January 31, 2002

Is the market coming back? All key economics point to the fact that we are in a recession, but a recovery is on its way. The National Bureau of Economic Research declared that a recession began last March. But why would analysts predict that a recession is coming to its end?

According to statistics, retail sales have held up well. Auto show rooms have also had people coming in, partially bolstered by attractive financing rates. In October, consumer spending rose at a 1.1% annual rate which accounted, according to analysts, for more than 69% of the total gross domestic product.

Oil has dipped back below $20.00 a barrel as non-OPEC producers, such as Russia have not cut back their production in accordance with OPEC?s desire to raise prices.

A reduction at the pump relates to billions of dollars of savings of oil costs for our country. The Fed Funds Rate was again reduced in December, though an additional rate decrease is not projected for January. The rallying bonds appears to have waned as evidence of an economic recovery has caused bond markets to no longer have the aggressive growth due to decreasing interest rates. According to Bloomberg News, for the last two years, increases in bond values have outpaced stock value. This is the first time that bond prices have increased more than stocks since the 1981-1982 recession.

Liquidity in the marketplace due to individuals maintaining a higher cash or liquid position is the highest that many analysts have seen in the last forty years. As cash accumulations have increased, the reduction in Fed Funds resulting in a lower yield to investors, causes many individuals to be willing to again consider investing in equities. As one to two percent yields, particularly on money markets are present, many investors are comparing that to the dividend yields available on stocks. Relative to stocks, equities, the S&P 500 has an average dividend yield of almost 1.3%. This makes the dividend yield quite competitive with many money market funds. Even the Fed has indicated the economy is improving, as interest rates were not further reduced at their late January, 2002 meeting.

What should an investor be looking at in today?s uncertain times? Certainly, all economists are predicting a recovery, but not as large or as aggressive as many other recoveries. That would mean that long term equity value of major corporations, as well as small corporations may have the ability to increase within the next six to twelve months. Smaller Cap stocks are currently priced at a larger discount relative to their asset values and their price to earnings than most large cap stocks. Relative to a research table regarding the end of recessions and the changes between large cap and small cap stocks, it has been indicated that smaller cap equities, tend to outperform large cap equities, within the twelve month period following a recession. The average rate of return on small caps over large caps, is approximately fifteen percentage points dated from 1949 through the present. There is of course, no guarantee that history will repeat itself, however it does mean that one should take a look at the potential of small cap stocks particularly over the next twelve to eighteen months.

Risk as usual is a factor that should be considered, as diversification is always the key to seeking solid gains. If one is successful with their investments, then your assets should continue to accumulate.

Another often overlooked aspect of investing is the issue of estate planning. As most of you are undoubtedly aware, there is still an estate tax. Currently, for estates that are not passing to a spouse, assets in the aggregate that have a value in excess of $1 million are subject to an estate tax. The estate tax is currently taxed at a maximum rate of 50%.

Credits against the estate tax escalate in subsequent years until the year 2009 where the exemption against the estate tax is $3.5 million. Amounts over that amount would still be subject to estate tax, until 2010. As currently written, the estate tax extinguishes in 2010, as then reinstated in 2011, with a reduction in the credit against the estate tax. Therefore, with a potential maximum estate tax of 50%, one should be prudent in looking to reduce the value of your estate as well as try to protect one?s assets.

Since a taxable estate is computed on the ?value? of the assets and not on the assets themselves, one of the keys to reducing the estate tax, is to reduce the ?value? of one?s assets. The issue then becomes, how does one reduce as asset?s value, while still retaining the asset?

One of the most commonly utilized techniques is through usage of a Family Limited Partnership (FLP) or a Limited Liability Company (LLC). By having an entity such as an LLC or FLP own your securities portfolio, case law has demonstrated that a discount of at least 20% is generally applicable. This means, with a properly drafted FLP or LLC, one may integrate this structure into their estate plan and reduce the value of their estate, simultaneously. For example, if one had a securities portfolio of $2 million and if this portfolio was transferred into a properly structured FLP or LLC, then for estate tax purposes, provided that all requisites were present for valuation reduction, the value of the exact same securities portfolio for estate taxes would be approximately $1.6 million. If one was subject to a 50% estate tax, on the excess of the value of their estate $2 million over the current $1 million credit, then in a simplified calculation the estate tax would initially be $500,000 ($2,000,000 - 1,000,000 x 50%). (Note: the figures are used as an example, they are not the exact tax rates.)

In the same scenario, if the estate tax valuation technique of a FLP or LLC had reduced the value of the securities portfolio by 20% or $400,000, then the total estate value would be $1.6 million. The estate tax, if we presume an estate tax rate of 50% for this example, would be $300,000 ($1,600,000 - $1,000,000 x 50%). This would result in a real savings to your family of $200,000.

Non-marketable securities, such as real estate, closely held stocks or other assets generally can receive a reduction of up to 35%. Therefore, it is not only important to accumulate and invest your assets, but it also important to remember there are ways to save on your estate tax leaving your portfolio or investments intact.

In future issues I will also discuss the tie-in of asset protection planning with estate valuation reductions, on your portfolio.

About The Author

Richard M. Colombik is a tax partner in the Itasca headquartered firm of Richard M. Colombik & Associates, P.C. Mr. Colombik concentrates his practice on IRS Tax Defense, Estate Planning and Asset Protection Plans for individuals as well as corporate clients. He received his B.S. Degree in Business from the University of Colorado and his J.D., Cum Laude, from the John Marshall Law School. He is also a Certified Public Accountant. Mr. Colombik has spoken at numerous engagements and is a well publicized author regarding Income Tax, Estate Tax, and Asset Protection Planning. He is currently a member of the Illinois State Bar Association?s Trust and Estate Section Council, an officer in the Northwest Suburban Bar Association and the Illinois Chapter of the American Association of Attorney-CPAs, a member in the Offshore Institute, the State Bar?s liaison to the Internal Revenue Service and the past chair of the ISBA Federal Taxation Section Council. Mr. Colombik may also be reached on the Internet at www.colombik.com.