Are you a multitasker? If so, you may appreciate an estate planning technique that can convert assets into a stream of lifetime income, provide a current tax deduction and leave the remainder to your favorite charity — all in one fell swoop. It’s the aptly named charitable remainder trust (CRT).
A CRT in action
You can set up one of two CRT types: a charitable remainder annuity trust (CRAT) or a charitable remainder unitrust (CRUT) and fund it with assets you own. The trust then pays out income to the designated beneficiary or beneficiaries — for example, the trust creator or a spouse — for life or a term of 20 years or less. Alternatively, if certain requirements are met, you can choose to have income paid to your children, other family members or an entity.
If it suits your needs, you may postpone taking income distributions until a later date. In the meantime, the assets in the CRT (ideally) continue to appreciate in value.
Typically, a CRT is funded with income-producing assets, such as real estate, securities and even stock in your own company. (Note: S corporation stock can’t be used for this purpose.) These assets may be supplemented by cash deposits or the transfer can be all cash.
When you transfer assets to the CRT, you qualify for a current tax deduction based on several factors, including the value of the assets at the time of transfer, the ages of the income beneficiaries and the Section 7520 rate. Generally, the greater the payout, the lower the deduction.
A matter of control
An important decision relating to a CRT is naming the trustee to manage its affairs. The trustee should be someone with the requisite financial acumen and knowledge of your personal situation. Thus, it could be an advisor, an institutional entity, a family member, a close friend or even you.
Because of the significant dollars at stake, many trust creators opt for a professional, perhaps someone who specializes in managing trust assets. If you’re leaning toward this option, interview several candidates and consider factors such as experience, investment performance and level of services provided.
If you decide to take on the task yourself, consider using a third-party professional to handle most of the paperwork and provide other support.
During the CRT’s term, it’s the trustee — not the charity — who calls the shots. The trustee is obligated to adhere to the terms of the trust and follow your instructions. Thus, you still maintain some measure of control. In fact, you may retain the right to change the trustee if you become dissatisfied or designate a different charity to receive the remainder assets.
Is a CRT right for you?
The short answer is that it depends on your specific circumstances. Be aware that a CRT is irrevocable. In other words, once it’s executed, there’s no going back and you generally can’t make other changes. So, you must be fully committed to this approach. Contact us with any questions.
© 2020 Covenant CPA
The annual gift tax exclusion allows you to transfer up to $15,000 per beneficiary gift-tax-free for 2020, without tapping your lifetime gift and estate tax exemption. And you can double the exclusion to $30,000 per beneficiary if you elect to split the gifts with your spouse.
It’s important to understand the rules surrounding gift-splitting to avoid unintended — and potentially costly — consequences.
Understanding the pitfalls
Common mistakes made when splitting gifts include:
Failing to make the election. To elect to split gifts, the donor must file a gift tax return and the nondonor must consent by checking a box on the return and signing it or, if a gift exceeds $30,000, filing his or her own gift tax return. Once you make the election, you must split all gifts to third parties for the year.
Splitting gifts with a noncitizen. To be eligible for gift-splitting, one spouse must be a U.S. citizen.
Divorcing and remarrying. To split gifts, you must be married at the time of the gift. You’re ineligible for gift-splitting if you divorce and either spouse remarries during the calendar year in which the gift was made.
Gifting a future interest. Gift-splitting can be used only for present interests. So, a gift in trust qualifies only if the beneficiary receives a present interest — for example, by providing the beneficiary with so-called Crummeywithdrawal rights.
Benefiting your spouse. Gift-splitting is ineffective if you make the gift to your spouse, rather than a third party; if you give your spouse a general power of appointment over the gifted property; or if your spouse is a potential beneficiary of the gift. For example, if you make a gift to a trust of which your spouse is a beneficiary, gift-splitting is prohibited unless the chances your spouse will benefit are extremely remote.
Be aware that, if you die within three years of splitting a gift, some of the tax benefits may be lost.
