neither of my Older Children are Guardians of any Younger Child, then I specifically request that, if at the time of my death, one or both of my Relatives who survive me are living in the Residence, my surviving Relatives be permitted the limited right to reside in the Residence and the use of the any furniture, furnishings and household effects, appurtenant thereto, (and any insurance policies related thereto, if any), for a reasonable the period of time following my death, so as to allow them sufficient time to relocate.  I suggest, but do not require that such reasonable period of time be Nine (9) months after the date of my death. 

d.       During such period of time as my Relatives choose to remain in the Residence my parents shall not be responsible to pay rent or furnish bond or other security therefore, furthermore, they shall not be responsible for all real property and similar taxes, assessments, carrying charges (including fire and extended coverage insurance premiums for the full insurable value thereof), and normal costs of maintenance and repair in respect thereto. Temporary, even long term absences, including but not limited to a temporary hospital or nursing home stay shall not affect their status as living in the Residence as provided herein. [Note the integration of life estate type provisions into this clause.]

d.      Investment language.

                                                                                       i.      The Trust Estate may consist of securities of a single integrated business, related or unrelated businesses in the same or different industries, one issuer, or securities or other equity interests of a few issuers, or a diversified portfolio of various types and issuers of securities.  The Fiduciary is not directed to distribute or dispose of any particular securities or other assets which may come into the Fiduciary's possession, where such distribution or disposition is primarily for the purpose of diversification of investment holdings of the Trust Estate.  The Fiduciary is not required to liquidate or adjust holdings solely because such holdings have a limited market.  The Fiduciary is not obligated to diversify the investment holdings of the Trust Estate and is hereby indemnified and held harmless from any such failure to diversify.

                                                                                      ii.      In addition to the investment powers conferred on the Trustee under this Trust, the Fiduciary is authorized (but is not directed) to acquire and retain investments not regarded as traditional or prudent for trusts, allocate of investments within the Trust's portfolio which would not be deemed prudent or advisable, including but not limited to investments and/or investment strategies that would be forbidden by the prudent investor standard applicable at such time.  The Fiduciary may therefore invest, any portion or even all of the Trust Estate in any manner in the Fiduciary's discretion, including in any type of security, option, improved or unimproved real property, tangible or intangible property, direct or indirect interests, joint ventures, limited liability companies, general partnerships, limited partnerships, mutual funds, corporations, foreign or domestic investments, closely held business investments, and so forth.

                                                                                    iii.      In formulating any investment policy or making any decision with respect to any assets relating to any closely held or family business and investment interests, it is Grantor's direction and intent that such interests may be held in the reasonable judgment of the Fiduciary. Grantor specifically indemnifies the Fiduciary for retaining any or all of such interests.

e.       Right of first refusal to permit heir to purchase property.

                                                                                       i.      Right of First Refusal on Family Home, Farm or other Asset. Right of First Refusal for Specific Personal Residence. 

                                                                                      ii.      If, at the time of my death, I own any interest in the real property located at 2 Street-Name Avenue, City-Name, State-Name Zip Code and the improvements thereon (the “Real Property”), I direct my Fiduciary to provide my son, Son-Name Last-Name (herein referred to in such capacity as “Buyer”), a right of first refusal to purchase the Real Property at its fair market value, as defined below (“Right of First Refusal”).  I recognize that Son-Name Last-Name may also be the Fiduciary and intentionally make no provisions to appoint an independent Fiduciary in this regards. [Client made a personal decision that raises conflict and other issues and opted not to address it. This clearly will be a potential issue with the other children. So it has been noted here as the client’s decision.] I do not intend the Right of First Refusal to extend to a successor or replacement property. [Comment: consider the “what ifs” and how far the planning should extend.]  I recognize that the above property might be sold or mortgaged prior to my death and I intentionally make no provision for such contingencies. [Comment: consider the “what ifs” and how far the planning should extend.] 

