If you’re putting aside money for college or other educational expenses, consider a tax-advantaged 529 savings plan. Also known as “college savings plans,” 529 plans were expanded by the Tax Cuts and Jobs Act (TCJA) to cover elementary and secondary school expenses as well. And while these plans are best known as an educational funding vehicle, they also offer estate planning benefits.

What do 529 plans cover?

529 plans allow you to contribute a substantial amount of cash (lifetime contribution limits can reach as high as $350,000 or more, depending on the plan) to a tax-advantaged investment account. Like a Roth IRA, contributions are nondeductible, but funds grow tax-deferred and earnings may be withdrawn tax-free provided they’re used for “qualified education expenses.”

Qualified expenses include tuition, fees, books, supplies, equipment, room and board and, under the TCJA, up to $10,000 per year in elementary or secondary school expenses. Earnings used for other purposes are subject to income tax and a 10% penalty.

What are the estate planning benefits?

These plans are unique among estate planning vehicles. Ordinarily, to shield assets from estate taxes, you must permanently relinquish all control over them. But contributions to a 529 plan are considered “completed gifts” — which means the assets are removed from your taxable estate, together with all future earnings on those assets — even though you retain considerable control over the money. For example, unlike most other estate planning vehicles, you can control the timing of distributions, change beneficiaries, move the funds into another 529 plan, or even cancel the plan and get your money back (subject to taxes and penalties).

As a completed gift, a 529 plan contribution is eligible for the annual gift tax exclusion (currently $15,000). But unlike other vehicles, you can bunch up to five years’ worth of annual exclusions into one year. This allows you to contribute up to $75,000 in one year, without triggering gift or generation-skipping transfer (GST) taxes and without using up any of your lifetime exemption. There are implications, however, if you don’t survive the five years.

Why does it matter?

You might think that these benefits are of little value now that the TCJA has temporarily doubled the lifetime gift and estate tax exemption to an inflation-adjusted $10 million ($20 million for married couples who design their estate plans properly). This year, the exemption amount is $11.4 million ($22.8 million for married couples).

After all, few families are currently affected by these taxes. But it’s still a good idea to shield wealth from potential estate taxes and to make the most of your annual exclusion. This is because the new exemptions are scheduled to return to their previous levels after 2025 and there’s nothing to stop lawmakers from reducing the exemption in the future. 529 plans and other traditional estate planning tools provide some insurance against future estate tax changes.

Contact us to learn more about how a 529 plan can help achieve your estate planning and education goals.

© 2019 Covenant CPA

Federal estate tax liability is no longer an issue for many families, now that the gift and estate tax exemption stands at $11.4 million for 2019. But there are still affluent individuals whose estates may be subject to hefty estate tax bills. If you expect your estate to have significant estate tax liability at your death, it’s critical to include a tax apportionment clause in your will or revocable trust.

An apportionment clause specifies how the estate tax burden will be allocated among your beneficiaries. Omission of this clause, or failure to word it carefully, may result in unintended consequences.

How to apportion estate taxes

There are many ways to apportion estate taxes. One option is to have all of the taxes paid out of assets passing through your will. Beneficiaries receiving assets outside your will — such as IRAs, retirement plans or life insurance proceeds — won’t bear any of the tax burden.

Another option is to allocate taxes among all beneficiaries, including those who receive assets outside your will. And yet another is to provide for the tax to be paid from your residuary estate — that is, the portion of your estate that remains after all specific gifts or requests have been made and all expenses and liabilities have been paid.

Omission of an apportionment clause

What if your will doesn’t have an apportionment clause? In that case, apportionment will be governed by applicable state law (although federal law covers certain situations).

Most states have some form of an “equitable apportionment” scheme. Essentially, this approach requires each beneficiary to pay the estate tax generated by the assets he or she receives. Some states provide for equitable apportionment among all beneficiaries while others limit apportionment to assets that pass through the will or to the residuary estate.

Often, state apportionment laws produce satisfactory results, but in some cases, they may be inconsistent with your wishes.