Extended gift tax return deadline is approaching
Remember that when you elect to split gifts with your spouse, you, the donor, must file a gift tax return and your spouse, the nondonor, must consent by checking a box on the return and signing it. Bear in mind that because of the COVID-19 pandemic, the IRS extended the gift tax filing deadline to July 15, 2020, so now is the time to act. Contact us with any questions regarding making gifts.
© 2020 Covenant CPA
You may have good intentions in keeping a trust a secret from its beneficiaries. Perhaps you have concerns that, if your children or other beneficiaries know about the trust, they might set aside educational or career pursuits. Be aware, however, that the law in many states forbids this practice by requiring a trust’s trustee to disclose a certain amount of information about the trust to the beneficiaries.
More states enforce the Uniform Trust Code
The Uniform Trust Code (UTC), which now 34 states (and the District of Columbia) have adopted, requires a trustee to provide trust details to any qualified beneficiary who makes a request. The UTC also requires the trustee to notify all qualified beneficiaries of their rights to information about the trust.
Qualified beneficiaries include primary beneficiaries, such as your children or others designated to receive distributions from the trust, as well as contingent beneficiaries, such as your grandchildren or others who would receive trust funds in the event a primary beneficiary’s interest terminates.
Consider a power of appointment
One way to avoid UTC disclosure requirements is by not naming your children as beneficiaries and, instead, granting your spouse or someone else a power of appointment over the trust. The power holder can direct trust funds to your children as needed, but because they’re not beneficiaries, the trustee isn’t required to inform them about the trust’s terms — or even its existence. The disadvantage of this approach is that the power holder is under no legal obligation to provide for your children.
Turn to us for help
Before taking action, it’s important to check the law in your state. Some states allow you to waive the trustee’s duty to disclose, while others allow you to name a third party to receive disclosures and look out for beneficiaries’ interests. In states where disclosure is unavoidable, you may want to explore alternative strategies. If you have questions regarding trusts in your estate plan, please contact us.
© 2020 Covenant CPA
Transferring a family business to the next generation requires a delicate balancing act. Estate and succession planning strategies aren’t always compatible, and family members often have conflicting interests. By starting early and planning carefully, however, it’s possible to resolve these conflicts and transfer the business in a tax-efficient manner.
Ownership vs. management succession
One reason transferring a family business is such a challenge is the distinction between ownership and management succession. From an estate planning perspective, transferring assets to the younger generation as early as possible allows you to remove future appreciation from your estate, minimizing estate taxes. However, you may not be ready to hand over the reins of your business or you may feel that your children aren’t yet ready to take over.
There are several ways owners can transfer ownership without immediately giving up control, including:
- Using a family limited partnership (FLP),
- Transferring nonvoting stock, or
- Establishing an employee stock ownership plan.
Another reason to separate ownership and management succession is to deal with family members who aren’t involved in the business. It’s not unusual for a family business owner to have substantially all of his or her wealth tied up in the business.
Providing heirs outside the business with nonvoting stock or other equity interests that don’t confer control can be an effective way to share the wealth with them while allowing those who work in the business to take over management.
Conflicting financial needs
Another challenge presented by family businesses is that the older and younger generations may have conflicting financial needs. Fortunately, strategies are available to generate cash flow for the owner while minimizing the burden on the next generation. They include:
An installment sale. This provides liquidity for the owner while improving the chances that the younger generation’s purchase can be funded by cash flows from the business. Plus, so long as the price and terms are comparable to arm’s-length transactions between unrelated parties, the sale shouldn’t trigger gift or estate taxes.
A grantor retained annuity trust (GRAT). By transferring business interests to a GRAT, the owner obtains a variety of gift and estate tax benefits (provided he or she survives the trust term) while enjoying a fixed income stream for a period of years. At the end of the term, the business is transferred to the owner’s children or other beneficiaries. GRATs are typically designed to be gift-tax-free.
An installment sale to an intentionally defective grantor trust (IDGT). Essentially a properly structured IDGT allows an owner to sell the business on a tax-advantaged basis while enjoying an income stream and retaining control during the trust term. Once the installment payments are complete, the business passes to the owner’s beneficiaries free of gift taxes.
