Are you considering replacing a car that you’re using in your business? There are several tax implications to keep in mind.
A cap on deductions
Cars are subject to more restrictive tax depreciation rules than those that apply to other depreciable assets. Under so-called “luxury auto” rules, depreciation deductions are artificially “capped.” So is the alternative Section 179 deduction that you can claim if you elect to expense (write-off in the year placed in service) all or part of the cost of a business car under the tax provision that for some assets allows expensing instead of depreciation. For example, for most cars that are subject to the caps and that are first placed in service in calendar year 2020 (including smaller trucks or vans built on a truck chassis that are treated as cars), the maximum depreciation and/or expensing deductions are:
- $18,100 for the first tax year in its recovery period (2020 for calendar year taxpayers);
- $16,100 for the second tax year;
- $9,700 for the third tax year; and
- $5,760 for each succeeding tax year.
The effect is generally to extend the number of years it takes to fully depreciate the vehicle.
The heavy SUV strategy
Because of the restrictions for cars, you might be better off from a tax standpoint if you replace your business car with a heavy sport utility vehicle (SUV), pickup or van. That’s because the caps on annual depreciation and expensing deductions for passenger automobiles don’t apply to trucks or vans (and that includes SUVs). What type of SUVs qualify? Those that are rated at more than 6,000 pounds gross (loaded) vehicle weight.
This means that in most cases you’ll be able to write off the entire cost of a new heavy SUV used entirely for business purposes as 100% bonus depreciation in the year you place it into service. And even if you elect out of bonus depreciation for the heavy SUV (which generally would apply to the entire depreciation class the SUV belongs in), you can elect to expense under Section 179 (subject to an aggregate dollar limit for all expensed assets), the cost of an SUV up to an inflation-adjusted limit ($25,900 for an SUV placed in service in tax years beginning in 2020). You’d then depreciate the remainder of the cost under the usual rules without regard to the annual caps.
The tax benefits described above are all subject to adjustment for non-business use. Also, if business use of an SUV doesn’t exceed 50% of total use, the SUV won’t be eligible for the expensing election, and would have to be depreciated on a straight-line method over a six-tax-year period.
Contact us if you’d like more information about tax breaks when you buy a heavy SUV for business.
© 2020 Covenant CPA
According to literature, the “seven deadly sins” are lust, gluttony, greed, laziness, wrath, envy and pride. Although individuals may be guilty of these from time to time, other types of “sins” can be fatal to an estate plan if you’re not careful. Here are four transgressions to avoid.
Sin #1: You don’t update beneficiary forms. Of course, your will spells out who gets what, where, when and how. But a will is often superseded by other documents like beneficiary forms for retirement plans, bank accounts, annuities and life insurance policies. Therefore, like your will, you must also keep these forms up-to-date.
For example, despite your intentions, retirement plan assets could go to a sibling — or even an ex-spouse — instead of your children or grandchildren if you haven’t updated your retirement plan beneficiary form in a long time. Review beneficiary forms for relevant accounts periodically and make the necessary adjustments.
Sin #2: You don’t properly fund trusts. Frequently, an estate plan will include one or more trusts, including a revocable living trust. The main benefit of a living trust is that assets don’t have to be probated and exposed to public inspection. It’s generally recommended that such a trust be used only as a complement to a will, not as a replacement.
However, the trust must be funded with assets, meaning that legal ownership of the assets must be transferred to the trust. For example, if real estate is being transferred, the deed must be changed to reflect this. If you’re transferring securities or bank accounts, you should follow the directions provided by the financial institutions. Otherwise, the assets may have to go through probate.
Sin #3: You don’t properly title assets. Both inside and outside of trusts, the manner in which you own assets can make a big difference. For instance, if you own property as joint tenants with rights of survivorship, the assets will go directly to the other named person, such as your spouse, on your death.
Not only is titling assets critical, you should review these designations periodically, just as you should your beneficiary designations. In particular, major changes in your personal circumstances or the prevailing laws could dictate a change in the ownership method.
Sin #4: You don’t coordinate different plan aspects. Typically, there are a number of moving parts to an estate plan, including a will, a power of attorney, trusts, retirement plan accounts and life insurance policies. Don’t look at each one in a vacuum. Even though they have different objectives, consider them to be components that should be coordinated within the overall plan.
For instance, arrange to take distributions from investments — including securities, qualified retirement plans, and traditional and Roth IRAs — in a way that preserves more wealth. Also, naming a revocable living trust as a retirement plan beneficiary could accelerate tax liability.
Work with us to make sure your estate plan continues to meet your objectives.
© 2020 Covenant CPA
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
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.
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
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
The economic fallout from the coronavirus (COVID-19) pandemic has forced business owners to reevaluate their operations and make difficult decisions. One place to look for the information you need to make rational, reasonable moves is your financial statements. Under U.S. Generally Accepted Accounting Principles, these typically comprise a statement of cash flows, a balance sheet and an income statement.
A statement of cash flows should be organized into three sections: cash flows from operating, financing and investing activities. Ideally, a company generates enough cash from operations to cover its expenses.