Avoid surprises

If you ignore tax apportionment when planning your estate, your wealth may not be distributed in the manner you intend. To avoid unpleasant surprises for your beneficiaries, be sure to include an apportionment clause that clearly spells out who will bear the burden of estate taxes. Contact us with any questions regarding taxes or estate planning.

© 2019 Covenant CPA

You probably don’t have to be told about the need for a will. But do you know what provisions should be included and what’s best to leave out? The answers to those questions depend on your situation and may depend on state law.

Basic provisions

Typically, a will begins with an introductory clause, identifying yourself along with where you reside (city, state, county, etc.). It should also state that this is your official will and replaces any previous wills.

After the introductory clause, a will generally explains how your debts and funeral expenses are to be paid. The provisions for repaying debt generally reflect applicable state laws.

Don’t include specific instructions for funeral arrangements. It’s likely that your will won’t be accessed in time. Spell out your wishes in a letter of instructions, which is an informal letter to your family.

A will may also be used to name a guardian for minor children. To be on the safe side, name a backup in case your initial choice is unable or unwilling to serve as guardian or predeceases you.

Specific bequests

One of the major sections of your will — and the one that usually requires the most introspection — divides up your remaining assets. Outside of your residuary estate, you’ll likely want to make specific bequests of tangible personal property to designated beneficiaries.

If you’re using a trust to transfer property, make sure you identify the property that remains outside the trust, such as furniture and electronic devices. Typically, these items won’t be suitable for inclusion in a trust. If your estate includes real estate, include detailed information about the property and identify the specific beneficiaries.

Once you’ve covered real estate and other tangible property, move on to intangible property, such as cash and securities. Again, you may handle these items through specific bequests where you describe the property the best you can.

Finally, most wills contain a residuary clause. As a result, assets that aren’t otherwise accounted for go to the named beneficiaries, often adult children, grandchildren or a combination of family members.

Naming an executor

Toward the end of the will, name the executor — usually a relative or professional — who is responsible for administering it. Of course, this should be a reputable person whom you trust. Also, include a successor executor if the first choice is unable to perform these duties. Frequently, a professional is used in this backup capacity.

Cross the t’s and dot the i’s

Your attorney will help you meet all the legal obligations for a valid will in the applicable state and keep it up to date. Sign the will, putting your initials on each page, with your signature attested to by witnesses. Include the addresses of the witnesses in case they ever need to be located. Don’t use beneficiaries as witnesses. This could lead to potential conflicts of interest. Contact us with questions.

© 2019 Covenant CPA

When it comes to estate planning, trusts are appealing for many reasons. They can enable you to hold and transfer assets for beneficiaries, avoid probate and reduce estate tax exposure. But they can be complicated to set up. One of the major decisions you’ll need to make when establishing a trust is who will act as your trustee. As the name implies, this individual or financial institution must be above reproach. But that’s just one quality of many that your trustee requires.

Both mundane and significant duties

Trustees have significant legal responsibilities, primarily related to administering the trust for the benefit of beneficiaries according to the terms of the trust document. But the role can require many different types of tasks. For example, even if a tax expert is engaged to prepare tax returns, the trustee is responsible for ensuring that they’re completed and filed correctly and on time.

One of the more challenging trustee duties is to accurately account for investments and distributions. When funds are distributed to cover a beneficiary’s education expenses, for example, the trustee should record both the distribution and the expenses covered by it. Beneficiaries are allowed to request an accounting of the transactions at any time.

The trustee needs to invest assets within the trust reasonably, prudently and for the long-term benefit of beneficiaries. And trustees must avoid conflicts of interest — that is, they can’t act for personal gain when managing the trust.

Finally, trustees must be impartial. They may need to decide between competing interests, while still acting within the terms of the trust document.

A tall order

Several qualities help make someone an effective trustee, including:

  • A solid understanding of tax and trust law,
  • Investment management experience,
  • Bookkeeping skills,
  • Integrity and honesty, and
  • The ability to work with all beneficiaries objectively and impartially.

And because some trusts continue for generations, trustees may need to be available for an extended period. For this reason, many people name a financial institution or professional advisor, rather than a friend or family member, as trustee.

