Generally, the proceeds of your life insurance policy are included in your taxable estate. You can remove them by transferring ownership of the policy, but there’s a catch: If you wait too long, your intentions may be defeated. Essentially, if ownership of the policy is transferred within three years of your death, the proceeds revert to your taxable estate.

Eliminating “incidents of ownership”

The proceeds of a life insurance policy are subject to federal estate tax if you retain any “incidents of ownership” in the policy. For example, you’re treated as having incidents of ownership if you have the right to:

  • Designate or change the policy’s beneficiary,
  • Borrow against the policy or pledge any cash reserve,
  • Surrender, convert or cancel the policy, or
  • Select a payment option for the beneficiary.

You can eliminate these incidents of ownership by transferring your policy. But first you need to determine who the new owner should be. To choose the best owner, consider why you want the insurance, such as to replace income, to provide liquidity or to transfer wealth to your heirs.

Understanding the ILIT option

An irrevocable life insurance trust (ILIT) can be one of the best ownership alternatives. Typically, if you transfer complete ownership of, and responsibility for, the policy to an ILIT, the policy will ― subject to the three years mentioned above ― be excluded from your estate. You’ll need to designate a trustee to handle the administrative duties. It might be a family member, a friend or a professional. Should you need any additional life insurance protection, it would work best if it were acquired by the ILIT from the outset.

An ILIT can also help you accomplish other estate planning objectives. It might be used to keep assets out of the clutches of creditors or to protect against spending sprees of your relatives. Also keep in mind that, as long as the policy has a named beneficiary, which in the case of an ILIT would be the ILIT itself, the proceeds of the life insurance policy won’t have to pass through probate.

The sooner, the better

If transferring ownership of your life insurance policy is right for you, the sooner you make the transfer, the better. Contact us with any questions regarding life insurance in your estate plan or ILITs.

© 2020 Covenant CPA

What happens if illness, injury or age-related dementia renders you unable to make decisions or communicate your wishes regarding your health care or financial affairs? Unless your estate plan addresses these situations, your family may be forced to seek a court-appointed guardian. Health care arrangements are particularly important because your wishes won’t necessarily coincide with someone else’s judgment about what’s “in your best interests.”

To help ensure that your wishes are carried out, create a health care power of attorney (HCPOA). Sometimes referred to as a “health care proxy” or “durable medical power of attorney,” an HCPOA appoints a representative to make medical decisions on your behalf if you’re unable to do so.

Choose a representative

Who should be your representative? The natural inclination may be to name your spouse or an adult child. This may be the right choice, but not always.

Consider whether the family member has a differing view on when to continue or terminate life-sustaining measures or would find it too difficult to make such decisions. Designate someone you trust to carry out your wishes.

Detail your health-care-related wishes

Your HCPOA should provide guidance on how to make health care decisions. Although it’s impossible to anticipate every potential scenario, the document can provide your representative with guiding principles.

For example: What are your desired health outcomes? Is your top priority to extend your life? Is artificial nutrition or hydration an option? Under what circumstances should life-sustaining treatment be withheld or terminated?

Additional documents

Another important document to have in place is a living will — which communicates your preferences regarding life-sustaining medical treatment in the event you are dying of a terminal condition or an end-stage condition. Also consider a revocable trust and durable power of attorney to provide for a trusted representative to manage your financial affairs in the event you’re unable to do so.

© 2020 Covenant CPA

Do you own a business with one or more individuals? Undoubtedly, your interest in the business represents a substantial part of your net worth and is likely your “pride and joy.” So it’s normal if your fondest wish is for the business to continue long after you’re gone or for you to keep it running if a co-owner or partner dies.

However, if adequate provisions aren’t made, the business may flounder if a leadership void isn’t filled. Or bitter family disputes may tear the organization apart. In the end, a “distress sale” may leave your heirs with substantially less than the company’s current value.

Fortunately, disastrous results may be avoided if you have a buy-sell agreement drafted during your lifetime. The agreement can dictate how the business is sold, to whom and for how much. Life insurance policies are often used to fund the transaction.

