For many people, an important goal of estate planning is to leave a legacy for their children, grandchildren and future generations. And what better way to do that than to help provide for their educational needs? A 529 plan can be a highly effective tool for funding tuition and other educational expenses on a tax-advantaged basis. But when the plan’s owner (typically a parent or grandparent) dies, there’s no guarantee that subsequent owners will continue to use it to fulfill the original owner’s vision.

To create a family education fund that lives on for generations, a carefully designed trust may be the best solution. But trusts have a significant drawback: Unlike 529 plans, the earnings of which are tax-exempt if used for qualified education expenses, trusts are subject to some of the highest federal income tax rates in the tax code.

One strategy for gaining the best of both worlds is to establish a family education trust that invests in one or more 529 plans.

Plan basics

529 plans are state-sponsored investment accounts that permit parents, grandparents and other family members to make substantial cash contributions. Contributions are nondeductible, but the funds grow tax-free and earnings may be withdrawn tax-free for federal income tax purposes provided they’re used for qualified education expenses. Qualified expenses include tuition, fees, books, supplies, equipment, and some room and board at most accredited colleges and universities and certain vocational schools. Contributions to 529 plans are removed from your taxable estate and shielded from gift taxes by your lifetime gift and estate tax exemption or annual exclusions.

In addition to the risk that a subsequent owner will use the funds for noneducational purposes, disadvantages of 529 plans include relatively limited investment choices and an inability to invest assets other than cash.

Holding a 529 plan in a trust

Establishing a trust to hold one or more 529 plans provides several significant benefits:

  • It allows you to maintain tax-advantaged education funds indefinitely (depending on applicable state law) to benefit future generations and keeps the funds out of the hands of those who would use them for other purposes.
  • It allows you to establish guidelines on which family members are eligible for educational assistance, direct how the funds will be used or distributed in the event they’re no longer needed for educational purposes, and appoint trustees and successor trustees to oversee the trust.
  • It can accept noncash contributions and hold a variety of investments and assets outside 529 plans.

A trust may also use funds held outside of 529 plans for purposes other than education, such as paying medical expenses or nonqualified living expenses.

Plan carefully

If you’re interested in setting up a family education trust to hold 529 plans and other investments, contact us. We can help you design a trust that maximizes educational benefits, minimizes taxes and offers the flexibility you need to shape your educational legacy.

© 2021 Covenant CPA

Building customers’ trust in your website

The events of the past year have taught business owners many important lessons. One of them is that, when a crisis hits, customers turn on their computers and look to their phones. According to one analysis of U.S. Department of Commerce data, consumers spent $347.26 billion online with U.S. retailers in the first half of 2020 — that’s a 30.1% increase from the same period in 2019.

Although online spending moderated a bit as the year went on, the fact remains that people’s expectations of most companies’ websites have soared. In fact, a June 2020 report by software giant Adobe indicated that the pandemic has markedly accelerated the growth of e-commerce — quite possibly by years, not just months.

Whether you sell directly to the buying public or engage primarily in B2B transactions, building customers’ trust in your website is more important than ever.

Identify yourself

Among the simplest ways to establish trust with customers and prospects is to convey to them that you’re a bona fide business staffed by actual human beings.

Include an “About Us” page with the names, photos and short bios of the owner(s), executives and key staff members. Doing so will help make the site friendlier and more relatable. You don’t want to look anonymous — it makes customers suspicious and less likely to buy.

Beyond that, be sure to clearly provide contact info. This includes a phone number and email address, hours of operation (including time zone), and your mailing address. If you’re a small business, use a street address if possible. Some companies won’t deliver to a P.O. box, and some customers won’t buy if you use one.

Keep contact links easy to find. No one wants to search all over a site looking for a way to get in touch with someone at the business. Include at least one contact link on every page.

Add trust elements

Another increasingly critical feature of business websites is “trust elements.” Examples include:

  • Icons of widely used payment security providers such as PayPal, Verisign and Visa,
  • A variety of payment alternatives, as well as free shipping or lower shipping costs for certain orders, and
  • Professionally coded, aesthetically pleasing and up-to-date layout and graphics.

Check and double-check the spelling and grammar used on your site. Remember, one of the hallmarks of many Internet scams is sloppy or nonsensical use of language.

Also, regularly check all links. Nothing sends a customer off to a competitor more quickly than the frustration of encountering nonfunctioning links. Such problems may also lead visitors to think they’ve been hacked.

Abide by the fundamentals

Of course, the cybersecurity of any business website begins (and some would say ends) with fundamental elements such as a responsible provider, firewalls, encryption software and proper password use. Nonetheless, how you design, maintain and update your site will likely have a substantial effect on your company’s profitability. Contact us for help measuring and assessing the impact of e-commerce on your business.

