Today’s topic, there are really two. First about keeping score, then we’ll talk about a disclaimer. What I mean keeping score, I get the biggest kick out of it I’m not sure why, the kick out of it is Walgreens, McDonald’s, you keep points and you get a discount. You get $7 discount if you come back within 30 days.

Welcome to our listener supported podcast, Money Talk, uncompromised absolute financial truths behind financial perceptions with host Ed Sutkowski and Chuck LeFebvre. Let’s listen in.

Chuck: I’m Chuck.

Ed: I’m Ed. Today’s topic, there are really two. First about keeping score, then we’ll talk about a disclaimer. What I mean keeping score, I get the biggest kick out of it I’m not sure why, the kick out of it is Walgreens, McDonald’s, you keep points and you get a discount. You get $7 discount if you come back within 30 days. Then we have baseball. Remember the movie “Moneyball”?

Chuck: I remember that book, yes. There was a movie too.

Ed: Yes, but keeping score– Anyway it worked, I guess, and now everyone is doing it.

Chuck: Right. Although I don’t quite understand these point systems. I’ve never met anyone who understands these point systems that for instance you get at Walgreens or wherever, does somebody understand that other than the people running the program?

Ed: No. It’s a marketing opportunity. I’d go back anyway. It’s right in the way home, that’s why I get special deals.

Chuck: I’ll tell you what this reminds me of is that when I was in the corporate world, we had a non-qualified deferred comp plan.

Ed: Now what do you mean by that?

Chuck: It was like a retirement plan. Like a 401k or any other normal type of retirement plan except this one was non-qualified in the sense that the trust that was associated with the retirement plan was not a tax-exempt trust. When it’s qualified, it means that it’s a tax-exempt trust; and the non-qualified plan is available only for “Highly-compensated employees or key employees.” It doesn’t get the same tax treatment like the 401k or traditional pension.

Ed: Let’s make sure that I understand. A qualified arrangement, the employer gets to deduct the amounts contributed to its tax-exempt trust. The earnings are deferred and special distribution rules apply as to when the distributions are made. Now non-qualified, it may be funded with what’s called a Rabbi Trust, but there’s no current deduction and only until the amounts are distributed.

Chuck: Correct.

Ed: The non-qualified can go to your dog Jack, in other words, you’ll have to cover everyone. Okay, so getting back to the story.

Chuck: We had one of those, and then we also had this stock bonus plan or the stock option plan and this point system thing that you see from these different businesses reminds me of, we had this stock plan where it was sort of like you earned the ability to get stock options based on some schedule. Then you actually got stock options based on a different schedule, and then they vested based on a different schedule. Then you could redeem them based on a different schedule.

Ed: A lawyer’s dream.

Chuck: Well, an accountant’s dream, because I was the only lawyer working for the organization and I didn’t understand the plan at all, and nobody understood the plan at all except for this one woman in the accounting department who would sit down with us once a year and explain for each of us. Here’s how much you got in stock options. It’s supposed to provide an incentive for you.

Ed: How can you if you don’t understand it?

Chuck: That’s exactly my point, and it’s the same thing with these guys. It’s like, “Well, okay. You’ve got this little program that’s put into place here.” Unless the customer understands what that is, how does that provide an incentive for the customer to do anything?

Ed: Well, I went by my favorite coffee stop which is McDonald’s. I picked up this Mariah Carey menu. You check out each day’s featured free item in December whatever the date was this is last year. You get it a free McChicken on the 14th if you buy one regular item, that’s with a dollar purchase. I’m thinking, “How can they afford? I can come up with a dollar or something and I get a sandwich free.” What is the margin there, Chuck?

Chuck: Oh yes. Well, I had a conversation with somebody who raised chickens. It turns out within the last week or so. The conclusion that we all reached was that there’s chickens that you raise in order to lay eggs, and then there’s chickens that you raise in order to serve as chicken, and the chickens that are raised for meat are typically served, they’re slaughtered, and they’re converted to meat at a pretty young age. Then the question is, well, what happens to these hens that are laying eggs for years and years and years? I think that’s what you’re getting for free.

Chuck: That’s my guess.

Ed: Nothing is free, except air. I’m not sure we’re trying to tread water, now we have to pay for water. Anyway, the other observation is a friend of mine who is a retired accountant has a double-entry system. He tracks every dollar spent, on a double-entry system. I asked him, “Why do you do that?” He said, “Well, it’s fun.” I can see doing and I encourage everyone to do their balance sheet at the end of the month, just to get a feel for what’s going on. We have attached to the website a form of the financial statement, and you can fill it out in pencil, see where you go. You get a look at what’s going on. Aside from that, I’m not sure why we do all these things with numbers but that’s the way of the world. Well, you are a math major.