For many businesses, the COVID-19 pandemic has caused revenue to drop precipitously without a proportionate decrease in certain (fixed) operating expenses. Keep a close eye on whether you’re reaching a danger point. To generate additional cash flow, you may need to borrow money — consider a Small Business Administration loan, if you’re eligible.
Assets and liabilities
Your balance sheet tallies your company’s assets, liabilities and net worth — creating a snapshot of its financial health on the statement date. Assets are typically listed in order of liquidity. Current assets (such as accounts receivable) are expected to be converted into cash within a year, while long-term assets (such as your plant and equipment) will be used to generate revenue beyond the next 12 months.
Similarly, liabilities are listed in order of maturity. Current liabilities (such as accounts payable) come due within a year, while long-term liabilities are payment obligations that extend beyond the current year.
As its name indicates, the balance sheet must balance — that is, assets must equal liabilities plus net worth. Net worth is the extent to which the book value of assets exceeds liabilities. In times of distress, certain assets (such as receivables, financial assets, pension funds and inventory) may need to be written off, and intangibles (such as brands and goodwill) may become impaired. These changes may cause the book value of a company’s net worth to be negative, suggesting that the business is insolvent. Other red flags include current assets growing faster than sales, and a deteriorating ratio of current assets to current liabilities.
Income and overhead
An income statement shows revenue and expenses over the accounting period. Revenue has fallen for many businesses as the result of social distancing during the COVID-19 outbreak. Fortunately, certain variable expenses — such as materials and direct labor costs — have also fallen.
Unfortunately, most fixed expenses — such as rent, equipment leasing fees, advertising, insurance premiums and manager salaries — are ongoing. Review costs that are categorized on the income statements as overhead and sales, general and administrative expenses. Consider whether you can scale back these items, renegotiate them or convert them into variable costs over the long run.
For example, you might return a leased copier that isn’t being used, decrease your insurance coverage or rely more on independent contractors, rather than employees, for certain tasks.
Your existing financial statements may not account for the sudden changes inflicted upon businesses worldwide by COVID-19. We can assist you in evaluating them, gleaning insightful data using updated numbers, and generating new ones going forward.
© 2020 Covenant CPA
Payable-on-death (POD) accounts provide a quick, simple and inexpensive way to transfer assets outside of probate. They can be used for bank accounts, certificates of deposit or even brokerage accounts. Setting one up is as easy as providing the bank with a signed POD beneficiary designation form. When you die, your beneficiaries just need to present a certified copy of the death certificate and their identification to the bank, and the money or securities are theirs.
Beware of pitfalls
POD accounts can backfire if they’re not coordinated carefully with the rest of your estate plan. Too often, people designate an account as POD as an afterthought without considering whether it may conflict with their wills, trusts or other estate planning documents.
Suppose, for example, that Sam dies with a will that divides his property equally among his three children. He also has a $50,000 bank account that’s payable on death to his oldest child. If the other two children want to fight over it, the conflict between the will and POD designation must be resolved in court, which delays the distribution of Sam’s estate and can generate substantial attorneys’ fees.
Another potential problem with POD accounts is that if you use them for most of your assets, the assets left in your estate may be insufficient to pay debts, taxes or other expenses. Your executor would then have to initiate a proceeding to bring assets back into the estate.
POD best practices
Generally, POD accounts are best used to hold a modest amount of funds that are available immediately to your executor or other representative to pay funeral expenses or other pressing cash needs while your estate is being administered. Using these accounts for more substantial assets could lead to intrafamily disputes or costly litigation.
If you use POD accounts as part of your estate plan, be sure to review the rest of your plan carefully to avoid potential conflicts. Contact us with any questions.
© 2020 Covenant CPA
Virtually everyone needs an estate plan, but it isn’t a one-size-fits-all proposition. Even though each person’s situation is unique, general guidelines can be drawn depending on your current stage of life.
The early years
If you’ve recently embarked on a career, gotten married or both, now is the time to build the foundation for your estate plan. And, if you’ve recently started a family, estate planning is even more critical.
Your will is at the forefront. Essentially, this document divides up your accumulated wealth upon death by deciding who gets what, where, when and how. With a basic will, you may, for instance, leave all your possessions to your spouse. If you have children, you might bequeath some assets to them through a trust managed by a designated party.
A will also designates the guardian of your children if you and your spouse should die prematurely. Make sure to include a successor in case your first choice is unable to meet the responsibilities.
During your early years, your will may be supplemented by other documents, including trusts, if it makes sense personally. In addition, you may have a durable power of attorney that authorizes someone to manage your financial affairs if you’re incapacitated. Frequently, the agent will be your spouse. Also, obtain insurance protection appropriate for your lifestyle.
The middle years
If you’re a middle-aged parent, your main financial goals might be to acquire a home, or perhaps a larger home, and to set aside enough money to cover retirement goals and put your children through college. So you should modify your existing estate planning documents to meet your changing needs.
For instance, if you have a will in place, you should periodically review and revise it to reflect your current circumstances. Typically, minor revisions to a will can be achieved through a codicil. If significant changes are required, your attorney can rewrite the will entirely.