© 2021 Covenant CPA

As a formal estate planning term, “tangible personal property” likely won’t elicit much emotion from you or your loved ones. However, the items that make up tangible personal property, such as jewelry, antiques, photographs and collectibles, may be the most difficult to plan for because of their significant sentimental value.

Without special planning on your part, squabbling among your family members over these items may lead to emotionally charged disputes and even litigation.

Communicate clearly

There’s no reason to guess which personal items mean the most to your children and other family members. Create a dialogue to find out who wants what and to express your feelings about how you’d like to share your prized possessions.

Having these conversations can help you identify potential conflicts. After learning of any ongoing issues, work out acceptable compromises during your lifetime.

Bequeath assets to specific beneficiaries

Some people have their beneficiaries choose the items they want or authorize their executors to distribute personal property as they see fit. For some families, this approach may work. But more often than not, it invites conflict.

Generally, the most effective strategy for avoiding costly disputes and litigation over personal property is to make specific bequests — in your will or revocable trust — to specific beneficiaries. For example, your will might leave your art collection to your son and your jewelry to your daughter.

If you use a revocable trust (sometimes referred to as a “living” trust), you must transfer ownership of personal property to the trust to ensure that the property is distributed according to the trust’s terms. The trust controls only the property you put into it. It’s also a good idea to have a “pour-over” will, which provides that any property you own at your death is transferred to your trust. Keep in mind, however, that property that passes through your will and pours into your trust generally must go through probate.

Plan for all of your assets

Your major assets, such as real estate and business interests, are top of mind as you prepare your estate plan, but don’t forget to also plan for your tangible personal property. These lower monetary valued assets may be more difficult to deal with, and more likely to result in disputes, than big-ticket items.

© 2021 Covenant CPA

There are two trust types that don’t require one or more human beneficiaries: charitable trusts and noncharitable purpose (NCP) trusts. A charitable trust is the more common of the two, but an NCP trust could also be a formidable tool to help achieve your estate planning goals.

Defining an NCP trust

Historically, trusts were required to have human beneficiaries. Why? Because, for a trust to be valid, there must be someone to enforce it. Charitable trusts were the exception: The attorney general of the relevant jurisdiction was authorized to enforce the trust in the public interest.

Over the years, however, many U.S. states and a number of foreign jurisdictions have enacted legislation (including provisions of the Uniform Probate Code and the Uniform Trust Code) that authorizes NCP trusts.

These trusts may be used to achieve a variety of purposes, such as caring for a pet or other animal (including its offspring); maintaining a gravesite; providing for future graveside religious ceremonies (often referred to as “honorary” trusts); maintaining art collections, antiques, automobiles, jewelry or other personal property; and funding or otherwise sustaining a family business.

A trust may be an NCP trust even if the grantor’s children or other heirs will ultimately receive trust property as “remaindermen.” Suppose, for example, that you create an NCP trust to maintain and exhibit your art collection. After a specified time period — let’s say 20 years — the trust terminates and the collection is distributed to your children. The fact that your children will receive the art once the trust has fulfilled its purpose doesn’t change its character as an NCP trust. Nor does it render the trust valid or enforceable absent an applicable NCP trust statute.

To be valid, an NCP trust must meet certain requirements. Most important, it must 1) have a purpose that’s certain, reasonable and attainable, 2) not violate public policy, and 3) be capable of enforcement. Typically, an NCP trust is enforced by a designated “enforcer” — someone whose job it is to ensure that the trust’s purpose is fulfilled and who has the authority to bring a court action — and/or a “trust protector,” who’s empowered to modify the trust when its purpose has been achieved or is no longer relevant.

Choosing the right jurisdiction 

The permitted uses of NCP trusts, as well as their duration, vary significantly from state to state, as do the powers of a trust protector or enforcer. Some states, for example, allow only pet trusts, honorary trusts or both. Other states authorize NCP trusts for most purposes, so long as they don’t violate public policy. Most states limit an NCP trust’s duration to a term of 21 years, although some permit longer terms or even “dynasty” NCP trusts of unlimited duration. Contact us for additional information.

© 2020 Covenant CPA

Wouldn’t it be great if your employees worked as if they owned the company? An employee stock ownership plan (ESOP) could make this a reality.

Under an ESOP, employee participants take part ownership of the business through a retirement savings arrangement. Meanwhile, the business and its existing owner(s) can benefit from some tax breaks, an extra-motivated workforce and a clearer path to a smooth succession.

How they work

To implement an ESOP, you establish a trust fund and either:

  • Contribute shares of stock or money to buy the stock (an “unleveraged” ESOP), or
  • Borrow funds to initially buy the stock, and then contribute cash to the plan to enable it to repay the loan (a “leveraged” ESOP).

