KTC NEWSLETTER WINTER 2021
WINTER 2021
KODIAK TRUST NEWS
GROWTH DESPITE COVID
Everyone is tired of hearing news about COVID! We are hearing news daily about many companies in financial difficulties due to COVID-19. But we have good news to report and that is that Kodiak Trust had a good year in 2020. Kodiak Trust Company, like all businesses, has been impacted by the restrictions due to COVID, such as:
·No face- to- face meetings with clients or advisors
· No corporate travel
· Meetings by Teams
·Need to adapt marketing plan to be electronically-driven
·And the list goes on!
Despite all the issues, KTC has had a year of growth in several ways:
·Growth in business. The following chart shows our growth in terms of number of trusts and assets under management.
· Increase in product line and expansion into domestic market. In 2020, KTC branched out into the domestic market and launched a marketing effort through newsletters and webinars focused on the advisor market. We issued our first newsletter and sponsored our first webinar in December. This newsletter is our Winter Issue and we are sponsoring 2 webinars in February (one in the international market aimed at STEP members and one in the domestic market aimed at Wealth Counsel members). Approximately 1/3 of the new trust accounts in 2020 were from the domestic market.
·Development of Infra-Structure: KTC has been able to continue to enhance its internal procedures due to several factors:
-The addition of additional Officers, Directors and Employees
-Development and addition of new technology such as the electronic access to statements by clients.
-On-going inspection through internal and external auditing processes.
·The on-going and deepening relationships with referring advisors: And most of all, credit for the on-going success of KTC is due to you—the advisor that refers their clients to us. We thank you for your support.
Again, thank you for your business in 2020. We look forward to a new and prosperous year in 2021 and are here to serve you and your clients.
Best Wishes,
Jeff Wright
CEO and President of Kodiak Trust Company
TRENDING NEWS
KEY POINTS OF BIDEN’S ANNOUNCED TAX PLAN
Despite the results of the recent runoffs in Georgia, the odds of dramatic tax reform are not certain. Some Democratic Senators who are facing reelection in 2022, may be reluctant to support a tax-increase agenda in the current COVID-19 ravaged economic environment. The same may hold true for at-risk Democratic House members who will be up for reelection in 2022. All things considered, it could be a daunting task to get significant tax changes through CONGRESS IN 2021 OR 2022. With this thought in mind, here are the most important proposed changes found in the Biden tax plan.
·Higher Maximum Individual Rate: Biden has stated that he will not increase taxes on anyone with less than $400,000/ year income. Biden intends to increase the maximum tax rate on ordinary income and short-term capital gains to 39.6%.
·Limit on Tax Savings from Itemized Deductions: The Biden plan would limit the tax benefit of itemized deductions to 28% for upper-income individuals. In other words, if you are in the maximum bracket of 39.6%, we are limited to the 28% ceiling on your deductions. Note: Biden favors the repeal of the current $10,000 cap on itemized deductions for state and local taxes.
·Higher Maximum Tax Rates on Individual Long-Term Capital Gains: The current effective rate is 20% plus 3.8% for NIIT or 23.8%. Biden proposes that for those with incomes above $1,000,000 that the same rate 39.6% for ordinary income rate apply plus the 3.8% for NIIT for a 43.4% capital gain tax rate—almost double the current effective rate.
Individuals: The current law hits the first $137,700 of 2020 rates at 12.4%. The figure increases to $142,000 for 2021 (increases annually for inflation). The Biden plan would restart the 12.4% Social Security tax on wages and net-self-employment income above $400,000.
·Elimination of Basis Step-Up for Inherited Assets: Current law allows for step-in basis to fair market value as of the date of the decedent’s death. Biden has proposed the elimination of this law.
Elimination of Certain Real Estate Tax Breaks: Biden would eliminate the following:
-$25,000 exemption from passive loss rules
-Like kind exchanges
-Faster depreciation write-offs for certain property
-Eliminate Qualified Business Income deductions (QBI).
·QBI Deduction Phaseout: QBI deductions would be phased out for all with taxable income above $400,000.
·More Generous Child & Dependent Child Care Credits: More generous credit of $8,000 for 1 child; $16,000 for 2 or more children for lower-income and middle-income families.
·Credits for Health Insurance Costs: the goal is to insure that no family pays more than 8.5% of their income on health insurance premiums.
·Credit for Homebuyers: $15,000 refundable credit for eligible first -time home buyers.
·Equalizing Tax Benefits from Retirement Plan Contributions: Under our current federal income tax system, the tax benefits from making retirement plan contributions are bigger for upper-income tax payers. Biden would equalize benefits across the income scale—no specific details have been given as of yet.
·Higher Corporate Taxes: The Biden plan calls for a 28% tax rate. Also would impose a 21% minimum tax on foreign earnings of US companies located overseas and a tax penalty on corporations that ship jobs overseas in order to sell products back to America.
