Virtually everyone needs an estate plan, but it isn’t a one-size-fits-all proposition. Even though each person’s situation is unique, general guidelines can be drawn depending on your current stage of life.
The early years
If you’ve recently embarked on a career, gotten married or both, now is the time to build the foundation for your estate plan. And, if you’ve recently started a family, estate planning is even more critical.
Your will is at the forefront. Essentially, this document divides up your accumulated wealth upon death by deciding who gets what, where, when and how. With a basic will, you may, for instance, leave all your possessions to your spouse. If you have children, you might bequeath some assets to them through a trust managed by a designated party.
A will also designates the guardian of your children if you and your spouse should die prematurely. Make sure to include a successor in case your first choice is unable to meet the responsibilities.
During your early years, your will may be supplemented by other documents, including trusts, if it makes sense personally. In addition, you may have a durable power of attorney that authorizes someone to manage your financial affairs if you’re incapacitated. Frequently, the agent will be your spouse. Also, obtain insurance protection appropriate for your lifestyle.
The middle years
If you’re a middle-aged parent, your main financial goals might be to acquire a home, or perhaps a larger home, and to set aside enough money to cover retirement goals and put your children through college. So you should modify your existing estate planning documents to meet your changing needs.
For instance, if you have a will in place, you should periodically review and revise it to reflect your current circumstances. Typically, minor revisions to a will can be achieved through a codicil. If significant changes are required, your attorney can rewrite the will entirely.
If you and your spouse decide to divorce, it’s critical to review and revise your estate plan to avoid unwanted outcomes.
The later years
Once you’ve reached retirement, you can usually relax somewhat, assuming you’re in good financial shape. But that doesn’t mean estate planning ends. It’s just time for the next chapter.
If you haven’t already done so, have your attorney draft a living will to complement a health care power of attorney. This document provides guidance in life-ending situations and can ease the stress for loved ones.
Finally, create or fine-tune, if you already have one written, a letter of instructions. Although not legally binding, it can provide an inventory of assets and offer directions concerning your financial affairs.
Revisit your plan periodically
Regardless of the stage of life you’re currently in, it’s important to bear in mind that your estate plan isn’t a static document. We can help review and revise your plan as needed.
© 2020 Covenant CPA
If you reside in a high-tax state, you may want to consider using nongrantor trusts to soften the blow of the $10,000 federal limit on state and local tax (SALT) deductions. The limit can significantly reduce itemized deductions if your state income and property taxes are well over $10,000. A potential strategy for avoiding the limit is to transfer interests in real estate to several nongrantor trusts, each of which enjoys its own $10,000 SALT deduction.
Grantor vs. nongrantor trusts
The main difference between a grantor and nongrantor trust is that a grantor trust is treated as your alter ego for tax purposes, while a nongrantor trust is treated as a separate entity. Traditionally, grantor trusts have been the vehicle of choice for estate planning purposes because the trust’s income is passed through to you, as grantor, and reported on your tax return.
That’s an advantage, because it allows the trust assets to grow tax-free, leaving more for your heirs. By paying the tax, you essentially provide an additional, tax-free gift to your loved ones that’s not limited by your gift tax exemption or annual gift tax exclusion. In addition, because the trust is an extension of you for tax purposes, you have the flexibility to sell property to the trust without triggering taxable gain.
Now that fewer families are subject to gift taxes, grantor trusts enjoy less of an advantage over nongrantor trusts. This creates an opportunity to employ nongrantor trusts to boost income tax deductions.
Nongrantor trusts in action
A nongrantor trust is a discrete legal entity, which files its own tax returns and claims its own deductions. The idea behind the strategy is to divide real estate that’s subject to more than $10,000 in property taxes among several trusts, each of which has its own SALT deduction up to $10,000. Each trust must also generate sufficient income against which to offset the deduction.
Before you attempt this strategy, beware of the multiple trust rule of Internal Revenue Code Section 643(f). That section provides that, under regulations prescribed by the U.S. Treasury Department, multiple trusts may be treated as a single trust if they have “substantially the same grantor or grantors and substantially the same primary beneficiary or beneficiaries” and a principal purpose of the arrangement is tax avoidance.
Bear in mind that to preserve the benefits of multiple trusts, it’s important to designate a different beneficiary for each trust.
Pass the SALT
If you’re losing valuable tax deductions because of the SALT limit, consider passing those deductions on to one or more nongrantor trusts. Consult with us before taking action, because these trusts must be structured carefully to ensure that they qualify as nongrantor trusts and don’t run afoul of the multiple trust rule.