Each family business is different, so it’s important to identify appropriate strategies in light of your objectives and resources. We’d be pleased to help.
© 2020 Covenant CPA
Using a revocable trust — sometimes referred to as a “living trust” — is a common estate planning strategy to manage one’s assets during life and to avoid probate at death. For the trust to be effective, you must “fund” it, meaning transferring ownership of your assets to the trust.
Perhaps you have collectible automobiles or other vehicle types. Should you consider transferring them to your revocable trust? If you still owe money on an auto loan, the lender may not allow you to transfer the title to the trust. But even if you own the vehicle outright (whether you paid cash for it or a loan has been paid off), there are risks in making such a transfer.
Steer clear of pitfalls
As the vehicle’s owner, the trust will be responsible in the event the vehicle is involved in an accident, exposing other trust assets to liability claims that aren’t covered by insurance. So you need to name the trust as an insured party on your liability insurance policy.
On the other hand, because you’re personally liable either way, owning a vehicle through your revocable trust may not be a big concern during your life. After your death, when the trust becomes irrevocable, an accident involving a trust-owned vehicle can place the other trust assets at risk.
Keeping a vehicle out of the trust eliminates this risk. The downside, of course, is that the vehicle may be subject to probate. However, some states offer streamlined procedures for transferring certain vehicles to heirs.
Turn to us for directions
Are you considering transferring automobiles or other vehicles to your revocable trust so they can avoid probate? Before taking action, it’s important to understand the pitfalls of such a move. Contact us with for additional details.
© 2020 Covenant CPA
The novel coronavirus (COVID-19) pandemic has caused some people to contemplate their own mortality or that of a family member. For those whose life expectancies are short — because of COVID-19 or for other reasons — estate planning can be difficult. But while money matters may be the last thing you want to think about when time is limited, a little planning can offer you and your family financial peace of mind.
Action steps to take
Here are some (but by no means all) of the steps you should take if you have a short life expectancy. These steps are also helpful if a loved one has been told that time is limited.
Gather documents. Review all estate planning documents, including your:
- Revocable or “living” trust,
- Other trusts,
- General power of attorney, and
- Advance medical directive, such as a “living will” or health care power of attorney.
Make sure these documents are up-to-date and continue to meet your estate planning objectives. Modify them as appropriate.
Take inventory. Catalog all your assets and liabilities, estimate their value, and determine how assets are titled to ensure that they’ll pass to their intended recipients. For example, do you own assets jointly with your ex-spouse? If so, title will pass to your ex-spouse on your death. There may be steps you can take to separate your interest in the property and dispose of it as you see fit.
If you have a safe deposit box, make sure someone is authorized to open it. If you have a personal safe, be sure that someone you trust knows its location and combination.
Review beneficiary designations. Take another look at beneficiary designations in your IRAs, pension plans, 401(k) plans and other retirement accounts, insurance policies, annuities, deferred compensation plans and other assets. Make sure a beneficiary is named and that the designation continues to meet your wishes. For example, a divorced individual may find that an ex-spouse is still named as beneficiary of a life insurance policy.
Review digital assets. Ensure that your family or representatives will have access to digital assets, such as email accounts, online bank and brokerage accounts, online photo galleries, digital music and book collections, social media accounts, websites, domain names, and cloud-based documents. You can do this by creating a list of usernames and passwords or by making arrangements with the custodians of these assets to provide access to your authorized representatives.
Gaining peace of mind
Although facing your own mortality can be difficult, great peace of mind can come from ensuring that your estate plan fulfills your wishes and minimizes the tax burden on your family. Contact us with any questions regarding your estate plan.
© 2020 Covenant CPA
Some of the most effective estate planning strategies involve setting up irrevocable trusts. For a trust to be deemed irrevocable, you, the grantor, lose all incidents of ownership of the trust’s assets. In other words, you’re effectively removing those assets from your taxable estate.