Buy-sell agreements in a nutshell

A buy-sell agreement may be used for virtually every type of business entity, including C corporations, S corporations, partnerships and limited liability companies. Typically, it applies to the shares of stock and any business real estate held by respective owners.

Although variations exist, the agreement essentially provides for the sale of a business interest to other owners or partners, the business entity itself, or a hybrid. Alternatively, the agreement may cover a sale to one or more long-time employees.

The agreement, which is typically signed by all affected parties, imposes restrictions on the future sale of the business or property. For instance, if you intend to leave a business interest to your children, you may provide for each child to sell or transfer his or her interest to another party or parties named in the agreement, such as grandchildren or other relatives.

Significantly, a buy-sell agreement often establishes a formula for determining the sale price of the business and its components. The formula may be based on financial statement figures, such as book value, adjusted book value, or the weighted average of historical earnings, or a combination of variables.

Understanding the benefits

Having a valid buy-sell agreement in writing removes much of the uncertainty that can happen when a business owner passes away. It provides a “ready, willing and able” buyer who’s arranged to purchase shares under the formula or at a fixed price. There’s no argument about what the business is worth among co-owners, partners or family members.

The buy-sell agreement addresses a host of problems about co-ownership of assets. For instance, if you have one partner who dies first, the partnership shares might pass to a family member who has a different vision for the future than you do.

Work with us to design a buy-sell agreement that helps preserve the value of your business for your family.

© 2020 Covenant CPA

With the federal gift and estate tax exemption now at a record high $11.58 million for 2020, most estates aren’t taxable. But that doesn’t mean making lifetime gifts isn’t without significant benefits — even if your estate isn’t taxable under the current rules. Let’s examine reasons why gifting remains an important part of estate planning.

Lifetime gifts reduce estate taxes

If your estate exceeds the exemption amount — or you believe it will in the future — regular lifetime gifts can substantially reduce your estate tax bill. The annual gift tax exclusion allows you to give up to $15,000 per recipient annually tax-free without using up any of your gift and estate tax exemption. In addition, direct payments of tuition or medical expenses on behalf of your loved ones are excluded from gift tax.

Taxable gifts — meaning gifts beyond the annual exclusion amount and not eligible for the tuition and medical expense exclusion — can also reduce estate tax liability by removing future appreciation from your taxable estate. You may be better off paying gift tax on an asset’s current value rather than estate tax on its appreciated value down the road.

When gifting appreciable assets, however, be sure to consider the potential income tax implications. Property transferred at death receives a “stepped-up basis” equal to its date-of-death fair market value, which means the recipient can turn around and sell the property free of capital gains taxes. Property transferred during life retains your tax basis, so it’s important to weigh the estate tax savings against the potential income tax costs.

Tax laws aren’t permanent

Even if your estate is within the exemption amount now, it pays to make regular gifts. Why? Because even though the Tax Cuts and Jobs Act doubled the exemption amount, and that amount will be adjusted annually for inflation, the doubling expires after 2025. Without further legislation, the exemption will return to an inflation-adjusted $5 million in 2026.

The good news is that the IRS issued final regulations in late 2019 that should provide comfort to taxpayers interested in making large gifts under the current gift and estate tax regime. 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.

Gifts provide nontax benefits

Tax planning aside, there are other reasons to make lifetime gifts. For example, perhaps you wish to use gifting to shape your family members’ behavior — for example, by providing gifts to those who attend college.

Regardless of the amount of your wealth, consider a program of regular lifetime giving. We can help you devise and incorporate a gifting program as part of your estate plan.

© 2020 Covenant CPA

Oh, no, your original will is missing!

In a world that’s increasingly paperless, you’re likely becoming accustomed to conducting a variety of transactions digitally. But when it comes to your last will and testament, only an original, signed document will do.

The original vs. a photocopy

Many people mistakenly believe that a photocopy of a signed will is sufficient. In fact, most states require that a deceased’s original will be filed with the county clerk and, if probate is necessary, presented to the probate court.