© 2020 Covenant CPA
The Tax Cuts and Jobs Act created a new program to encourage investment in economically distressed areas through generous tax incentives. The Qualified Opportunity Zone (QOZ) program relies on investments in Qualified Opportunity Funds (QOFs) — funds that can provide wealthy taxpayers with some new avenues for estate planning.
3 big tax benefits
Investors in QOFs stand to reap three significant tax breaks:
- They can defer capital gains on the disposition of appreciated property by reinvesting the gains in a QOF within 180 days of disposition. The tax is deferred until the QOF investment is sold or Dec. 31, 2026, whichever is earlier.
- Depending on how long they hold their QOF investment, they can eliminate 10% to 15% of the tax.
- After 10 years, post-acquisition appreciation on the investment is tax-exempt.
By incorporating QOFs in your estate planning, you can reduce both capital gains and transfer tax liabilities.
Estate planning implications
Proposed regulations make clear that a QOF investor’s death isn’t an “inclusion event” that would trigger tax on the deferred gains. In addition, most of the activities involved in administering an estate or trust (for example, transferring the interest to the estate or distributing the interest) won’t trigger the gain. But the sale of the QOF interest by the estate, the trust or a beneficiary would. Gifts of QOF interests also are generally considered inclusion events that make the deferred gains immediately taxable.
You could avoid this, though, by gifting your interest to a grantor trust. Both revocable living trusts and irrevocable grantor trusts qualify. However, transfers to the latter are completed gifts and therefore produce greater potential tax savings in situations where the income and gains of the trust are taxed to the grantor, in turn reducing the grantor’s estate by the amount of income taxes paid. (Note, though, that the termination of grantor trust status for reasons other than the grantor’s death is treated as an inclusion event.)
For example, you could transfer a highly appreciated asset to an irrevocable trust with no gift tax under the federal gift and estate tax exemption ($11.40 million for 2019 and $11.58 million for 2020). The trust could sell the asset and defer the gains into a QOF investment.
Another option for transferring QOF interests is the grantor retained annuity trust (GRAT), which allows you to make a gift to a trust and receive an annuity interest roughly equal to the fair market value of the gift. Any appreciation beyond the amount required to pay the annuity also passes to the beneficiaries without gift tax.
Contact us for additional information.
© 2019 Covenant CPA
The IRS has issued final regulations that should provide comfort to taxpayers interested in making large gifts under the current gift and estate tax regime. The final regs generally adopt, with some revisions, proposed regs that the IRS released in November 2018.
The need for clarification
The Tax Cuts and Jobs Act (TCJA) temporarily doubled the gift and estate tax exemption from $5 million to $10 million for gifts made or estates of decedents dying after Dec. 31, 2017, and before Jan. 1, 2026. The exemption is adjusted annually for inflation ($11.40 million for 2019 and $11.58 million for 2020). After 2025, though, the exemption is scheduled to drop back to pre-2018 levels.
With the estate tax a flat 40%, the higher threshold for tax-free transfers of wealth would seem to be great news, but some taxpayers became worried about a so-called “clawback” if they die after 2025. Specifically, they wondered if they would lose the tax benefit of the higher exemption amount if they didn’t die before the exemption returned to the lower amount.
The concern was that a taxpayer would make gifts during his or her lifetime based on the higher exemption, only to have their credit calculated based on the amount in effect at the time of death. To address this fear, the final regs provide a special rule for such circumstances that allows the estate to compute its estate tax credit using the higher of the exemption amount applicable to gifts made during life or the amount applicable on the date of death.
Let’s say that you made $9 million in taxable gifts in 2019, while the exemption amount of $11.40 million is in effect. But you die after 2025, when the exemption drops to $6.8 million ($5 million adjusted for inflation).
Under the new regs, the credit applied to compute the estate tax is based on the $9 million of the $11.4 million exemption used to compute the gift tax credit. In other words, your estate won’t have to pay tax on the $2.2 million in gifts that exceeds the exemption amount at death ($9 million less $6.8 million), and the credit to the estate tax will reflect the $2.4 million of the amount remaining after the gifts were made ($11.4 million less $9 million).
If, however, you made taxable gifts of only $4 million, the new regs won’t apply. The total amounts allowable as a credit when calculating the gift tax ($4 million) is less than the credit based on the $6.8 million exemption amount at death. So, the estate tax credit is based on the exemption amount at death, rather than the amount under the TCJA.