                                                                                    iii.      My Fiduciary shall inform Son-Name Last-Name of this Right of First Refusal, by notice, as defined below.  The notice shall be sent within Thirty (30) days of the final determination of the fair market value of the Real Property, as determined below. If Son-Name Last-Name is the Fiduciary then he shall be deemed to have received said Notice on the date of the final determination of the fair market value of the Real Property, as determined below, without any formal notice.

                                                                                    iv.      Son-Name Last-Name may exercise this Right of First Refusal by giving my Fiduciary (but if he is the Fiduciary notice shall be deemed automatically to have been given) and my other living Children (but not the other Children’s heirs, successors or assigns) notice of the intention to exercise the Right of First Refusal within Thirty (30) days of the mailing or delivery by the Fiduciary of the notice of this Right of First Refusal to Son-Name Last-Name (or the effective date of such notice if Son-Name Last-Name is also the Fiduciary).  If the statement of intent is not provided by Son-Name Last-Name within Thirty (30) days, then this Right of First Refusal shall lapse.

                                                                                     v.      The fair market value of the Real Property for purposes of this provision shall be determined as follows:

1.        My Fiduciary shall obtain a written appraisal (which must specify the assumptions upon which it is based, the credentials of the appraiser, and identify and analyze comparable properties) of the Real Property within Ninety (90) days of the appointment of my Fiduciary (the “Fiduciary Appraisal”).  The expense of the Fiduciary Appraisal shall be borne by my Estate. I have intentionally not mandated that the Fiduciary Appraisal be certified or comply with any specific tax regulations or other promulgated standards.

2.        A copy of the Fiduciary Appraisal shall be distributed by my Fiduciary by notice, as hereinafter defined, to each of my Children who survive me, within Ten (10) business days of the Fiduciary’s receipt of the Fiduciary Appraisal.

3.        If any of my Children object to the Fiduciary Appraisal, then said objectant shall give written notice to my Fiduciary within Twenty Five (25) days from the date that the Fiduciary sent the notice of the Fiduciary Appraisal. Son-Name Last-Name may only object if he is not the Fiduciary.

4.        The objectant’s notice must include a complete copy of an appraisal obtained by the objectant at the objectant’s own cost and expense (the “Challenge Appraisal”).

5.        Any Challenge Appraisal must expressly address the differences between its assumptions and conclusions and that of the Fiduciary Appraisal in reasonable detail.

6.        Any Challenge Appraisal shall be sent by the Fiduciary to each of my then living Children within Ten (10) business days of the Fiduciary’s receipt of such Challenge Appraisal. If Son-Name Last-Name shall be Fiduciary he shall be deemed to have received the Challenge Appraisal individually when he receives it in his capacity as Fiduciary.

7.        If an unanimous agreement is not reached among all parties as to the fair market value of the Real Property within Fifteen (15) days from the date of the last Challenge Appraisal being distributed by notice by my Fiduciary, then all appraisers (i.e., the appraiser who performed the Fiduciary Appraisal, and the appraisers who performed each Challenge Appraisal) shall select one of the following options.  If no selection is agreed upon within Thirty (30) days from the date of the last Challenge Appraisal being distributed by notice by my Fiduciary to then a simple average of all appraisals shall be made:

a.        Agree on an appraised value which is somewhere between the highest to lowest of the various values.

b.       Average any two or more of the Appraisals.

c.        If the difference between the highest and lowest appraisal is more than Fifty Thousand Dollars ($50,000.00) then all of the appraisers may select another independent appraiser, who must be an MAI certified appraiser (unless all parties agree to the contrary in writing), whose appraisal shall control as the final and uncontestable fair market value of the Real Property. [The objective is to resolve small differences with no further costs.]

8.        If my Fiduciary does not receive any Challenge Appraisal by the Twenty Fifth (25th) day following the date of the dispatch of the notice containing such Fiduciary Appraisal (excluding the day of dispatch), then all beneficiaries shall be bound by the Fiduciary Appraisal.