If your family or executor can’t find your original will, there’s a presumption in most states that you destroyed it with the intent to revoke it. That means the court will generally administer your estate as if you died without a will.

It’s possible to overcome this presumption. For example, if all interested parties agree that a signed copy reflects your wishes, they may be able to convince a court to admit it. But to avoid costly, time-consuming legal headaches, it’s best to ensure that your family can locate your original will when they need it.

Storage solutions

There isn’t one right place to keep your will — it depends on your circumstances and your comfort level with the storage arrangements. Wherever you decide to keep your will, it’s critical that 1) it be stored safely, and 2) your family knows how to find it.

Options include:

  • Having your accountant, attorney or another trusted advisor hold your will and making sure your family knows how to contact him or her.
  • Storing your will at your home or office in a fireproof lockbox or safe and ensuring that someone you trust knows where it is and how to retrieve it.

Storing your original will and other estate planning documents safely — and communicating their location to your loved ones — will help ensure that your wishes are carried out. Contact us if you have questions regarding your will or other estate planning documents.

© 2020 Covenant CPA

You may use a qualified disclaimer to refuse a bequest from a loved one. Doing so will cause an asset to bypass your estate and go to the next beneficiary in line. What are the reasons you’d take this action? Here are five reasons:

1. Gift and estate tax savings. This is often cited as the main incentive for using a qualified disclaimer. For starters, the unlimited marital deduction shelters all transfers between spouses from gift and estate tax. In addition, transfers to nonspouse beneficiaries, such as your children and grandchildren, may be covered by the gift and estate tax exemption.

Currently, the exemption can shelter a generous $11.58 million in assets for 2020. By maximizing portability of any unused exemption amount, a married couple can effectively pass up to $23.16 million in 2020 to their heirs free of gift and estate taxes.

However, despite these lofty amounts, wealthier individuals, including those who aren’t married and can’t benefit from the unlimited marital deduction or portability, still might have estate tax liability concerns. By using a disclaimer, you ensure that the exemption won’t be further eroded by the inherited amount. Assuming you don’t need the money, shifting the funds to the younger generation without it ever touching your hands can save gift and estate tax for the family as a whole.

2. Generation-skipping transfer (GST) tax. Disclaimers may also be useful in planning for the GST tax. This tax applies to most transfers that skip a generation, such as bequests and gifts from a grandparent to a grandchild or comparable transfers through trusts. Like the gift and estate tax exemption, the GST tax exemption is $11.58 million for 2020.

If GST tax liability is a concern, you may wish to disclaim an inheritance. For instance, if you disclaim a parent’s assets, the parent’s exemption can shelter the transfer from the GST tax when the inheritance goes directly to your children. The GST tax exemption for your own assets won’t be affected.

3. Family businesses. A disclaimer may also be used as a means for passing a family-owned business to the younger generation. By disclaiming an interest in the business, you may be able to position stock ownership to your family’s benefit.

4. Creditor protection. Any inheritance you receive would immediately be subject to creditors’ claims. It might be possible to avoid dire results by using a disclaimer to protect these assets. However, state laws and federal bankruptcy laws may defeat or hinder this goal. Consult with your estate planning advisor about your specific situation.

5. Charitable deductions. In some cases, a charitable contribution may be structured to provide a life estate, with the remainder going to a charitable organization. Without the benefit of a charitable remainder trust, an estate won’t qualify for a charitable deduction in this instance, but using a disclaimer can provide a deduction because the assets will pass directly to the charity.   

Before you make a final decision on whether to accept a bequest or use a qualified disclaimer to refuse it, contact us for guidance.

© 2020 Covenant CPA

It’s August, and that means it’s time to get ready to go back to school for many students. If your child recently graduated from high school and is heading to college in the next few weeks, besides assembling the essentials — such as clothing, toiletries, bedding and a laptop — consider having your child “pack” a few estate planning documents that he or she may need at this stage of life.

Needless to say, having all the necessary financial and medical documents may be more important than ever because of the COVID-19 pandemic. And even if your student is staying home to participate in online learning this year, having these documents prepared now can provide peace of mind when he or she returns to campus.