But what if you’re uncomfortable placing your assets beyond your control? What happens if your financial fortunes take a turn for the worse after you’ve irrevocably transferred a sizable portion of your wealth? This may be an especially pertinent question in light of the current economic downturn resulting from the novel coronavirus (COVID-19) pandemic.
If you’re married, and feel as though your marriage is strong, a spousal lifetime access trust (SLAT) allows you to obtain the benefits of an irrevocable trust while creating a financial backup plan.
A SLAT in action
A SLAT is simply an irrevocable trust that authorizes the trustee to make distributions to your spouse if needs arise. Like other irrevocable trusts, a SLAT can be designed to benefit your children, grandchildren or future generations. You can use your lifetime gift tax and generation-skipping transfer tax exemptions (currently, $11.58 million each) to shield contributions to the trust, as well as future appreciation, from transfer taxes. And the trust assets also receive some protection against claims by your beneficiaries’ creditors, including any former spouses.
The key benefit of a SLAT is that by naming your spouse as a lifetime beneficiary you retain indirect access to the trust assets. You can set up the trust to make distributions based on an “ascertainable standard” — such as your spouse’s health, education, maintenance or support — or you can give the trustee full discretion to distribute income or principal to your spouse.
To keep the trust assets out of your taxable estate, you must not act as trustee. You can appoint your spouse as trustee, but only if distributions are limited to an ascertainable standard. If you desire greater flexibility over distributions to your spouse, appoint an independent trustee. Also, the trust document must prohibit distributions in satisfaction of your legal support obligations.
Another critical requirement is to fund the trust with your separate property. If you use marital or community property, there’s a risk that the trust assets will end up in your spouse’s estate.
Understand the pitfalls
There’s a significant risk inherent in the SLAT strategy: If your spouse predeceases you, or if you and your spouse divorce, you’ll lose your indirect access to the trust assets. One way to mitigate this risk is to use dual SLATs. In other words, you and your spouse each establish an irrevocable trust using your separate property and naming each other as lifetime beneficiaries.
If you’re considering using a SLAT, or would like to learn about other estate planning strategies, contact us to learn more about the benefits and risks.
© 2020 Covenant CPA
There are several tools you can use to build flexibility into your estate plan. Flexibility is especially important now because of an uncertain estate planning environment.
The federal gift and estate tax exemption currently is an inflation-adjusted $11.58 million (the highest it’s ever been) but it’s scheduled to drop to its pre-2018 level of $5 million (indexed for inflation) on January 1, 2026. This window of opportunity could close sooner, however, depending on the results of this fall’s election. One of the most versatile tools available to add flexibility to your estate plan is the power of appointment.
How does it work?
A power of appointment is simply a provision in your estate plan that permits another person — a beneficiary, family member or trusted advisor, for example — to determine how, when and to whom certain assets in your estate or trust will be distributed. The person who receives a power of appointment is called the “holder.”
These powers come in several forms. A testamentary power of appointment allows the holder to direct the distribution of assets at death through his or her will or trust. An inter vivos power of appointment allows the holder to determine the disposition of assets during his or her lifetime.
Powers may be general or limited. A general power of appointment allows the holder to distribute assets to anyone, including him- or herself. A limited power has one or more restrictions. In most cases, limited powers don’t allow holders to distribute assets for their own benefit (unless distributions are strictly based on “ascertainable standards” related to the holder’s health, education or support). Typically, limited powers authorize the holder to distribute assets among a specific class of people. For example, you might give your daughter a limited power of appointment to distribute assets among her children.
The distinction between general and limited powers has significant tax implications. Assets subject to a general power are included in the holder’s taxable estate, even if the holder doesn’t execute the power. Limited powers generally don’t expose the holder to gift or estate tax liability.
Dealing with uncertainty
Powers of appointment provide flexibility and enhance the chances that you’ll achieve your estate planning goals. They allow you to postpone the determination of how your wealth will be distributed until the holder has all the relevant facts. If you’d like to build more certainty into your estate plan, please contact us.
© 2020 Covenant CPA
The novel coronavirus (COVID-19) pandemic has refocused people’s thoughts on the health and safety of their families. In addition to taking the necessary steps today to protect your loved ones, it’s equally important to consider their financial security in the future.
If you don’t have a will, drafting one should be your first step in developing a comprehensive estate plan. Because of stay-at-home orders in many states, it may be tempting to turn to online do-it-yourself (DIY) tools that promise to help you create a will (and other estate planning documents). Even though this may be a relatively cheap option, using these online tools is risky except in the simplest cases.
A will that isn’t executed properly under state law isn’t legally binding. Therefore, your assets may be divided according to state intestacy laws, regardless of your intentions. And, if you have young children, a court may appoint their legal guardian.
No “one-size-fits-all” solution
Despite what you might have read online, there’s no single prototype for wills. It’s complicated because the laws can vary widely from state to state. For instance, some states recognize oral wills, while others don’t. Or a state may require two or even three attesting witnesses.
One common mistake of DIY wills is leaving out important provisions that can lead to challenges in the future. Case in point: If the will doesn’t include a residuary clause addressing amounts that are “left over” after estate debts and tax payments have been settled, an unspecified party could walk away with a large sum of money. It might even be a family member you had wanted to “disinherit.”
Turn to a professional
The bottom line is that there is too much risk by taking shortcuts when it comes to drafting your will. Have your will drafted and executed by a reputable attorney. Questions? Contact us.
© 2020 Covenant CPA
If you have outstanding loans to your children, grandchildren or other family members, consider forgiving those loans to take advantage of the current, record-high $11.58 million gift and estate tax exemption. Bear in mind that in 2026, the exemption amount will revert to $5 million ($10 million for married couples), indexed for inflation.
Under the right circumstances, an intrafamily loan can be a powerful estate planning tool because it allows you to transfer wealth to your loved ones free of gift taxes — to the extent the loan proceeds achieve a certain level of returns. But an outright gift is a far more effective way to transfer wealth, provided you don’t need the interest income and have enough unused exemption to shield it from transfer taxes.
Do intrafamily loans save taxes?
Generally, to ensure the desired tax outcome, an intrafamily loan must have an interest rate that equals or exceeds the applicable federal rate (AFR) at the time the loan is made. The principal and interest are included in the lender’s estate, so the key to transferring wealth tax-free is for the borrower to invest the loan proceeds in a business, real estate or other opportunity whose returns outperform the AFR.
The excess of these investment returns over the interest expense is essentially a tax-free gift to the borrower. Intrafamily loans work best in a low-interest-rate environment, when it’s easier to outperform the AFR.
Why forgive a loan?
An intrafamily loan is an attractive estate planning tool if you’ve already used up your exemption or if you wish to save it for future transfers. But if you have exemption to spare, forgiving an intrafamily loan allows you to transfer the entire loan principal plus any accrued interest tax-free, not just the excess of the borrower’s returns over the AFR.
It can be a strategy for taking advantage of the increased exemption amount before it disappears at the end of 2025. Of course, if you need the funds for your own living expenses, loan forgiveness may not be an option.
What about income taxes?
Before you forgive an intrafamily loan, consider any potential income tax issues for you and the borrower. In most cases, forgiving a loan to a loved one is considered a gift, which generally has no income tax consequences for either party.
Although forgiveness of a loan sometimes results in cancellation of debt (COD) income to the borrower, the tax code recognizes an exception for debts canceled as a “gift, bequest, devise or inheritance.” There’s also an exception for a borrower who’s insolvent at the time the debt is forgiven. But be careful: If there’s evidence that forgiving a loan isn’t intended as a gift — for example, if the borrower doesn’t have the cash needed to make the loan payments but isn’t technically insolvent — the IRS may argue that the borrower has COD income.
We can assist you in determining whether forgiving loans is a good strategy and, if it is, help implement that strategy without triggering unwanted tax consequences.
© 2020 Covenant CPA