Naming a friend or family member as a trustee may seem appealing because it appears to be a way to reduce or avoid the fees associated with an institutional trustee. But it’s important to recognize that taking on the responsibilities of a trustee requires an investment of time, energy and expertise, and that trustees deserve compensation. Even if trust documents don’t provide a fee for the trustee, many states allow for a “reasonable fee.” Before engaging a trustee, make sure you understand what services are included in the fee. But it’s generally not a good idea to try to avoid paying a trustee fee.

Consider all options

Naming a trustee is an important decision, as this person or institution will be responsible for carrying out the terms outlined in the trust documents. We can help you weigh the options available to you.

© 2019 Covenant CPA

A common estate planning mistake that people make is to own property jointly with an adult child or other family member. True, adding a loved one to the title of your home, bank account or other property can be a simple technique for leaving property to that person without the need for probate. But any convenience gained is usually outweighed by a variety of negative consequences. Here are four:

1. Higher gift and estate taxes. Depending on the size of your estate, joint ownership may trigger gift and estate taxes. When you add a family member’s name to an asset’s title as joint owner, for example, it’s considered a taxable gift of half the asset’s value. And your interest in the asset — including any future appreciation — remains in your taxable estate. These taxes usually can be minimized or even eliminated by transferring the asset to an irrevocable trust.

2. Higher income taxes. Generally, property transferred at death receives a stepped-up basis, allowing your heirs to sell it without incurring capital gains tax liability. But if you add an heir to the property’s title as joint owner, only your interest in the property will enjoy this benefit. Any appreciation in the value of your heir’s interests between the date he or she is added to the title and the date of your death is subject to capital gains tax.

3. Exposure to creditors’ claims. Unlike property transferred to a properly designed trust, jointly held property may be exposed to claims by the joint owner’s creditors (and also claims from a former spouse).

4. Loss of control. A joint owner has the right to sell his or her interest to an outside buyer without your consent and the buyer may be able to go to court to force a sale of the property. In addition, when you die, the entire property will go to the surviving owner(s), regardless of the terms of your will or other estate planning documents.

If you currently jointly own property with a family member, contact us at 205-345-9898 and info@covenantcpa.com. We can suggest alternative estate planning techniques to ease any gift, estate and income tax liability, and limit your exposure to creditors’ claims.

© 2019 CovenantCPA

Like most businesses, yours probably has a variety of physical assets, such as production equipment, office furnishings and a plethora of technological devices. But the largest physical asset in your portfolio may be your real estate holdings — that is, the building and the land it sits on.

Under such circumstances, many business owners choose to separate ownership of the real estate from the company itself. A typical purpose of this strategy is to shield these assets from claims by creditors if the business ever files for bankruptcy (assuming the property isn’t pledged as loan collateral). In addition, the property is better protected against claims that may arise if a customer is injured on the property and sues the business.

But there’s another reason to consider separating your business interests from your real estate holdings: to benefit your succession plan.

Ownership transition

A common and generally effective way to separate the ownership of real estate from a company is to form a distinct entity, such as a limited liability company (LLC) or a limited liability partnership (LLP), to hold legal title to the property. Your business will then rent the property from the entity in a tenant-landlord relationship.

Using this strategy can help you transition ownership of your company to one or more chosen successors, or to reward employees for strong performance. By holding real estate in a separate entity, you can sell shares in the company to the successors or employees without transferring ownership of the real estate.

In addition, retaining title to the property will allow you to collect rent from the new owners. Doing so can be a valuable source of cash flow during retirement.

You could also realize estate planning benefits. When real estate is held in a separate legal entity, you can gift business interests to your heirs without giving up interest in the property.

Complex strategy

The details involved in separating the title to your real estate from your business can be complex. Our firm can help you determine whether this strategy would suit your company and succession plan, including a close examination of the potential tax benefits or risks. Call or email us today- 205-345-9898, info@covenantcpa.com.

© 2019 Covenant CPA

If a prime objective of your estate plan is to leave a lasting legacy, a dynasty trust may be the right estate planning vehicle for you. And, thanks to the substantially increased generation-skipping transfer (GST) tax exemption amount established by the Tax Cuts and Jobs Act, a dynasty trust is more appealing than ever.