                                                                                    vi.      If all of my Children agree in writing to forgo their rights to obtain a Challenge Appraisal, my Fiduciary may rely on such written agreement and proceed as if the time period for such challenge has passed.

                                                                                  vii.      Any “notice” required hereunder shall be in writing, via certified mail, hand delivery or national overnight courier, costs of shipping or mailing pre-paid by the sender thereof, and, if such person sending the notice is not my Fiduciary, with a copy to the Fiduciary.

                                                                                 viii.      The closing of the sale of the Real Property shall be at the time and place agreed to by the Buyer and my estate, but shall in no event be more than One Hundred Twenty (120) days following the date upon which my Fiduciary received notice from the Buyer indicating that the Buyer elected to exercise this Right of First Refusal, or Thirty (30) days from the end of the above process.

                                                                                     ix.      The terms of the payment shall be as follows:

1.        Buyer shall pay Twenty Five (25%) percent of the purchase price of the Real Property at the time of the closing of the transaction.

2.        The balance of the purchase price, plus interest, shall be paid by the Buyer to my Fiduciary (or the beneficiaries of the estate, in the event the estate is terminated during such time) within Two (2) years of the closing.

3.        Notwithstanding the previous sentence, the Buyer shall have the right to prepay.

4.        The interest rate shall be the federal short term interest rate, calculated in accordance with Section 1274(d) of the Internal Revenue Code.

5.        The amounts unpaid shall be evidenced by a promissory note executed by the Buyer in favor of my estate and secured by a mortgage on said Real Property.  In consummating such purchase, the Fiduciary is directed to permit the Buyer to use any portion of such Buyer’s bequest under this Will to pay for the Real Property.

6.        [The above details are intended to minimize the disputes between the heirs and provide some reasonable time for the child opting to buy the property to obtain financing without undue hardship.]

                                                                                      x.      The Fiduciary shall be given reasonable latitude to interpret and apply the above provisions and resolve any inconsistencies or uncertainty in the above process.

f.        Tangible personal property.

                                                                                       i.      By Lottery to Designated Persons.

1.        I give and bequeath to such of my *LOTTERY BENEFICIARIES, as shall survive me, the balance of my *LOTTERY PROPERTY  as may be selected by each of them as provided below. 

2.        In making such selections, *FIRST BENEFICIARY shall choose first in each round. All other beneficiaries shall draw lots to determine who shall choose second and who shall choose third (in alternate rounds their positions shall reverse); and shall choose fourth in each round. Each person shall have the right to select one item per round, and this procedure shall continue until all of the property designated in this provision shall have been selected or three of the above-named persons, at the end of a round, have no interest in proceeding.  Any items not selected shall be sold by the Fiduciary and the net proceeds of sale shall be added to and form a part of my residuary estate and be dealt with and disposed of accordingly.

3.        In case of any difference of opinion with respect to the property passing under this provision, the decision of the Executor shall be final and conclusive upon all parties.

g.       Directed trusts generally.

                                                                                       i.      , the Institutional Trustee shall not have any responsibility or obligation whatsoever, other than to serve in an administrative trustee capacity under this Agreement by having custody of Trust Estate. This limitation on responsibility shall include by way of example, and not limitation, any investment decisions which are obligations of the Investment Adviser and to whom the Institutional Trustee shall have the relationship of a directed trustee. Further, by way of example and not limitation, the Institutional Trustee shall have no duty to review or monitor trust investments while the Investment Adviser is acting, or to seek advice or direction from the Investment Adviser, it being specifically intended that the Institutional Trustee be relieved and excluded from all responsibility for investment performance of the Trust Estate while the Investment Adviser is acting, and the Institutional Trustee shall have no liability for following the directions of the Investment Adviser.

h.       Directed trust bifurcated as to marketable and closely held business (or other illiquid) assets.