Chuck: Oh, yes. I actually can understand him saying, “Oh, it’s fun.” That makes a sick kind of sense to me, but is it an exercise that you can really justify the time you’re putting into it? The answer that is well, not unless you actually are having fun doing it. For most people, numbers are not fun. For a few of us weirdos, yes, we actually enjoy that.

Ed: Well, I’m a little weird, but not as weird as you are. On a scale of 1 to 10, you’re the weirdest. Maybe I’m a 4 or 5, but maybe a 7 and something. The point is, I think there’s a reason for this. Challenge me, the point is the world and life is so random, you’d never know whether you’re going to make it to the office or to the store. You could be gone in an instant, things could change but the numbers tend to be perfect. We can bring to the table a state of perfection in an otherwise imperfect life.

Chuck: Yes, it makes perfect sense to me.

Ed: People love to do that, have them foot, but why are you footing this column, so what? Well, I don’t know why. I think, I don’t know is I’m gaining a sense of security and I can make something foot, make some sense when the rest of the world doesn’t make any sense at all.

Chuck: It’s a little island of order in a sea of chaos.

Ed: That’s okay, I guess. I’m sorry, but I’m not committed to that.

Chuck: If you’re into that sort of thing. I don’t do this as a hobby but I can appreciate those work projects where it’s necessary to make sure you understand all the numbers and where they’re coming and where they’re going. For me, that’s a treat when the work dictates doing that, whereas most people start looking around for someone else who can do that for them if the work dictates.

Ed: That’s the gap, it seems to me that you gain a little more credibility intellectually yourself if you’re doing your financial statement every month. I’m not saying you should do your tax return depending on how complex it is but let’s assume that it’s fairly complex, but you do your financial statement every month. It’d be nice if you could do a cash receipts and disbursement schedule every month, showing, listing where your sources of cash would be, and what your expenditures are. You can see periodically or what’s going on, for example, in the month of January, you look at your prior year’s cash received and disbursements. You can predict what’s going on in the current year. Nothing wrong with that. I like to visit about a disclaimer. Again, it’s a situation where the perception is you get something, a disclaimer is not a gift. It is an opportunity to pass property to others at no transfer tax. Let’s go back a little bit about the federal transfer tax system. In 2018, $3 trillion in collections, only 23 billion or three-quarters of 1% were for the transfer tax system. The year 2017, the State’s got about three-quarters of 1% of $858 billion. The Federal exclusion amounts have been increased now to $12,000,060 or 24,120,000 per married couple, likewise, generations skipping transfer tax special valuation for purposes of reducing some farm land or business property. It can save you up to $500,000. Chuck, the estate tax system is a little different or can be a little different?

Chuck: Yes. Many states have inheritance taxes which are really deemed to be a tax on the person receiving property.

Ed: Wait a minute. We have a tax on the transfer.

Chuck: Yes.

Ed: Now you’re telling me is a tax–

Chuck: Tax on the recipient.

Ed: Right?

Chuck: The federal tax is an estate tax, meaning it is a tax on the decedent and its attacks on the transfer of property to heirs and legatees. These state inheritance, they’re typically inheritance taxes are considered to be taxes on the recipient for the receipt of property from a decedent. Those are typically depending on your relationship to the decedent, there might be different tax rates that apply and those are typically fairly low tax rates in comparison to the federal estate tax. There’s a few states that are like Illinois that have estate tax rather than an inheritance tax. The way the state estate tax works, is similar in theory to the federal estate tax is a tax on the decedent, again, typically at a lower tax rate than the federal estate tax. In the case of Illinois, it has a much lower exemption amount. You just mentioned that the federal estate tax has an exemption amount of 12 million, $60,000 per person. The Illinois estate tax has an exemption that’s less than a third of that, it’s a $4 million exemption before you start having to pay Illinois estate tax. Now, the federal estate tax is backstopped by a gift tax. In other words, you can’t get out of paying federal estate tax by giving all your property away during life, because at some point the federal government will tax those gifts as well. This is where Illinois is a little different because Illinois does not have a gift tax. Even though they have the estate tax. There’s a very complicated interaction between these two taxes for people who live in Illinois, at least, and states that have similar structure estate taxes.

Ed: Well, just to make sure that I understand, we have the gift tax, transfer taxes after you’ve earned the money you pay payroll taxes, Illinois state taxes, whatever all the income taxes paid. Now, you got the asset. Now you’ve got an investment return. You pay a tax on investment return. Now, you want to transfer it. You’ve got a lifetime transfer by way of a gift, if you will, and the transfer on death. Now, in the case of the lifetime transfer, the tax cost of the end. Transfer property carries over into the hands of the donee.