If you and your spouse decide to divorce, it’s critical to review and revise your estate plan to avoid unwanted outcomes.
The later years
Once you’ve reached retirement, you can usually relax somewhat, assuming you’re in good financial shape. But that doesn’t mean estate planning ends. It’s just time for the next chapter.
If you haven’t already done so, have your attorney draft a living will to complement a health care power of attorney. This document provides guidance in life-ending situations and can ease the stress for loved ones.
Finally, create or fine-tune, if you already have one written, a letter of instructions. Although not legally binding, it can provide an inventory of assets and offer directions concerning your financial affairs.
Revisit your plan periodically
Regardless of the stage of life you’re currently in, it’s important to bear in mind that your estate plan isn’t a static document. We can help review and revise your plan as needed.
© 2020 Covenant CPA
If you reside in a high-tax state, you may want to consider using nongrantor trusts to soften the blow of the $10,000 federal limit on state and local tax (SALT) deductions. The limit can significantly reduce itemized deductions if your state income and property taxes are well over $10,000. A potential strategy for avoiding the limit is to transfer interests in real estate to several nongrantor trusts, each of which enjoys its own $10,000 SALT deduction.
Grantor vs. nongrantor trusts
The main difference between a grantor and nongrantor trust is that a grantor trust is treated as your alter ego for tax purposes, while a nongrantor trust is treated as a separate entity. Traditionally, grantor trusts have been the vehicle of choice for estate planning purposes because the trust’s income is passed through to you, as grantor, and reported on your tax return.
That’s an advantage, because it allows the trust assets to grow tax-free, leaving more for your heirs. By paying the tax, you essentially provide an additional, tax-free gift to your loved ones that’s not limited by your gift tax exemption or annual gift tax exclusion. In addition, because the trust is an extension of you for tax purposes, you have the flexibility to sell property to the trust without triggering taxable gain.
Now that fewer families are subject to gift taxes, grantor trusts enjoy less of an advantage over nongrantor trusts. This creates an opportunity to employ nongrantor trusts to boost income tax deductions.
Nongrantor trusts in action
A nongrantor trust is a discrete legal entity, which files its own tax returns and claims its own deductions. The idea behind the strategy is to divide real estate that’s subject to more than $10,000 in property taxes among several trusts, each of which has its own SALT deduction up to $10,000. Each trust must also generate sufficient income against which to offset the deduction.
Before you attempt this strategy, beware of the multiple trust rule of Internal Revenue Code Section 643(f). That section provides that, under regulations prescribed by the U.S. Treasury Department, multiple trusts may be treated as a single trust if they have “substantially the same grantor or grantors and substantially the same primary beneficiary or beneficiaries” and a principal purpose of the arrangement is tax avoidance.
Bear in mind that to preserve the benefits of multiple trusts, it’s important to designate a different beneficiary for each trust.
Pass the SALT
If you’re losing valuable tax deductions because of the SALT limit, consider passing those deductions on to one or more nongrantor trusts. Consult with us before taking action, because these trusts must be structured carefully to ensure that they qualify as nongrantor trusts and don’t run afoul of the multiple trust rule.
© 2020 Covenant CPA
The word “probate” may conjure images of lengthy delays waiting for wealth to be transferred and bitter disputes among family members. Plus, probate records are open to the public, so all your “dirty linen” may be aired. The reality is that probate doesn’t have to be so terrible, and often isn’t, but both asset owners and their heirs should know what’s in store.
In basic terms, probate is the process of settling an estate and passing legal title of ownership of assets to heirs. If the deceased person has a valid will, probate begins when the executor named in the will presents the document in the county courthouse. If there’s no will — the deceased has died “intestate” in legal parlance — the court will appoint someone to administer the estate. Thereafter, this person becomes the estate’s legal representative.
Probate is predicated on state law, so the exact process varies from state to state. This has led to numerous misconceptions about the length of probate. On average, the process takes six to nine months, but it can run longer for complex situations in certain states.
Planning to avoid probate
Certain assets are automatically exempt from probate. But you also may be able to avoid the process with additional planning. The easiest way to do this is through the initial form of ownership or use of a living trust.
By using joint ownership with rights of survivorship, you acquire the property with another party, such as your spouse. The property then automatically passes to the surviving joint tenant on the death of the deceased joint tenant. This form of ownership typically is used when a married couple buys a home or other real estate. Similarly, with a tenancy by entirety, which is limited to married couples, the property goes to the surviving spouse without being probated.
A revocable living trust is often used to avoid probate and protect privacy. The assets transferred to the trust, managed by a trustee, pass to the designated beneficiaries on your death. Thus, you may coordinate your will with a living trust, providing a quick transfer of wealth for some assets. You can act as the trustee and retain control over these assets during your lifetime.
Achieving all estate planning goals
When it comes to probate planning, discuss your options with family members to develop the best approach for your personal situation. Also, bear in mind that avoiding probate should be only one goal of your estate plan. We can help you develop a strategy that minimizes probate while reducing taxes and achieving your other goals.
© 2019 Covenant CPA