·New Corporate Minimum Tax: Biden would impose a 15% tax on corporations with $100 million in annual income.
·New Financial Risk Fee for Big Financial Institutions: Biden would introduce banks, bank holding companies and non-bank financial institutions with $50 billion+ of assets to beef up funds available to FDIC,
·Green Energy Tax Changes: Specific plans are not given, but the Biden plan will offer tax incentives for carbon emission reduction and will eliminate or phase out deductions for gas and oil drilling costs and depletion.
This article summarizes the most important announced proposals in the Biden tax plan. Other changes will be forth coming as the New Administration and Congress work to formulate a new tax law. In the meantime, with COVID economic impact, we never know what unexpected developments will occur and how taxes might be affected.
ADVISOR’S CORNER | ACCUVEST GLOBAL ADVISORS
BENEATH AND BEYOND S&P 500
2020 ended with the S&P500 Index closing at 3,756. At this level, the S&P500 enters 2021 with a forward price-to-earnings ratio of 22.3x and a dividend yield of 1.6%. Over the last 25 years these metrics have averaged 16.56x and 2.05%, respectively. It is fair to conclude that the US equity index is relatively expensive, compared to history. A similar conclusion can be reached when comparing US equities to the rest of the world. At the end of 2020, the MSCI All Country World Index, excluding the United States, closed with a forward price-to-earnings ratio of 16.7x (a 25% discount to the US) and a 2.7% dividend yield (over 1% more).
In 2020, the S&P500 experienced a historic -34% drawdown, ending March 23, followed by an impressive 68% rally into December 31st. US Equities produced great divergence between the returns of “Styles” and “Sectors” during 2020. The most extreme examples were seen between the returns for US Large Growth (+38.5%) and US Large Value (+2.8%), and between US Technology (+43.6%) and US Energy (-32.5%).
At the close of 2020, the 5 largest stocks in the S&P500 (Apple, Microsoft, Amazon, Google and Facebook) represented 21.7% of the entire S&P500 index. These 5 companies trade at 33x 2021 earnings, while the remaining 495 stocks in the index trade at 19x 2021 earnings. The addition of Tesla, now the sixth largest company in the S&P500, does not improve the valuations of the S&P500 Index.
The economic implications of the Covid-19 crisis contributed to these divergences, but these style and sector trends were in place for most the previous bull market cycle (2009-2020). From the lows of 2009 to the start of 2020, US Large Growth outperformed US Large Value by 159%. Meanwhile, the US Technology Sector outperformed US Energy by 623% and the United States (S&P500) outperformed International (MSCI All Country ex-US Index) by 297%.
Since the Financial Crisis (2009), weak growth and low interest rates have driven investors to seek out “secular growth” via US technology, contributing to increasingly high US growth and technology valuations, and generating market imbalances last seen during the 1999-2000 Dot.com bubble. 2020 marketed an acceleration of those trends. Now, the divergence in performance and valuations within the S&P500, as well as outside the US, rests at historic levels. With massive government spending, unprecedented central bank support, and Covid-19 vaccinations underway, there is hope for an economic recovery in 2021. In this environment, what has worked for the last several years may not work as well in the future. To capture opportunities in the future, investors may have to be more precise and dynamic with their exposures in the US, and be willing to look outside the US for additional opportunities for diversification and return enhancement.
CHANGING THE SITUS OF A TRUST:
SHOPPING FOR INCOME TAX SAVINGS
I t is becoming more common for a resident of one state to establish a trust in another jurisdiction with more favorable trust and tax laws than their home state. There are several reasons for this growing trend: favorable rulings in U.S. trust tax cases; favorable decanting statutes in many states; increasing state and local taxes in many states; and a heightened awareness on the part of advisors and their clients.
U.S. Trust Tax Cases: We have had three significant court cases with one issue—the nexus between a state and a trust. We reviewed two of those court cases (Kaestner and Fielding) in our last newsletter. The third case is Linn v. Illinois Department of Revenue.
Linn, Kaestner, and Fielding have differences, but they all share the same issue: When is a state allowed to tax a trust’s undistributed income?
The three cases argued over their states’ nexus with the trust and turned to the U.S. Constitution’s Due Process Clause in the courts.
In Linn, the Illinois Department of Revenue focused their argument on an Illinois statute which stated, “resident means: an irrevocable trust, the grantor of which was domiciled in the state at the time such trust became irrevocable.” But as stated in previous cases (Kaestner & Fielding), there must be nexus between a state and the taxable entity. Otherwise,it is unconstitutional for a state to tax the entity even if the state’s statute looks to support such taxation.
Like Fielding in Minnesota, Illinois taxed the undistributed income of an irrevocable trust based solely on a grantor’s residence when the grantor established the trust. Illinois believed that once an irrevocable trust was established in Illinois, that the trust would always be an Illinois trust.