                                                                                       i.      Determination of Assets Classified as Readily Marketable for Purposes of Determining Investment Adviser Responsibility

1.        The Business Investment Adviser shall be responsible for formulation and implementing an investment policy for the Trust Estate comprised of closely held business and non-marketable investments in accordance with the terms of this Trustee Agreement, excluding *SPCIALBUSINESS (as defined below.

2.        The *SPECIALBUSINESS Investment Adviser shall be responsible for formulating and implementing an investment policy for the Trust Estate comprised of closely held business and nonmarketable investments in accordance with the terms of this Trust Agreement. *SPECIALBUSINESS. are defined as *#DEFINEBUSINESS.

3.        The Marketable Investment Adviser shall be responsible for formulating and implementing an investment policy for the Trust Estate comprised of marketable security investment, in accordance with the terms of this Trust Agreement.

4.       #Comment: The following provisions should be considered if separate investment advisers are named for marketable and non-marketable assets.

                                                                                     ii.      Determination of Assets Classified as Readily Marketable for purposes of Determining Investment Responsibility

1.        In the event of any conflict between the Investment Adviser for "readily marketable" securities, and the Investment Adviser for the assets of the Trust Estate which are closely held business assets or other not readily marketable assets as to whether a particular asset should be classified as "readily marketable", shall be determined in the absolute discretion of the Trust Protector.

2.        If no Trust Protector shall then be serving, then the determination shall be made by the Institutional Trustee, after Notice requesting the Institutional Trustee to assume the responsibility for such determination, and the Institutional Trustee's Acceptance in its sole discretion to assume such decision making responsibility, shall make such determination. The Institutional Trustee shall not, as a result of making such a determination, have any responsibility for the investment decisions or results concerning such particular asset made by others.

3.        The #Trust Protector shall be responsible for transferring assets between each of these segments of the Trust Estate in the Trust Protector's discretion and shall have no liability whatsoever for the consequences of such actions unless made with intentional malice or in bad faith.

i.         Situs considerations.

                                                                                       i.      Real property subject to probate and possible state estate tax.

                                                                                     ii.      Real property held by a non-resident in an entity, such as an LLC could escape state estate tax.

                                                                                    iii.      Real property in a state that does not have an estate tax that is transferred into an entity or revocable living trust might then become subject to estate tax in the state of the owner/decedent’s domicile.

j.        Insurance trusts.

                                                                                       i.      Transactions With Grantor's Estate.                 The Trustee is authorized and empowered, at any time and from time to time: (i) to purchase at fair market value from the legal representatives of the Grantor's estate any property constituting a part, or all, of the Grantor's estate, and (ii) to loan for adequate consideration to the legal representatives of the Grantor's estate such part, or all, of the Trust Estate, upon such arm's-length terms and conditions as the Trustee deem advisable.

                                                                                      ii.      Authority to Retain Specific Closely Held Business Interests.

1.        #In formulating any investment policy or making any decision with respect to any assets, and assets relating to this Trust, Grantor's family's closely held *#*DESCRIBE BUSINESSES and related business and investment interests, it is Grantor's direction and intent that such interests be held so long as it is reasonable for the purpose of providing long term financial security to Grantor's family, an opportunity for employment for Grantor's family (including Grantor's #spouse and #children, and if practicable, Grantor's #grandchildren as well).

2.        Grantor further states that as a result of Grantor's family's long involvement with such #*DESCRIBE business and investment interests, Grantor has an emotional attachment to such interests and therefore directs the Trustee to consider this in making any determination to sell, liquidate or restructure said business interests.