The shares in the trust are allocated to individual employees’ accounts, often using a formula based on their respective compensation. The business must formally adopt the plan and submit plan documents to the IRS, along with certain forms.

Tax impact

Among the biggest benefits of an ESOP is that contributions to qualified retirement plans (including ESOPs) are typically tax-deductible for employers. However, employer contributions to all defined contribution plans, including ESOPs, are generally limited to 25% of covered payroll. But C corporations with leveraged ESOPs can deduct contributions used to pay interest on the loans. That is, the interest isn’t counted toward the 25% limit.

Dividends paid on ESOP stock passed through to employees or used to repay an ESOP loan may be tax-deductible for C corporations, so long as they’re reasonable. Dividends voluntarily reinvested by employees in company stock in the ESOP also are usually deductible by the business. (Employees, however, should review the tax implications of dividends.)

In another potential benefit, shareholders in some closely held C corporations can sell stock to the ESOP and defer federal income taxes on any gains from the sales, with several stipulations. One is that the ESOP must own at least 30% of the company’s stock immediately after the sale. In addition, the sellers must reinvest the proceeds (or an equivalent amount) in qualified replacement property securities of domestic operation corporations within a set period.

Finally, when a business owner is ready to retire or otherwise depart the company, the business can make tax-deductible contributions to the ESOP to buy out the departing owner’s shares or have the ESOP borrow money to buy the shares.

Risks to consider

An ESOP’s tax impact for entity types other than C corporations varies somewhat from what we’ve discussed here. And while these plans do offer many potential benefits, they also present risks such as complexity of setup and administration and a strain on cash flow in some situations. Please contact us to discuss further. We can help you determine whether an ESOP would make sense for your business.

© 2020 Covenant CPA

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

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

Don’t worry! A broken trust can be fixed

There are good reasons why estate planning advisors recommend you revisit and, if necessary, revise your estate plan periodically: changing circumstances, including family situations and new tax laws. While it’s relatively simple to change a beneficiary, what if an irrevocable trust no longer serves your purposes? Depending on applicable state law, you may have options to fix a “broken” trust.

Reasons why a trust can break

A trust that works just fine when it’s established may no longer achieve its original goals if your family circumstances change. If you divorce, for example, a trust for the benefit of your spouse may no longer be desirable. If your children grow up to be financially independent, they may prefer that you leave your wealth to their children. Or perhaps you prefer not to share your wealth with a beneficiary who has developed a drug or alcohol problem or has proven to be profligate.

Another reason is new tax laws. Many trusts were created when gift, estate and generation-skipping transfer (GST) tax exemption amounts were relatively low. Today, however, the exemptions have risen to $11.4 million, so trusts designed to minimize gift, estate and GST taxes may no longer be necessary. And with transfer taxes out of the picture, the higher income taxes often associated with these trusts — previously overshadowed by transfer tax concerns — become a more important factor.

Here are possible remedies

If you have one or more trusts in need of repair, you may have several remedies at your disposal, depending on applicable law in the state where you live and, if different, in the state where the trust is located. Potential remedies include:

Re-formation. The Uniform Trust Code (UTC), adopted in more than half the states, provides several remedies for broken trusts. Non-UTC states may provide similar remedies. Re-formation allows you to ask a court to rewrite a trust’s terms to conform with the grantor’s intent. This remedy is available if the trust’s original terms were based on a legal or factual mistake.

Modification. This remedy may be available, also through court proceedings, if unanticipated circumstances require changes in order to achieve the trust’s purposes. Some states permit modification — even if it’s inconsistent with the trust’s purposes — with the consent of the grantor and all the beneficiaries.

Decanting. Many states have decanting laws, which allow a trustee, according to his or her distribution powers, to “pour” funds from one trust into another with different terms and even in a different location. Depending on your circumstances and applicable state law, decanting may allow a trustee to correct errors, take advantage of new tax laws or another state’s asset protection laws, add or eliminate beneficiaries, extend the trust term, and make other changes, often without court approval.

Before you make any changes, it’s critical to consult your attorney and tax advisor to discuss the potential benefits and risks.

© 2019 Covenant CPA

The record-high exemption amount currently in effect means that fewer families are affected by gift and estate taxes. As a result, the estate planning focus for many people has shifted from transfer taxes to income taxes. A nongrantor trust can be an effective option to reduce income taxes, and it offers a way around the itemized deduction limitations imposed by the Tax Cuts and Jobs Act (TCJA).

What’s a nongrantor trust?