Let’s take a closer look at four such documents:

1. Health care power of attorney. With a health care power of attorney (sometimes referred to as a “health care proxy” or “durable medical power of attorney”), your child appoints someone — probably you or his or her other parent — to make health care decisions on his or her behalf should he or she be unable to do so. A health care power of attorney should provide guidance on how to make health care decisions. Although it’s impossible to anticipate every potential scenario, the document can provide guiding principles.

2. HIPAA authorization. To accompany the health care power of attorney, Health Insurance Portability and Accountability Act (HIPAA) authorization gives health care providers the ability to share information about your child’s medical condition with you. Absent a HIPAA authorization, making health care decisions could be more difficult.

3. Financial power of attorney. A financial power of attorney appoints someone to make financial decisions or execute transactions on your child’s behalf under certain circumstances. For example, a power of attorney might authorize you to handle your child’s financial affairs while he or she is out of the country studying abroad or, in the case of a “durable” power of attorney, incapacitated.

4. Will. Although your child is still in his or her upper teens or early twenties, he or she may not be too young to have a will drawn up. This is especially true if your child owns assets. A will is a legal document that arranges for the distribution of property after a person dies. It names an executor or personal representative who’ll be responsible for overseeing the estate as it goes through probate.

If you have questions about any of these documents, don’t hesitate to give us a call. We can help provide peace of mind that your child’s health and financial affairs are properly handled.

© 2020 Covenant CPA

You’ve probably seen it in the movies or on TV: A close-knit family gathers to find out what’s contained in the will of a wealthy patriarch or matriarch. When the terms are revealed, a niece, for example, benefits at the expense her uncle, causing a ruckus. This “bad blood” continues to boil between estranged family members, who won’t even speak to one another.

Unfortunately, a comparable scenario can play out in real life if you don’t make proper provisions. With some planning, you can avoid family disputes or at least minimize the chances of your will being contested by your loved ones.

Start at the beginning

Before you (and your spouse, if married) set the table for your will, which is the centerpiece of any comprehensive estate plan, discuss estate matters with close family members who’ll likely be affected. This may include children, siblings, adult grandchildren and possibly others. Present an outline regarding the disposition of your assets and other important aspects.

This doesn’t mean you should be specific about everything in the will, but it’s a good idea to provide a basic overview of your estate. Consider the input of other family members; don’t just pay lip service to their feedback. In fact, they may raise issues that you hadn’t taken into account.

This meeting — which may require several sessions — may head off potential problems and better prepare your heirs. It certainly avoids the kind of “shockers” often depicted on screen.

Means of protection

Although there are no absolute guarantees, consider the following methods for bulletproofing your will from a legal challenge:

Draft a no-contest clause. Also called an “in terrorem clause,” this language provides that, if any person in your will challenges it, he or she is excluded from your estate. It’s often used to thwart contests to a will.

This puts the onus squarely on the beneficiary. If he or she asserts that the estate isn’t divided equitably, the beneficiary risks receiving nothing. Be aware that, in some states, this clause may not be enforceable or may be subject to certain exceptions.

Choose witnesses wisely. You may want to use witnesses who know you well, such as close friends or business associates. They can convincingly state that you were of sound mind when you made out the will. You also may want to choose witnesses who are in good health, preferably younger than you and easily traceable.

Obtain a physician’s note. A note from a physician about your health status is recommended. For instance, it can state that you have the requisite mental capacity to make estate planning decisions and thus will be useful in avoiding legal challenges.

Last but not least

After your will is drafted, don’t make the mistake of putting it in a safe where you may forget about it. Review it periodically with your attorney. By fine-tuning the will, you improve the likelihood that it’ll deter a legal challenge and, if necessary, prevail in court. Contact us with any questions regarding your will.

© 2020 Covenant CPA

Nearly everyone owns at least some digital assets, such as online bank and brokerage accounts, bill-paying services, cloud-based document storage, digital music collections, social media accounts, and domain names. But what happens to these assets when you die or if you become incapacitated?