GST tax and dynasty trusts

A dynasty trust allows substantial amounts of wealth to grow and compound free of federal gift, estate and GST taxes, providing tax-free benefits for your grandchildren and future generations. The longevity of a dynasty trust varies from state to state, but it’s becoming more common for states to allow these trusts to last for hundreds of years or even in perpetuity.

Avoiding GST tax liability is critical to a dynasty trust’s success. An additional 40% tax on transfers to grandchildren or others that skip a generation, the GST tax can quickly consume substantial amounts of wealth. The key to avoiding the tax is to leverage your $11.40 million GST tax exemption.

For example, let’s say you haven’t used any of your $11.40 million combined gift and estate tax exemption. In 2019, you transfer $10 million to a properly structured dynasty trust. There’s no gift tax on the transaction because it’s within your unused exemption amount. And the funds, together with all future appreciation, are removed from your taxable estate.

Most important, by allocating your GST tax exemption to your trust contributions, you ensure that any future distributions or other transfers of trust assets to your grandchildren or subsequent generations will avoid GST taxes. This is true even if the value of the assets grows well beyond the exemption amount or the exemption is reduced in the future.

Setting up a dynasty trust

A dynasty trust can be established during your lifetime, as an inter vivos trust or part of your will as a testamentary trust. An inter vivos transfer to a dynasty trust may have additional benefits associated with transferring assets that have greater appreciation potential out of your taxable estate.

After creating the trust, you must determine which assets to transfer to it. Because the emphasis is on protecting appreciated property, consider funding the trust with securities, real estate, life insurance policies and business interests.

Finally, you must appoint a trustee. Your choices may include a succession of family members or estate planning professionals. For most people, however, a safer approach is to use a reputable trust company with a proven track record, as opposed to assigning this duty to family members who might not be born yet.

If you think a dynasty trust might be right for your family, talk with us before taking action. A currently effective dynasty trust is irrevocable — meaning that, once you create it, you may be unable to modify the arrangement if your family dynamic changes. Contact us with questions at 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA

Planning your estate around specific assets is risky and, in most cases, should be avoided. If you leave specific assets — such as homes, cars or stock — to specific people, you may inadvertently disinherit them.

Illustrating the problem

Let’s say Debbie has three children — Abbie, Mary Kate and Lizzie — and wishes to treat them equally in her estate plan. In her will, Debbie leaves a $500,000 mutual fund to Abbie and her home valued at $500,000 to Mary Kate. She also names Lizzie as beneficiary of a $500,000 life insurance policy.

When Debbie dies years later, the mutual fund balance has grown to $750,000. In addition, she had sold the home for $750,000, invested the proceeds in the mutual fund and allowed the life insurance policy to lapse. But she neglected to revise her will. The result? Abbie receives the mutual fund, with a balance of $1.5 million, and Mary Kate and Lizzie are disinherited.

Even if Debbie continued to own the home, it could have declined in value after she drafted her will (rather than increased), leaving Mary Kate with less than her sisters.

Avoiding this outcome

It’s generally preferable to divide your estate based on dollar values or percentages rather than specific assets. Debbie, for example, could have placed the mutual fund, home and insurance policy in a trust and divided the value of the trust equally between her three children.

If it’s important to you that specific assets go to specific heirs — for example, because you want your oldest child to receive the family home or you want your family business to go to a child who works for the company — there are planning techniques you can use to avoid undesired consequences. For example, your trust might provide for your assets to be divided equally but also provide for your children to receive specific assets at fair market value as part of their shares. If you have questions regarding the division of your assets to your heirs, contact us. We can review your plan and address your concerns. 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA

Spring and summer are the optimum seasons for selling a home. And interest rates are currently attractive, so buyers may be out in full force in your area. Freddie Mac reports that the average 30-year fixed mortgage rate was 4.14% during the week of May 2, 2019, while the 15-year mortgage rate was 3.6%. This is down 0.41 and 0.43%, respectively, from a year earlier.

But before you contact a realtor to sell your home, you should review the tax considerations.