A nongrantor trust is simply a trust that’s a separate taxable entity. The trust owns the assets it holds and is responsible for taxes on any income those assets generate. A grantor trust, in contrast, is one in which the grantor retains certain powers and, therefore, is treated as the owner for income tax purposes.

Both grantor and nongrantor trusts can be structured so that contributions are considered “completed gifts” for transfer tax purposes (thereby removing contributed assets from the grantor’s taxable estate). But traditionally, grantor trusts have been the estate planning tool of choice. Why? It’s because the trust’s income is taxed to the grantor, reducing the size of the grantor’s estate and allowing the trust assets to grow tax-free, leaving more wealth for beneficiaries. Essentially, the grantor’s tax payments serve as an additional tax-free gift.

With less emphasis today on gift and estate tax savings, nongrantor trusts offer some significant benefits.

How can nongrantor trusts reduce income taxes?

The TCJA places limits on itemized deductions, but nongrantor trusts may offer a way to avoid those limitations. The law nearly doubled the standard deduction to $12,000 for individuals and $24,000 for married couples. (Indexed annually for inflation, the 2019 standard deduction amounts are $12,200 for individuals and $24,400 for married couples.) The TCJA also limits deductions for state and local taxes (SALT) to $10,000.

These changes reduce or eliminate the benefits of itemized deductions for many taxpayers, especially those in high-SALT states. By placing assets in nongrantor trusts, it may be possible to increase your deductions, because each trust enjoys its own $10,000 SALT deduction.

For example, Andy and Kate, a married couple filing jointly, pay well over $10,000 per year in state income taxes. They also own two homes, each of which generates $20,000 per year in property taxes. Under the TCJA, the couple’s SALT deduction is limited to $10,000, which covers a portion of their state income taxes, but they receive no tax benefit for the $40,000 they pay in property taxes.

To avoid this limitation, Andy and Kate transfer the two homes to an LLC, together with assets that earn approximately $40,000 per year in income. Next, they give 25% LLC interests to four nongrantor trusts. Each trust earns around $10,000 per year, which is offset by its $10,000 property tax deduction. Essentially, this strategy allows the couple to deduct their entire $40,000 property tax bill.

Beware the multiple trust rule

If you’re considering this strategy, be aware that the tax code contains a provision that treats multiple trusts with substantially the same grantors and beneficiaries as a single trust if their purpose is tax avoidance.

To ensure that this rule doesn’t erase the benefits of the nongrantor trust strategy, designate a different beneficiary for each trust. Contact us for more information at 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA

If a prime objective of your estate plan is to leave a lasting legacy, a dynasty trust may be the right estate planning vehicle for you. And, thanks to the substantially increased generation-skipping transfer (GST) tax exemption amount established by the Tax Cuts and Jobs Act, a dynasty trust is more appealing than ever.

GST tax and dynasty trusts

A dynasty trust allows substantial amounts of wealth to grow and compound free of federal gift, estate and GST taxes, providing tax-free benefits for your grandchildren and future generations. The longevity of a dynasty trust varies from state to state, but it’s becoming more common for states to allow these trusts to last for hundreds of years or even in perpetuity.

Avoiding GST tax liability is critical to a dynasty trust’s success. An additional 40% tax on transfers to grandchildren or others that skip a generation, the GST tax can quickly consume substantial amounts of wealth. The key to avoiding the tax is to leverage your $11.40 million GST tax exemption.

For example, let’s say you haven’t used any of your $11.40 million combined gift and estate tax exemption. In 2019, you transfer $10 million to a properly structured dynasty trust. There’s no gift tax on the transaction because it’s within your unused exemption amount. And the funds, together with all future appreciation, are removed from your taxable estate.

Most important, by allocating your GST tax exemption to your trust contributions, you ensure that any future distributions or other transfers of trust assets to your grandchildren or subsequent generations will avoid GST taxes. This is true even if the value of the assets grows well beyond the exemption amount or the exemption is reduced in the future.

Setting up a dynasty trust

A dynasty trust can be established during your lifetime, as an inter vivos trust or part of your will as a testamentary trust. An inter vivos transfer to a dynasty trust may have additional benefits associated with transferring assets that have greater appreciation potential out of your taxable estate.

After creating the trust, you must determine which assets to transfer to it. Because the emphasis is on protecting appreciated property, consider funding the trust with securities, real estate, life insurance policies and business interests.

Finally, you must appoint a trustee. Your choices may include a succession of family members or estate planning professionals. For most people, however, a safer approach is to use a reputable trust company with a proven track record, as opposed to assigning this duty to family members who might not be born yet.

If you think a dynasty trust might be right for your family, talk with us before taking action. A currently effective dynasty trust is irrevocable — meaning that, once you create it, you may be unable to modify the arrangement if your family dynamic changes. Contact us with questions at 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA