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
Forensic accountants have many tools to help them find evidence of hidden assets or fraud. But one of the most effective, particularly in divorce matters or legal disputes with former business partners, is a lifestyle analysis. This method involves developing a financial profile of a subject and then examining mismatches between the person’s known resources and lifestyle.
Forensic accountants develop a financial profile of a subject by examining:
Bank deposits. The expert reconstructs the subject’s income by analyzing bank deposits, canceled checks and currency transactions, as well as accounts for cash payments from undeposited receipts and non-income cash sources, such as gifts and insurance proceeds.
Expenditures. Here, the expert analyzes the subject’s personal income sources and uses of cash during a given time period. If the person is spending more than he or she is taking in, the excess likely is unreported income.
Assets. Experts assume that unsubstantiated increases in a subject’s net worth reflect unreported income. To estimate net worth, an expert reviews bank and brokerage statements, real estate records, and loan and credit card applications.
Proving that a person has unreported income is one thing. Tracing that income to assets or accounts that can be used to support a legal claim or enforce a judgment is another story. To do this, forensic accountants may scrutinize the assets noted above, as well as insurance policies, court filings, employment applications, credit reports and tax returns.
Tax returns can be particularly useful because people have strong incentives to prepare accurate returns. For example, they may fear being charged with tax evasion if they lie to the IRS. As a result, tax return entries often reveal clues about assets or income that someone is otherwise attempting to conceal. Another potentially fruitful strategy is to interview people with knowledge about the subject’s finances, such as accountants, real estate agents and business partners.
Note that building a financial profile of someone other than a spouse in a divorce matter or a former business partner in a legal dispute can be challenging. In the case of occupational fraud suspects, experts may know the individual’s salary and have access to publicly available information such as real estate sale and purchase records and court filings. But they need a court’s authorization to request bank and tax records and other personal data.
Can’t fool the experts
The good news is that people who try to conceal income and assets usually can’t fool experienced fraud investigators. Contact us to conduct a lifestyle analysis.
© 2020 Covenant CPA
The business use of websites is widespread. But surprisingly, the IRS hasn’t yet issued formal guidance on when Internet website costs can be deducted.
Fortunately, established rules that generally apply to the deductibility of business costs, and IRS guidance that applies to software costs, provide business taxpayers launching a website with some guidance as to the proper treatment of the costs.
Hardware or software?
Let’s start with the hardware you may need to operate a website. The costs involved fall under the standard rules for depreciable equipment. Specifically, once these assets are up and running, you can deduct 100% of the cost in the first year they’re placed in service (before 2023). This favorable treatment is allowed under the 100% first-year bonus depreciation break.
In later years, you can probably deduct 100% of these costs in the year the assets are placed in service under the Section 179 first-year depreciation deduction privilege. However, Sec. 179 deductions are subject to several limitations.
For tax years beginning in 2020, the maximum Sec. 179 deduction is $1.04 million, subject to a phaseout rule. Under the rule, the deduction is phased out if more than a specified amount of qualified property is placed in service during the year. The threshold amount for 2020 is $2.59 million.
There’s also a taxable income limit. Under it, your Sec. 179 deduction can’t exceed your business taxable income. In other words, Sec. 179 deductions can’t create or increase an overall tax loss. However, any Sec. 179 deduction amount that you can’t immediately deduct is carried forward and can be deducted in later years (to the extent permitted by the applicable limits).
Similar rules apply to purchased off-the-shelf software. However, software license fees are treated differently from purchased software costs for tax purposes. Payments for leased or licensed software used for your website are currently deductible as ordinary and necessary business expenses.
Was the software developed internally?
An alternative position is that your software development costs represent currently deductible research and development costs under the tax code. To qualify for this treatment, the costs must be paid or incurred by December 31, 2022.
A more conservative approach would be to capitalize the costs of internally developed software. Then you would depreciate them over 36 months.
If your website is primarily for advertising, you can also currently deduct internal website software development costs as ordinary and necessary business expenses.
Are you paying a third party?
Some companies hire third parties to set up and run their websites. In general, payments to third parties are currently deductible as ordinary and necessary business expenses.
What about before business begins?
Start-up expenses can include website development costs. Up to $5,000 of otherwise deductible expenses that are incurred before your business commences can generally be deducted in the year business commences. However, if your start-up expenses exceed $50,000, the $5,000 current deduction limit starts to be chipped away. Above this amount, you must capitalize some, or all, of your start-up expenses and amortize them over 60 months, starting with the month that business commences.
We can determine the appropriate treatment of website costs for federal income tax purposes. Contact us if you have questions or want more information.
© 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?
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