Here are the Linn case facts:
A.N. Pritzker established a trust in Illinois in 1961 with Illinois trustees. Forty plus years later, the trustee distributed the property from the Illinois trust to a new
trust in Texas. At the time of the distribution of property to the Texas trust, the trust was administered in Texas, but some of the trust provisions remained under Illinois law. In 2005, a Texas court modified the Texas trust removing all references to Illinois law. As of 2006, after the Texas court modification:
·No beneficiaries lived in Illinois
·No trustees lived in Illinois
·No assets were custodied in Illinois
·There were no Illinois provisions in the trust
The Illinois Fourth District Appellate Court concluded that Illinois had no right to tax the trust stating, “what happened historically with the trust in Illinois courts and under Illinois law has no bearing” and that the trust is receiving benefits from Texas, not Illinois.
The take-away from the Linn, Kaestner and Fielding cases:
There is a trend towards the high courts deciding that a significant nexus between a state and an entity must exist for the state to tax the entity constitutionally.
Another take-away from Linn, is that the Illinois Fourth District Appellate Court recognized the validity of the “appointed trust” and not the “invaded trust”validating the ability to migrate a trust from one jurisdiction to another through a decanting process.
Trust Decanting Statutes:
Many states have adopted and expanded their decanting statutes. The availability of this process has taken the sting out of the word “irrevocable” in utilizing irrevocable trusts. There are many reasons to want to change the provisions of an irrevocable trust and “decanting a trust” is much easier and less costly than amending a trust through court order or a non-judicial settlement arrangement.
Some of the standard reasons for wanting to create a new trust include the need to correct drafting error and vague language or to adapt the trust to changed family circumstances.
A few states with favorable trusts laws (Alaska, Nevada, South Dakota and Delaware) have been very public about their beauty contests to keep their trust statutes competitive, especially their decanting statutes. This increased awareness has led to more trusts be decanted from states with less favorable trust laws (such as asset protection statutes, rules against perpetuities statutes, etc.) to states with more favorable
statutes principally Alaska, Nevada, South Dakota and Delaware. Perhaps one of the most compelling reasons currently for trust migration is to shop states for more favorable state and local tax laws.
Alaska, a state with no income tax, has the broadest and most comprehensive decanting statutes (AS 13.36.157-13.36.159) has seen a real increase in the number of out of state trusts (created by out-of-state residents) change situs to Alaska with decanted trusts to conform to Alaska trust provisions.
Steps to Trust Decanting:
The following steps should be made:
1.Review the trust to be invaded or decanted: does it prohibit decanting? Does it allow for the change of situs?
2.Does the trustee have discretion or authority to distribute income or principal of the trust either to or for the benefit of the beneficiaries? If yes, the property which is subject to that discretion or authority may be transferred to a second irrevocable trust.
3.Change the situs of the trust to Alaska with an Alaska trustee so that the trust is domiciled in Alaska so that the Alaska decanting statutes apply.
4.Trustee establishes the new trust.
5.Trustee, through a Memorandum of Appointment, appoints the assets to the appointment trust (new trust) from the invaded trust (old trust). In Alaska, notice (30- day notice) is required to all parties of the trusts. Court approval is not required to decant a trust. Decanting is not prohibited if a beneficiary objects.
It is important to note what cannot be done in the decanting process:
1.New beneficiaries cannot be added to the second trust.
2.Reducing the income interest of the first trust if the trust is a marital trust, charitable trust, or a grantor retained annuity trust.
3.There are additional restrictions if the trustee is a beneficiary of the first trust.
A Case Study:
Eve, a California resident, established an irrevocable trust for the benefit of her two sons and their children (none of the beneficiaries are California residents). Over time Eve transferred to the trust (through gifts and installment sale) the interests in four LLCs (Nevada LLCs and Delaware LLCs) which owned commercial real estate in Florida, Ohio, and Oregon. The trust was subject to federal tax (37%) and California tax (12.3%) on undistributed taxable income. The trustee of the trust changed the trust situs to Alaska to an Alaska Trustee (Kodiak Trust Company) so that the new trustee could decant the Alaska domiciled trust into a second trust with language that conformed to the Alaska statutes. What did we achieve in the process?
1.We no longer have state income tax to pay on undistributed net income.
2.We have stronger asset protection laws.
3.We have a 1000- year rule against perpetuity.
4.We can use the Alaska Pre-Mortem Probate statute to validate the trust prior to Eve’s death which eliminates the potential risk of protests by beneficiaries.
In Conclusion:
There is a growing trend in migrating trusts from one jurisdiction to another fostered by favorable tax court cases, competitive decanting provisions in several states, increasing tax rates in many states, and an increased public awareness. If you have a client that should consider relocating their trusts and require additional information, please feel free to call us at Kodiak Trust Company. We are here to assist you in servicing your clients’ needs.
Want Additional Information?
please contact us at
Kodiak Trust Company:
907-302-2990
kodiaktrust.com