Even though the TCJA and the final regs provide a strong tax incentive to transfer assets, it’s important to remember that the offer is “use it or lose it.” The new regs apply only to gifts made during the 2018-2025 period, so contact us now to formalize your gifting strategies.
© 2019 Covenant CPA
With the lifetime gift and estate tax exemption at $11.40 million for 2019 ($11.58 million for 2020), you may think you don’t have to worry about gift and estate taxes.
However, there are no guarantees that estate tax law won’t be revised in the future or that your accumulated assets won’t eventually exceed the available exemption (which is scheduled to drop significantly in 2026). Thus, there’s a need to investigate other tax-saving possibilities.
Beyond annual exclusion gifts
Under the annual gift tax exclusion, you can reduce your taxable estate without using up any of your lifetime exemption by giving each recipient gifts valued up to $15,000 a year. For example, if you have three children and seven grandchildren, you can give each one $15,000 tax free, for a total of $150,000 in 2019. If your spouse joins in the gifts, the tax-free total is doubled to $300,000.
But what if you want to give away more without dipping into your lifetime exemption? Then direct payments of medical expenses or tuition may be right for you.
Ins and outs of direct payments
If you pay medical expenses on behalf of someone directly to a health care provider, those payments are exempt from gift tax above and beyond any amount covered by the annual gift tax exclusion. The same is true for paying the tuition expenses of a student directly to the school.
For example, if you give your granddaughter $15,000 in 2019 and then pay her $35,000 tuition bill at an elite private college, the entire $50,000 is sheltered from gift tax. But remember that the gift must be made directly to the educational institution (or health care provider). If you give the money to your granddaughter and she uses it to pay the tuition, the amount won’t be eligible for the direct payment exemption.
On the other hand, direct payments of tuition can reduce a student’s eligibility for financial aid on a dollar-for-dollar basis, while with gifts made directly to the student, only 20% of the gifted assets would be counted as assets of the student for financial aid purposes. Accordingly, careful analysis of the trade-offs between the potential tax savings and impairment of financial aid eligibility should be considered. Contact us with any questions.
© 2019 Covenant CPA
The word “probate” may conjure images of lengthy delays waiting for wealth to be transferred and bitter disputes among family members. Plus, probate records are open to the public, so all your “dirty linen” may be aired. The reality is that probate doesn’t have to be so terrible, and often isn’t, but both asset owners and their heirs should know what’s in store.
In basic terms, probate is the process of settling an estate and passing legal title of ownership of assets to heirs. If the deceased person has a valid will, probate begins when the executor named in the will presents the document in the county courthouse. If there’s no will — the deceased has died “intestate” in legal parlance — the court will appoint someone to administer the estate. Thereafter, this person becomes the estate’s legal representative.
Probate is predicated on state law, so the exact process varies from state to state. This has led to numerous misconceptions about the length of probate. On average, the process takes six to nine months, but it can run longer for complex situations in certain states.
Planning to avoid probate
Certain assets are automatically exempt from probate. But you also may be able to avoid the process with additional planning. The easiest way to do this is through the initial form of ownership or use of a living trust.
By using joint ownership with rights of survivorship, you acquire the property with another party, such as your spouse. The property then automatically passes to the surviving joint tenant on the death of the deceased joint tenant. This form of ownership typically is used when a married couple buys a home or other real estate. Similarly, with a tenancy by entirety, which is limited to married couples, the property goes to the surviving spouse without being probated.
A revocable living trust is often used to avoid probate and protect privacy. The assets transferred to the trust, managed by a trustee, pass to the designated beneficiaries on your death. Thus, you may coordinate your will with a living trust, providing a quick transfer of wealth for some assets. You can act as the trustee and retain control over these assets during your lifetime.
Achieving all estate planning goals
When it comes to probate planning, discuss your options with family members to develop the best approach for your personal situation. Also, bear in mind that avoiding probate should be only one goal of your estate plan. We can help you develop a strategy that minimizes probate while reducing taxes and achieving your other goals.
© 2019 Covenant CPA
The Tax Cuts and Jobs Act (TCJA) reduced individual income tax rates, but it left the 3.8% net investment income tax (NIIT) in place. It’s important to address the NIIT in your estate plan, because it can erode your earnings from interest, dividends, capital gains and other investments, leaving less for your heirs.
How it works
The NIIT applies to individuals with modified adjusted gross income (MAGI) over $200,000. The threshold is $250,000 for joint filers and qualifying widows or widowers and $125,000 for married taxpayers filing separately. The tax is equal to 3.8% of 1) your net investment income, or 2) the amount by which your MAGI exceeds the threshold, whichever is less.