Chuck: Correct.

Ed: Versus if you hold that till death, you get to increase the tax basis.

Chuck: Right.

Ed: As a consequence, the donee, if you will, the transferee saves some income tax.

Chuck: There’s interaction between these transfer taxes and the income tax as well because of that.

Ed: Ideally, you want to give your property way of death.

Chuck: Yes.

Ed: That’s not a really good opportunity. It seems to me good planning is to die with all appreciated property.

Chuck: Yes. Give away all your cash during your lifetime and then die with property that has low basis. That would be the ideal way to manage that.

Ed: Well, that’s the plan now, convincing people to do that is I’ve not had much way of success, but that gets us to the question of a disclaimer.

Chuck: Right.

Ed: I can receive from my grandfather or father money during my life or assets during my lifetime and at death, but I don’t have to accept it. Could you give me that?

Chuck: Right.

Ed: Make sure that I understand what’s going on.

Chuck: Yes, exactly. This idea of a disclaimer is really a lawyer talk for a pretty simple concept. In order to make a gift to somebody, either during your lifetime or at death, you can’t actually force them to receive property against their will.

Ed: Wait a minute. You’re going to give me a million dollars, I don’t have to accept it.

Chuck: You don’t have to accept it. The idea is that I can offer, I can put a million dollars on the table and if you don’t pick it up, then you have failed to accept that gift. Because we have these transfer taxes that are in play and because people sometimes fight over estates and estate settlement, this concept of not accepting a gift has been formalized into the idea of a disclaimer. In particular, in federal law in the concept of a what’s called a qualified disclaimer, which means that your refusal to accept a gift, if it meets certain criteria that are set out in the tax code, then your refusal to accept a gift will not in itself be deemed a gift that you are making to whoever receives it in your stead.

Ed: Then we have that $16,000 per year per donee annual exclusion plus then you can erode in your basic exclusion amount. I’m talking federal purposes, but a disclaimer gets around that.

Chuck: If it’s a qualified disclaimer, it is not considered to be a gift at all. For instance, you could say in your will keep things simple. I want my estate to go equally to my two children who survive me. Let’s say that you have two children, you’ve got a son and a daughter, and your son decides, “I would just let my share of the estate go to my sister. She needs it more,” or whatever.

Ed: Or my children.

Chuck: The son can disclaim his inheritance and it will pass by operation of law to whoever would otherwise receive it if he had predeceased you. That act of disclaiming his inheritance will not be deemed to be a gift.

Ed: Another way. Make sure, I understand it, it’s treated as if the person disclaiming died before the ancestor.

Chuck: Correct.

Ed: Which is a fiction. It can be part, it can be all, it can be joint tendency property. You can disclaim a lifetime gift and you can disclaim a transfer on death.

Chuck: Correct. In order for it to be a qualified disclaimer, so you can make a disclaimer that’s valid under every state that has their own property laws. They’re all very similar from state to state, but whether a disclaimer is valid is determined by state property law. Whether it is a qualified disclaimer meaning it’s not treated as a gift is determined by federal law. In general, the overlay that there’s several different rules that apply, but the most important of which for it to be a qualified disclaimer is that it has to be an unqualified disclaimer, meaning there’s not any side deal in place and it has to be made in writing and within nine months of the date in the case of a death transfer, for instance, nine months of the date of death. Generally within nine months of the date of the transfer.

Ed: I’m going to put this in context. Look at the federal level only, we have an exclusion in the operation of the estate tax of this year, $12,060,000 or $24,120,000 for married couple. Yet if, for example, I have purchased $60,000 worth of Tesla and I’m single and it’s now worth $12,060,000 and I die and I give that to you. You now have a new tax basis for that of $12,060,000 I’m a resident of Texas, so there’s no estate tax and you sell that. You are going to save about 28% or 32% or whatever anywhere from the quarter of that amount. It’s a pretty good deal. The idea is to die rather than give away.

Chuck: Yes.

Ed: Now, I’d like to put this in context in every day example. If we’re concerned about estate taxes, we’ve got this $12,060,000 exclusion hence for the basic intergeneration skipping transfer tax. We’re not going to worry about a disclaimer otherwise, except let’s assume for a moment that Pete is to receive an IRA from an ancestor of X millions of dollars. We know that the recipient of an IRA that is an individual who did not own, wasn’t that person’s IRA, and a non-spouse recipient, must empty that IRA within 10 years in the date of the death of the ancestor. We have this 10-year empty out rule, how could a disclaimer, a couple with any other instrument save or avoid this 10-year empty out rule?