3.        However, Grantor does not intend this statement to be interpreted as an absolute prohibition on the Trustee from mortgaging, selling, leasing (even long term), liquidating, or restructuring any portion or all of such interests if the circumstances demand it. By way of example and not limitation, #*if the physical or geographical surroundings of any particular property (or property owned by an entity in which my estate or a Trust hereunder owns an interest) has so deteriorated, or in the judgment of the Trustee is likely to so deteriorate in the foreseeable future, that a sale or other transaction is advisable to avoid economic loss, then such transaction should not be prohibited. Further, by way of example and not limitation, if none of Grantor's #family members is able or willing, and in the reasonable judgment of the Trustee is unlikely to be able or willing in the foreseeable future, to assist in the management of, or be gainfully employed (full or part-time) by, any property or entity constituting part of such interests, then sale or another transaction should not be prohibited.

                                                                                    iii.      The Trustee may in its discretion loan funds to, make investments in, or otherwise deal with the #Family Business#, any partnership of persons which include any or all of the #Family Business or Grantor’s family members and other matters deemed reasonable or advisable in the Trustee’s discretion to advance the Objectives of the Trust set forth above.

k.      Operating agreements and other entity governing documents.

                                                                                       i.      Additional Capital Contributions.

1.        Comment: If the estate includes LLC or other entity interests that hold illiquid assets, bear in mind the impact of capital call requirements. Consider the following sample clause.

2.        In addition to the initial capital contributions, the Members may determine, by a *#unanimous *#Two-Thirds or greater majority *#vote of Membership interests, from time to time that additional capital contributions are needed to enable the Company to conduct its business and affairs.

3.        Upon a determination being made that additional mandatory capital contributions shall be made, Notice (as defined below) shall be given to all Members in writing at least Ten (10) business days prior to the date on which such additional contributions are due.

4.        Such notice shall describe in reasonable detail, the purposes and uses of such additional capital, the amounts of additional capital required, and the date by which payment of the additional capital is required. 

5.        Each Member shall be obligated to make such additional capital contribution, *#in proportion to such Member’s Percentage Interest, to the extent of any unfulfilled commitment.

6.        Any Member who has fulfilled that Member's commitment, shall have the right, but not the obligation to make the additional capital contributions needed in excess of such Member's Percentage Interest under the following conditions *#

                                                                                     ii.      Comment: Consider the reality of whether distributions are certain, likely, or unreliable. That is critical to the determination as to whether the ownership interests is illiquid.

1.        Available cash flow, after payment of all expenses and establishment of reasonable reserves, shall be distributed to the Members according to their Percentage Interests, in such amounts and at such times as a #majority #all #OTHERPERCENTAGE of  Members shall determine consistent with the Members’ fiduciary duty to the Company and the other Members of the Company.

                                                                                    iii.      Rights of first refusal have become common and may impact liquidity. #Comment: Consider the pros/cons of addressing the issue raised in Hackl V. Commr. 118 TC 14 (2002), aff'd, 335 F.3d 664 (7th Cir. 2003), of the existence of a present interest to support gifts of Membership interests qualifying for the annual gift tax exclusion. This might be achieved by adding a right of first refusal, or provision analogous to a "Crummey" demand power to the general transfer restrictions or distribution clauses. If there is no present contemplation of annual gift transfers, this issue may be better not to be addressed in the Operating Agreement as such a provision may detract from the general discounts.

1.        If a Member or a Substitute Member desires to sell his, her or its Interest (the “Offeror”) and has received a bona fide third party offer in writing (the “Offer”), the Offeror shall, within Ten (10) days of receiving such Offer, provide the Company Notice of same and the first option to purchase the Offeror’s Interest on the same terms and conditions as the Offer (the “First Option”)  by written notice (the “Offer Notice”) to the Company and each of its Members.  The Company may elect, by written notice to the Offeror and to the other Members (the “First Exercise Notice”) given within Sixty (60) days after receiving the Offer Notice (the “First Response Date”), to purchase the Offeror’s Interest.  If, on or before the First Response Date, there is a First Exercise Notice, then the Offeror shall be required to sell the Interest to the Company under the same terms and conditions contained in the Offer…