Suppose, for example, that you’re married filing jointly and you have $350,000 in MAGI. Presuming $125,000 in net investment income, your NIIT is 3.8% of $100,000 (the excess of your MAGI over the threshold, which is less than your net investment income), or $3,800.
Nongrantor trusts — with limited exceptions — are also subject to the NIIT, and at a much lower threshold: For 2019, the tax applies to the lesser of 1) the trust’s undistributed net investment income or 2) the amount by which the trust’s AGI exceeds $12,751.
Reducing the tax
You can reduce or eliminate the NIIT by lowering your MAGI, lowering your net investment income, or both. Techniques for doing so include:
- Reducing this year’s MAGI by deferring income, accelerating expenses or maxing out contributions to retirement accounts,
- Selling poor-performing investments to offset the losses against investment gains you’ve realized during the year, or
- Reducing net investment income by investing in tax-exempt municipal bonds or in growth stocks that generate little or no current income.
If you own an interest in a business, you may be able to reduce NIIT by increasing your level of participation. Income from a business in which you “materially participate” isn’t considered net investment income. (But keep in mind that increasing your participation may, in certain cases, trigger self-employment tax liability.)
For trusts, you can reduce or eliminate the NIIT by:
- Structuring them as grantor trusts,
- Distributing the trust’s income to its beneficiaries (remember, the NIIT applies only to undistributed income), or
- Shifting the trust’s investments into tax-exempt municipal bonds, growth stocks or tax-deferred investments (such as life insurance).
Keep in mind that, if you use a grantor trust, its income will be passed through to you as grantor, potentially increasing your personal liability for NIIT.
Review your plan
The NIIT can affect the financial performance of your personal investments as well as your trusts. To maximize the amount of wealth available for your heirs, be sure to consider strategies for reducing the impact of this tax. Contact us with any questions.
© 2019 Covenant CPA
There are good reasons why estate planning advisors recommend you revisit and, if necessary, revise your estate plan periodically: changing circumstances, including family situations and new tax laws. While it’s relatively simple to change a beneficiary, what if an irrevocable trust no longer serves your purposes? Depending on applicable state law, you may have options to fix a “broken” trust.
Reasons why a trust can break
A trust that works just fine when it’s established may no longer achieve its original goals if your family circumstances change. If you divorce, for example, a trust for the benefit of your spouse may no longer be desirable. If your children grow up to be financially independent, they may prefer that you leave your wealth to their children. Or perhaps you prefer not to share your wealth with a beneficiary who has developed a drug or alcohol problem or has proven to be profligate.
Another reason is new tax laws. Many trusts were created when gift, estate and generation-skipping transfer (GST) tax exemption amounts were relatively low. Today, however, the exemptions have risen to $11.4 million, so trusts designed to minimize gift, estate and GST taxes may no longer be necessary. And with transfer taxes out of the picture, the higher income taxes often associated with these trusts — previously overshadowed by transfer tax concerns — become a more important factor.
Here are possible remedies
If you have one or more trusts in need of repair, you may have several remedies at your disposal, depending on applicable law in the state where you live and, if different, in the state where the trust is located. Potential remedies include:
Re-formation. The Uniform Trust Code (UTC), adopted in more than half the states, provides several remedies for broken trusts. Non-UTC states may provide similar remedies. Re-formation allows you to ask a court to rewrite a trust’s terms to conform with the grantor’s intent. This remedy is available if the trust’s original terms were based on a legal or factual mistake.
Modification. This remedy may be available, also through court proceedings, if unanticipated circumstances require changes in order to achieve the trust’s purposes. Some states permit modification — even if it’s inconsistent with the trust’s purposes — with the consent of the grantor and all the beneficiaries.
Decanting. Many states have decanting laws, which allow a trustee, according to his or her distribution powers, to “pour” funds from one trust into another with different terms and even in a different location. Depending on your circumstances and applicable state law, decanting may allow a trustee to correct errors, take advantage of new tax laws or another state’s asset protection laws, add or eliminate beneficiaries, extend the trust term, and make other changes, often without court approval.
Before you make any changes, it’s critical to consult your attorney and tax advisor to discuss the potential benefits and risks.
© 2019 Covenant CPA
Despite what you might think, estate planning isn’t limited to only the rich and famous. In fact, your family is likely to benefit from a comprehensive plan that divides your wealth, protects your well-being and provides a compass for your family’s future.