Chuck: For instance, if by virtue of you disclaiming all or a part of the IRA, the IRA passes to somebody who’s in a lower income tax bracket than you. Then when that person still has to follow this 10-year empty out rule, but they’ll be incurring income by distributions from the IRA at a lower income tax rate. That’s one way. The other way is assuming both you and the person who would receive it when you disclaim are both in the same income tax bracket, but it’s not the highest income tax bracket by disclaiming a portion of the IRA, you’re causing that income that’s generated by taking distributions of the out of the IRA to be distributed among multiple taxpayers, which makes it less likely that you’re going to be pushed into a higher tax bracket. It has to do with tax brackets. Now, I guess there’s a couple wrinkles here, for instance, if the person who had received that IRA when you disclaimed is disabled or is a minor, those can be exceptions to this 10-year payout rule. They might actually be able to stretch the IRA for longer depending on who they are.

Ed: Well, getting back, we know that there’s fewer than 500 human beings in the United States that have at least 25 million in an IRA, but we’re seeing significant accumulations in IRAs without regarding other assets. It’s not unusual. This issue of disclaimer income tax bracket also we’ve talked about the use of different trust arrangement of Charitable Remainder Trust.

Chuck: Yes. I think probably for both of us, our favorite way of getting around this 10-year rule is to have the beneficiary of the IRA be a Charitable Remainder Trust, which effectively means that the IRA pays out over the lifetime of beneficiary rather than this 10-year rule.

Ed: Well, let’s assume for example, that the beneficiary of the disclaimed property in the IRA as age 35 so this Charitable Remainder Trust makes sense. The trust can provide for a distribution of 5% of the value of the subject property valued at December 31 of each year. There’d be a lump sum from the IRA to the Charitable Remainder Trust but that trust doesn’t pay any tax. As the distribution is made, the recipient receives that and pays an income tax. The character of the assets into the CRT remains the same. The whole card is who’s the ultimate beneficiary.

Chuck: It has to go to a charitable remainder. Of course, the Charitable Remainder Trust itself has to meet certain structural rules that are built into the code in order to be valid, probably the most important one of which in this context is that the duration of that trust is limited because the actuarial value of the portion of that trust goes to charity to at least has to be 10% at least. If the beneficiary of that IRA is below a certain age-

Ed: 35, example.

Chuck: -then what that means is that you actually cannot structure a CRT that lasts that beneficiary’s lifetime that will meet the definition of a Charitable Remainder Trust under the code.

Ed: This is why we got the actual age, by the way. Someone who’s 35 gets an interest in Charitable Remainder Trust and that person lives to 90. Great. Ultimately, that benefit, the charitable beneficiary could be, for example, a donor-advised fund, it could be the owner’s foundation. It could be all sorts of things. The opportunity to get around this 10-year empty out rule is there. The opportunity to realign assets by way of a disclaimer is there without regard to the tax implication. Also, you can cure a misunderstanding of the part of the owner as to how the property is to be disposed of. A short story I know we’re engaged in one situation where this gentleman hated lawyers, which is very unusual. I can’t imagine anyone disliking a lawyer.

Chuck: I dislike almost all lawyers. There’s about three exceptions.

Ed: I already know one. The bottom line is, so this gentleman didn’t seek the advice of an attorney and assumed that his spouse received all the assets. Guess what?

Chuck: I know the end of the story. You should probably just say what it is.

Ed: The end of the story is by virtue of the rules of intestate succession, the wife didn’t receive it all, so the other recipients, the family members, had to quote disclaim and end up so the surviving spouse got all the property and surviving spouse can do certain things. Guess who didn’t like that?

Chuck: Yes.

Ed: Uncle Sam. Actually, we’re doing something evil. I can remember the agent saying, you’re avoiding tax. That’s right. We’re avoiding tax. Is there something criminal about avoiding tax?

Chuck: Apparently.

Ed: He didn’t say this but I surmise he didn’t have any money. Let’s not get to that. The point is, there are opportunities, whenever there’s an objection, there’s a barrier, there typically is a way under, around, and not necessarily through the barriers.

Chuck: This disclaimer concept is a very useful tool really in estates of all sizes. For smaller estates, people may have a real concern about making sure the assets go to beneficiary who needs it most or can make the most effective use of it. For the larger estates, you have assets that are hot in the tax sense and you want to manage the tax liability.

Ed: The IRA.

Chuck: Yes, and it’s a perfect example of that. I think it’s just good for everybody. There is a time limit and so you want to make sure that you’re thinking about this early in the process.

Ed: I think about nine months gestation period for human being, not an elephant and estate tax return if any has to be filed within nine months. We got all kinds of permutations, but the bottom line is every event is also an opportunity.

Chuck: Exactly.

Ed: With that, we’ll see you next time, Chuck.

Chuck: Great.

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