The answer depends on several factors, including the terms of your service agreements with the custodians of digital assets, applicable laws and the terms of your estate plan. To reduce uncertainty, address your digital assets in your estate plan.

Pass on passwords

The simplest way to provide your family, executor or trustee with access to your digital assets is to leave a list of accounts and login credentials in a safe deposit box or other secure location. The disadvantage of this approach is that you’ll need to revise the list every time you change your password or add a new account. For this reason, consider storing this information using password management software and providing the master password to your representatives.

Or, you can use an online service designed for digital estate planning. These services store up-to-date information about your digital assets and establish procedures for releasing it to your designated beneficiary after your death or if you become incapacitated.

Know the law

Although sharing login credentials with your representatives is important, it’s no substitute for covering digital assets in your estate plan. For one thing, a third party who accesses your account without formal authorization may violate federal or state privacy laws.

In addition, many states have laws, such as the Uniform Fiduciary Access to Digital Assets Act (UFADAA), that establish default rules regarding access to digital assets by executors, trustees and other fiduciaries. If those rules are inconsistent with your wishes, you’ll want to modify them in your plan.

The UFADAA allows people to provide for the disposition of digital assets using online settings offered by the account provider. For example, Facebook enables users to specify whether their accounts will be deleted or memorialized if they die and to designate a “legacy contact” to maintain their memorial pages.

The act also allows people to establish rules in their wills, trusts or powers of attorney. If users don’t have specific instructions regarding digital assets, the act allows the account provider’s service agreement to override default rules.

Take inventory

To ensure that your wishes are carried out, take inventory of your digital assets now. Then, talk to us about including these important assets in your estate plan.

© 2020 Covenant CPA

If you have adopted children or unadopted stepchildren, estate planning is critical to ensure that your property is distributed the way you desire.

Adopted children

Adopted children are placed on an equal footing with biological children in most situations for estate planning purposes. Thus, adopted and biological children are treated the same way under a state’s intestate succession laws, which control who inherits property in the absence of a will.

In addition, adopted children generally are treated identically to biological children for purposes of wills or trusts that provide for gifts or distributions to a class of persons, such as “children,” “grandchildren” or “lineal descendants” — even if the child was adopted after the will or trust was executed.

Unadopted stepchildren

Stepchildren generally don’t have any inheritance rights with respect to their parents’ new spouses unless the spouse legally adopts them. If you have stepchildren and want them to share in your estate, you should amend your estate plan to provide for them expressly.

Of course, you can also consider adoption, but you shouldn’t adopt stepchildren only for estate planning reasons. Adoption gives you all of the legal rights and responsibilities of a parent during your life, so that must be carefully considered.

Adoption will also affect the adopted children’s ability to inherit from (or through) their other biological parent’s relatives. In most states, when a child is adopted by a stepparent, the adoption decree severs the parent-child relationship with the other biological parent and his or her family.

That means the child can’t inherit from that biological parent’s branch of the family — and vice versa — through intestate succession. For example, if Jane is adopted by her stepfather, Steve, the adoption would terminate Jane’s intestate succession rights with respect to her biological father, Ed, and consequently, Ed’s family.

Most states provide an exception for certain “family realignments.” From the previous example, let’s suppose that Ed is deceased. In that case, Steve’s adoption of Jane wouldn’t sever the connection to Ed’s family. If, for example, Ed’s sister Emily dies intestate, Jane will be included in the class of heirs. In a state that doesn’t recognize a family realignment exception, however, Jane won’t be considered Emily’s heir.

If you wish to exclude stepchildren from your estate, in most cases it’s sufficient to do nothing. But some states permit stepchildren to inherit through intestate succession under certain circumstances.

Put it in writing

To ensure your desired treatment of adopted children or stepchildren, the best strategy is for you and your spouse or partner to spell out your wishes in wills, trusts and other estate planning documents. As with most estate planning issues, relying on the laws of intestate succession can lead to unwelcome surprises. Contact us with your questions.

© 2020 Covenant CPA