Dividing your wealth
Estate planning is often associated with the division of your assets, and this is certainly a key component. It’s typically accomplished, for the most part, by drafting a will, which is the foundation of an estate plan.
With a valid will, you determine who gets what. It can cover everything from the securities in your portfolio to personal property, such as cars, artwork or other family heirlooms.
In contrast, if you die without a will — referred to as dying “intestate” — state law will control the disposition of your assets. This may result in unintended consequences. For example, children from a prior marriage may be excluded if state law dictates that all assets are to go to a surviving spouse.
In addition, you’ll need to name the executor of your estate. He or she will be responsible for carrying out your wishes according to your will. Your executor may be a professional, a family member or a friend. Also, designate a successor in case your first choice is unable to handle the duties.
If your estate plan includes only a will, your estate will most likely have to go through probate. Probate is a court-supervised process to protect the rights of creditors and beneficiaries and to ensure the orderly and timely transfer of assets. The complexity and duration of probate depends on the size of your estate and state law.
If you transfer assets to a living trust, those assets are exempt from the probate process. Thus, a living trust may supplement a will, giving heirs fast access to funds.
Protecting your well-being
An estate plan can help ensure that your long-term health care is handled in the way that you wish. Notably, you can create a health care power of attorney. It grants another person — for example, a family member or a friend — the right to act on your behalf in the event you’re incapacitated. A power of attorney may be coordinated with a living will specifying your wishes in end-of-life situations, along with other health care directives.
Providing a compass
Finally, an estate plan can accomplish a variety of other objectives, depending on your preferences and circumstances. If you have minor children, you can name a guardian in your will in the event of your premature death. Without such a provision, the courts will appoint a guardian, regardless of your intent.
Your estate plan can also protect against creditors, primarily through trusts designed for these purposes. Accordingly, while trusts were often seen mainly as tax-saving devices in the past, they can fulfill a multitude of other roles.
Let the planning begin
Now that the need for an estate plan is clear, don’t delay any longer. Contact us to begin the process or if you have any questions.
© 2019 Covenant CPA
Fewer people currently are subject to transfer taxes than ever before. But gift, estate and generation-skipping transfer (GST) taxes continue to place a burden on families with significant amounts of wealth tied up in illiquid closely held businesses, including farms.
Fortunately, Internal Revenue Code Section 6166 provides some relief, allowing the estates of family business owners to defer estate taxes and pay them in installments if certain requirements are met.
Sec. 6166 benefits
For families with substantial closely held business interests, an election to defer estate taxes under Sec. 6166 can help them avoid having to sell business assets to pay estate taxes. It allows an estate to pay interest only (at modest rates) for four years and then to stretch out estate tax payments over 10 years in equal annual installments. The goal is to enable the estate to pay the taxes out of business earnings or otherwise to buy enough time to raise the necessary funds without disrupting business operations.
Be aware that deferral isn’t available for the entire estate tax liability. Rather, it’s limited to the amount of tax attributable to qualifying closely held business interests.
Sec. 6166 requirements
Estate tax deferral is available if 1) the deceased was a U.S. citizen or resident who owned a closely held business at the time of his or her death, 2) the value of the deceased’s interest in the business exceeds 35% of his or her adjusted gross estate, and 3) the estate’s executor or other personal representative makes a Sec. 6166 election on a timely filed estate tax return.
To qualify as a “closely held business,” an entity must conduct an active trade or business at the time of the deceased’s death (and only assets used to conduct that trade or business count for purposes of the 35% threshold). Merely managing investment assets isn’t enough.
In addition, a closely held business must be structured as:
- A sole proprietorship,
- A partnership (including certain limited liability companies taxed as partnerships), provided either 1) 20% or more of the entity’s total capital interest is included in the deceased’s estate, or 2) the entity has a maximum of 45 partners, or
- A corporation, provided either 1) 20% or more of the corporation’s voting stock is included in the deceased’s estate, or 2) the corporation has a maximum of 45 shareholders.
Several special rules make it easier to satisfy Sec. 6166’s requirements. For example, if an estate holds interests in multiple closely held businesses, and owns at least 20% of each business, it may combine them and treat them as a single closely held business for purposes of the 35% threshold. In addition, the section treats stock and partnership interests held by certain family members as owned by the deceased.
On the other hand, the interests owned by corporations, partnerships, estates and trusts are attributed to the underlying shareholders, partners or beneficiaries. This can make it harder to stay under the 45-partner/shareholder limit.
Contact us with questions.
© 2019 Covenant CPA