Sometimes estates that are large enough for estate taxes to be a concern are asset rich but cash poor, without the liquidity needed to pay those taxes. An intrafamily loan is one option. While a life insurance policy can be used to cover taxes and other estate expenses, a benefit of using an intrafamily loan is that, if it’s properly structured, the estate can deduct the full amount of interest upfront. Doing so reduces the estate’s size and, thus, its estate tax liability.
Deducting the interest
An estate can deduct interest if it’s a permitted expense under local probate law, actually and necessarily incurred in the administration of the estate, ascertainable with reasonable certainty, and will be paid. Under probate law in most jurisdictions, interest is a permitted expense. And, generally, interest on a loan used to avoid a forced sale or liquidation is considered “actually and necessarily incurred.”
To ensure that interest is “ascertainable with reasonable certainty,” the loan terms shouldn’t allow prepayment and should provide that, in the event of default, all interest for the remainder of the loan’s term will be accelerated. Without these provisions, the IRS or a court would likely conclude that future interest isn’t ascertainable with reasonable certainty and would disallow the upfront deduction. Instead, the estate would deduct interest as it’s accrued and recalculate its estate tax liability in future years.
The requirement that interest “will be paid” generally isn’t an issue, unless there’s some reason to believe that the estate won’t be able to generate sufficient income to cover the interest payments.
Ensuring the loan is bona fide
For the interest to be deductible, the loan also must be bona fide. A loan from a bank or other financial institution shouldn’t have any trouble meeting this standard.
But if the loan is from a related party, such as a family-controlled trust or corporation, the IRS may question whether the transaction is bona fide. So the parties should take steps to demonstrate that the transaction is a true loan.
Among other things, they should:
- Set a reasonable interest rate (based on current IRS rates),
- Execute a promissory note,
- Provide for collateral or other security to ensure the loan is repaid,
- Pay the interest payments in a timely manner, and
- Otherwise treat the loan as an arm’s-length transaction.
It’s critical that the loan’s terms be reasonable and that the parties be able to demonstrate a “genuine intention to create a debt with a reasonable expectation of repayment.”
If you’re considering making an intrafamily loan, contact us at 205-345-9898. We’d be pleased to answer any questions you may have.
© 2018 Covenant CPA
Will you be age 50 or older on December 31? Are you still working? Are you already contributing to your 401(k) plan or Savings Incentive Match Plan for Employees (SIMPLE) up to the regular annual limit? Then you may want to make “catch-up” contributions by the end of the year. Increasing your retirement plan contributions can be particularly advantageous if your itemized deductions for 2018 will be smaller than in the past because of changes under the Tax Cuts and Jobs Act (TCJA).
Catch-up contributions are additional contributions beyond the regular annual limits that can be made to certain retirement accounts. They were designed to help taxpayers who didn’t save much for retirement earlier in their careers to “catch up.” But there’s no rule that limits catch-up contributions to such taxpayers.
So catch-up contributions can be a great option for anyone who is old enough to be eligible, has been maxing out their regular contribution limit and has sufficient earned income to contribute more. The contributions are generally pretax (except in the case of Roth accounts), so they can reduce your taxable income for the year.
More benefits now?
This additional reduction to taxable income might be especially beneficial in 2018 if in the past you had significant itemized deductions that now will be reduced or eliminated by the TCJA. For example, the TCJA eliminates miscellaneous itemized deductions subject to the 2% of adjusted gross income floor — such as unreimbursed employee expenses (including home-off expenses) and certain professional and investment fees.
If, say, in 2018 you have $5,000 of expenses that in the past would have qualified as miscellaneous itemized deductions, an additional $5,000 catch-up contribution can make up for the loss of those deductions. Plus, you benefit from adding to your retirement nest egg and potential tax-deferred growth.
Other deductions that are reduced or eliminated include state and local taxes, mortgage and home equity interest expenses, casualty and theft losses, and moving expenses. If these changes affect you, catch-up contributions can help make up for your reduced deductions.
2018 contribution limits
Under 2018 401(k) limits, if you’re age 50 or older and you have reached the $18,500 maximum limit for all employees, you can contribute an extra $6,000, for a total of $24,500. If your employer offers a SIMPLE instead, your regular contribution maxes out at $12,500 in 2018. If you’re 50 or older, you’re allowed to contribute an additional $3,000 — or $15,500 in total for the year.
But, check with your employer because, while most 401(k) plans and SIMPLEs offer catch-up contributions, not all do. Also keep in mind that additional rules and limits apply.
Catch-up contributions are also available for IRAs, but the deadline for 2018 contributions is later: April 15, 2019. And whether your traditional IRA contributions will be deductible depends on your income and whether you or your spouse participates in an employer-sponsored retirement plan. Please contact us at 205-345-9898 for more information about catch-up contributions and other year-end tax planning strategies.
© 2018 Covenant CPA
One could say that there are only two key milestones in retirement planning: the day you begin participating in a retirement savings account and the day you begin drawing money from it. But, of course, there are others as well.
One is the day you turn 50 years old. Why? Because those age 50 or older on December 31 of any given year can start making “catch-up” contributions to their employer-sponsored retirement plans by that date. These are additional contributions to certain retirement accounts beyond the regular annual limits.
Maybe you haven’t yet saved as much for retirement as you’d like to. Or perhaps you’d just like to make the most of tax-advantaged savings opportunities. Whatever the case may be, let’s get caught up with the latest catch-up contribution amounts.
401(k)s and SIMPLEs
Under 2018 401(k) limits, if you’re age 50 or older, after you’ve reached the $18,500 maximum limit for all employees, you can contribute an extra $6,000, for a total of $24,500. If your employer offers a Savings Incentive Match Plan for Employees (SIMPLE) instead, your regular contribution maxes out at $12,500 in 2018. If you’re 50 or older, you’re allowed to contribute an additional $3,000 — or $15,500 in total for the year.
But, check with your employer because, while most 401(k) plans and SIMPLEs offer catch-up contributions, not all do.
If you’re self-employed, retirement plans such as an individual 401(k) — or solo 401(k) — also allow catch-up contributions. A solo 401(k) is a plan for those with no other employees. You can defer 100% of your self-employment income or compensation, up to the regular yearly deferral limit of $18,500, plus a $6,000 catch-up contribution in 2018. But that’s just the employee salary deferral portion of the contribution.
You can also make an “employer” contribution of up to 20% of self-employment income or 25% of compensation. The total combined employee-employer contribution is limited to $55,000, plus the $6,000 catch-up contribution.
Catch-up contributions to non-Roth accounts not only can enlarge your retirement nest egg, but also can reduce your 2018 tax liability. And keep in mind that catch-up contributions are available for IRAs, too, but the deadline for 2018 contributions is April 15, 2019. If you have questions about catch-up contributions or other retirement saving strategies, please contact us.
© 2018 Covenant CPA