Sellers can exclude some gain

If you’re selling your principal residence, and you meet certain requirements, you can exclude up to $250,000 ($500,000 for joint filers) of gain. Gain that qualifies for the exclusion is also excluded from the 3.8% net investment income tax.

To qualify for the exclusion, you must meet these tests:

  1. The ownership test. You must have owned the property for at least two years during the five-year period ending on the sale date.
  2. The use test. You must have used the property as a principal residence for at least two years during the same five-year period. (Periods of ownership and use don’t need to overlap.)

In addition, you can’t use the exclusion more than once every two years.

Handling bigger gains 

What if you’re fortunate enough to have more than $250,000/$500,000 of profit when selling your home? Any gain that doesn’t qualify for the exclusion generally will be taxed at your long-term capital gains rate, provided you owned the home for at least a year. If you didn’t, the gain will be considered short term and subject to your ordinary-income rate, which could be more than double your long-term rate.

Other tax issues

Here are some additional tax considerations when selling a home:

Keep track of your basis. To support an accurate tax basis, be sure to maintain thorough records, including information on your original cost and subsequent improvements, reduced by any casualty losses and depreciation claimed based on business use.

Be aware that you can’t deduct a loss. If you sell your principal residence at a loss, it generally isn’t deductible. But if part of your home is rented out or used exclusively for your business, the loss attributable to that portion may be deductible.

If you’re selling a second home (for example, a vacation home), be aware that it won’t be eligible for the gain exclusion. But if it qualifies as a rental property, it can be considered a business asset, and you may be able to defer tax on any gains through an installment sale or a Section 1031 exchange. Or you may be able to deduct a loss.

Your home is probably your largest investment. So before selling it, make sure you understand the tax implications. We can help you plan ahead to minimize taxes and answer any questions you have about your situation. Call or email us- 205-345-9898, info@covenantcpa.com.

© 2019 CovenantCPA

Estate planning isn’t just about what happens to your assets after you die. It’s also about protecting yourself and your loved ones. This includes having a plan for making critical medical decisions in the event you’re unable to make them yourself. And, as with other aspects of your estate plan, the time to act is now, while you’re healthy. If an illness or injury renders you unconscious or otherwise incapacitated, it will be too late.

Without a plan that expresses your wishes, your family may have to make medical decisions on your behalf or petition a court for a conservatorship. Either way, there’s no guarantee that these decisions will be made the way you would want, or by the person you would choose.

2 documents, 2 purposes

To ensure that your wishes are carried out, and that your family is spared the burden of guessing — or arguing over — what you would decide, put those wishes in writing. Generally, that means executing two documents: 1) a living will and 2) a health care power of attorney (HCPA).

Unfortunately, these documents are known by many different names, which can lead to confusion. Living wills are sometimes called “advance directives,” “health care directives” or “directives to physicians.” And HCPAs may also be known as “durable medical powers of attorney,” “durable powers of attorney for health care” or “health care proxies.” In some states, “advance directive” refers to a single document that contains both a living will and an HCPA.

For the sake of convenience, we’ll use the terms “living will” and “HCPA.” Regardless of terminology, these documents basically serve two important purposes: 1) to guide health care providers in the event you become unable to communicate or are unconscious, and 2) to appoint someone you trust to make medical decisions on your behalf.

Living will

A living will expresses your preferences for the use of life-sustaining medical procedures, such as artificial feeding and breathing, surgery, invasive diagnostic tests, and pain medication. It also specifies the situations in which these procedures should be used or withheld.

Living wills often contain a do not resuscitate order (DNR), which instructs medical personnel to not perform CPR in the event of cardiac arrest.

HCPA

An HCPA authorizes a surrogate — your spouse, child or another trusted representative — to make medical decisions or consent to medical treatment on your behalf if you’re unable to do so. It’s broader than a living will, which generally is limited to end-of-life situations, although there may be some overlap.

An HCPA might authorize your surrogate to make medical decisions that don’t conflict with your living will, including consenting to medical treatment, placing you in a nursing home or other facility, or even implementing or discontinuing life-prolonging measures.

It’s a good idea to have both a living will and an HCPA or, if allowed by state law, a single document that combines the two. Contact us if you have questions regarding either document 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA