With the federal gift and estate tax exemption at $11.40 million for 2019, people whose estates are below the exemption amount are shifting their focus to income tax reduction. High-income taxpayers — particularly those who live in high-income-tax states — may want to consider incomplete nongrantor trusts, which make it possible to eliminate state taxes on trust income.
Defining an incomplete nongrantor trust
Generally, trusts are classified as either grantor trusts or nongrantor trusts. In a grantor trust, you, as “grantor,” establish the trust and retain certain powers over it. You’re treated as the trust’s owner for income tax purposes and pay taxes on income generated by the trust assets.
In a nongrantor trust, you relinquish certain controls over the trust so that you aren’t considered the owner for income tax purposes. Instead, the trust becomes a separate legal entity, with income tax responsibility shifting to the trust itself. By setting up the trust in a no-income-tax state (typically by having it administered by a trust company located in that state), it’s possible to avoid state income taxes.
Ordinarily, when you contribute assets to a nongrantor trust you make a taxable gift to the trust beneficiaries. By structuring the trust as an incomplete nongrantor trust, you can avoid triggering gift taxes, or tapping your gift and estate tax exemption. This requires relinquishing just enough control to ensure nongrantor status, while retaining enough control so that transfers to the trust aren’t considered completed gifts for gift-tax purposes.
Analyzing the benefits
Although the trust will allow you to receive distributions, assets you place in the trust should produce income that you don’t need. If you take money out, trust taxable income could follow to you and be taxed in your state of residence.
Incomplete nongrantor trusts aren’t right for everyone. It depends on your particular circumstances and the tax laws in your home state.
While this strategy can produce significant state income tax savings, it may increase federal income taxes, depending on your individual tax bracket. Nongrantor trusts pay federal income taxes at the highest marginal rate (currently, 37%) once income reaches $12,700 for 2019, while the 37% rate threshold is $612,350 for married couples filing jointly and $510,300 for singles and heads of households. If you’re not in the 37% bracket, the increased federal income taxes the incomplete nongrantor trust would pay might outweigh the state income tax savings.
Also, if federal estate taxes aren’t a concern now but could be in the future — such as if your estate could exceed the estate tax exemption when it drops to an inflation-adjusted $5 million in 2026, as currently scheduled — be sure to consider the potential estate tax consequences. Incomplete gifts remain in your estate for estate tax purposes.
Is it right for you?
To determine whether an incomplete nongrantor trust is right for you, weigh the potential state income tax savings against the potential federal estate and income tax costs. Contact us with any questions at 205-345-9898.
© 2018 Covenant CPA
Those who run family-owned businesses often underestimate the need for a succession plan. After all, they say, we’re a family business — there will always be a family member here to keep the company going and no one will stand in the way.
Not necessarily. In one all-too-common scenario, two of the owner’s children inherit the business and, while one wants to keep the business in the family, the other is eager to sell. Such conflicts can erupt into open combat between heirs and even destroy the company. So, it’s important for you, as a family business owner, to create a formal succession plan — and to communicate it well before it’s needed.
Talk it out
A good succession plan addresses the death, incapacity or retirement of an owner. It answers questions now about future ownership and any potential sale so that successors don’t have to scramble during what can be an emotionally traumatic time.
The key to making any plan work is to clearly communicate it with all stakeholders. Allow your children to voice their intentions. If there’s an obvious difference between siblings, resolving that conflict needs to be central to your succession plan.
Perhaps the simplest option, if you have sufficient assets outside your business, is to leave your business only to those heirs who want to be actively involved in running it. You can leave assets such as investment securities, real estate or insurance policies to your other heirs.
Another option is for the heirs who’d like to run the business to buy out the other heirs. But they’ll need capital to do that. You might buy an insurance policy with proceeds that will be paid to the successor on your death. Or, as you near retirement, it may be possible to arrange buyout financing with your company’s current lenders.
If those solutions aren’t viable, hammer out a temporary compromise between your heirs. In a scenario where they are split about selling, the heirs who want to sell might compromise by agreeing to hold off for a specified period. That would give the other heirs time to amass capital to buy their relatives out or find a new co-owner, such as a private equity investor.
Family comes first
For a family-owned business, family should indeed come first. To ensure that your children or other relatives won’t squabble over the company after your death, make a succession plan that will accommodate all your heirs’ wishes. We can provide assistance, including helping you divide your assets fairly and anticipating the applicable income tax and estate tax issues. Call us at 205-345-9898.
© 2018 Covenant CPA
As the holidays approach and the year draws to a close, many taxpayers make charitable gifts — both in the spirit of the season and as a year-end tax planning strategy. But with the tax law changes that go into effect in 2018 and the many rules that apply to the charitable deduction, it’s a good idea to check deductibility before making any year-end donations.
Confirm you can still benefit from itemizing
Last year’s Tax Cuts and Jobs Act (TCJA) didn’t put new limits on or suspend the charitable deduction, like it did to many other itemized deductions. Nevertheless, it will reduce or eliminate the tax benefits of charitable giving for many taxpayers this year.
Itemizing saves tax only if itemized deductions exceed the standard deduction. For 2018 through 2025, the TCJA significantly increases the standard deduction, to $24,000 for married couples filing jointly, $18,000 for heads of households, and $12,000 for singles and married couples filing separately.
The nearly doubled standard deduction combined with the new limits or suspensions of some common itemized deductions means you may no longer have enough itemized deductions to exceed the standard deduction. And if that’s the case, your donations won’t save you tax.
So before you make any year-end charitable gifts, total up your potential itemized deductions for the year, including the donations you’re considering. If the total is less than your standard deduction, your year-end donations won’t provide a tax benefit.
You might, however, be able to preserve your charitable deduction by “bunching” donations into alternating years. This can allow you to exceed the standard deduction and claim a charitable deduction (and other itemized deductions) every other year.
Meet the delivery deadline
To be deductible on your 2018 return, a charitable gift must be made by Dec. 31, 2018. According to the IRS, a donation generally is “made” at the time of its “unconditional delivery.” The delivery date depends in part on what you donate and how you donate it. Here are a few examples for common donations:
Check. The date you mail it.
Credit card. The date you make the charge.
Stock certificate. The date you mail the properly endorsed stock certificate to the charity.
Make sure the organization is “qualified”
To be deductible, a donation also must be made to a “qualified charity” — one that’s eligible to receive tax-deductible contributions.
The IRS’s online search tool, Tax Exempt Organization Search, can help you easily find out whether an organization is eligible to receive tax-deductible charitable contributions. You can access this tool at http://apps.irs.gov/app/eos. Information about organizations eligible to receive deductible contributions is updated monthly. Remember that political donations aren’t deductible.
Consider other rules
We’ve discussed only some of the rules for the charitable deduction; many others apply. We can answer any questions you have about the deductibility of donations or changes to the standard deduction and itemized deductions. Call us today at 205-345-9898.
© 2018 Covenant CPA
Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2019. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
- File 2018 Forms W-2, “Wage and Tax Statement,” with the Social Security Administration and provide copies to your employees.
- Provide copies of 2018 Forms 1099-MISC, “Miscellaneous Income,” to recipients of income from your business where required.
- File 2018 Forms 1099-MISC reporting nonemployee compensation payments in Box 7 with the IRS.
- File Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” for 2018. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it’s more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 11 to file the return.
- File Form 941, “Employer’s Quarterly Federal Tax Return,” to report Medicare, Social Security and income taxes withheld in the fourth quarter of 2018. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until February 11 to file the return. (Employers that have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944,“Employer’s Annual Federal Tax Return.”)
- File Form 945, “Annual Return of Withheld Federal Income Tax,” for 2018 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on accounts such as pensions, annuities and IRAs. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 11 to file the return.
- File 2018 Forms 1099-MISC with the IRS if 1) they’re not required to be filed earlier and 2) you’re filing paper copies. (Otherwise, the filing deadline is April 1.)
- If a calendar-year partnership or S corporation, file or extend your 2018 tax return and pay any tax due. If the return isn’t extended, this is also the last day to make 2018 contributions to pension and profit-sharing plans.
Call us for help with your taxes at 205-345-9898.
© 2018 Covenant CPA