Category Archives: Estate Planning

Add spendthrift language to a trust to safeguard assets

Posted on by

Protecting assets from creditors is a critical aspect of estate planning, but you need to think about more than just your own creditors: You also need to consider your heirs’ creditors. Adding spendthrift language to a trust benefiting your heirs can help safeguard assets.

Spendthrift language explained

Despite its name, the purpose of a spendthrift trust isn’t just to protect profligate heirs from themselves. Although that’s one use for this trust type, even the most financially responsible heirs can be exposed to frivolous lawsuits, dishonest business partners or unscrupulous creditors. A properly designed spendthrift trust can protect assets against such attacks.

It can also protect your loved ones in the event of relationship changes. If one of your children divorces, your child’s spouse generally can’t claim a share of the trust property in the divorce settlement.

Also, if your child predeceases his or her spouse, the spouse generally is entitled by law to a significant portion of your child’s estate, including property you left the child outright. In some cases, that may be a desirable outcome. But in others, such as second marriages when there are children from a prior marriage, a spendthrift trust can prevent your child’s inheritance from ending up in the hands of his or her spouse rather than in those of your grandchildren.

A variety of trusts can be spendthrift trusts. It’s just a matter of including a spendthrift clause, which restricts a beneficiary’s ability to assign or transfer his or her interest in the trust and restricts the rights of creditors to reach the trust assets.

Additional considerations

It’s important to recognize that the protection offered by a spendthrift trust isn’t absolute. Depending on applicable law, it may be possible for government agencies to reach the trust assets — to satisfy a tax obligation, for example.

Generally, the more discretion you give the trustee over distributions from the trust, the greater the protection against creditors’ claims. If the trust requires the trustee to make distributions for a beneficiary’s support, for example, a court may rule that a creditor can reach the trust assets to satisfy support-related debts. For increased protection, it’s preferable to give the trustee full discretion over whether and when to make distributions.

Protect wealth after transfer

Protecting your wealth after you’ve transferred it to your family is just as important as other estate planning strategies such as reducing tax liability on the transfer. One way to do this is to include spendthrift language in a trust. Contact us to learn whether a spendthrift trust is right for your estate plan at 205-345-9898 or [email protected].

© 2019 CovenantCPA

If art donations are part of your estate plan, consider these four tips

Posted on by

Charitable giving is a key part of estate planning for many people. If you have a collection of valuable art and are charitably minded, consider donating one or more pieces to receive tax deductions. Generally, it’s advantageous to donate appreciated property to avoid capital gains taxes. Because the top federal capital gains rate for art and other “collectibles” is 28%, donating art is particularly effective.

Considerations before donating

If you’re considering a donation of art, here are four tips to keep in mind:

1. Get an appraisal. Given the subjective nature of art valuation and the potential for abuse, the IRS scrutinizes charitable donations and other transactions involving valuable artwork. Most art donations require a “qualified appraisal” by a “qualified appraiser.” IRS rules contain detailed requirements about the qualifications an appraiser must possess and the contents of an appraisal.

IRS auditors are required to refer all gifts of art valued at $20,000 or more to the IRS Art Advisory Panel. The panel’s findings are the IRS’s official position on the art’s value, so it’s critical to provide a solid appraisal to support your valuation.

2. Donate to a public charity. To maximize your charitable deduction, donate artwork to a public charity, such as a museum or university with public charity status. These donations generally entitle you to deduct the artwork’s full fair market value. If you donate art to a private foundation, your deduction will be limited to your cost. Keep in mind that the amount you may deduct in a given year is limited to a percentage of your adjusted gross income (30% for public charities, 50% for private charities) with the excess carried over to future years.

3. Beware the related-use rule. To qualify for a full fair-market-value deduction, the charity’s use of the artwork must be related to its tax-exempt purpose. So, for example, if you donate a painting to a museum for display or to a university for use in art classes, you’ll satisfy the related-use rule.

Even if the related-use rule is satisfied initially, you may lose some or all of your deductions if the artwork is worth more than $5,000 and the charity sells or otherwise disposes of it within three years after receiving it.

4. Transfer the copyright. If you own both the work of art and the copyright to the work, you must assign the copyright to the charity to qualify for a charitable deduction.

Fractional donations

At one time, it was possible to give art away gradually using a series of fractional gifts, and claim increasing deductions if the art continued to appreciate. Under current rules, however, the deduction for future fractional gifts is limited to the value of the initial fractional gift (or, if lower, the fair market value of the later fractional gift).

The rules surrounding donations of art can be complex. We can help you achieve your charitable giving goals while maximizing your tax benefits. Contact us today at 205-345-9898 or [email protected].

© 2019 CovenantCPA

Properly funding your revocable trust is the key to unlocking its benefits

Posted on by

If your estate plan includes a revocable trust — also known as a “living” trust — it’s critical to ensure that the trust is properly funded. Revocable trusts offer significant benefits, including asset management (in the event you become incapacitated) and probate avoidance. But these benefits aren’t available if you don’t fund the trust.

Funding the trust

Funding a living trust is a simple matter of transferring ownership of assets to the trust or, in some cases, designating the trust as beneficiary. Assets you should consider transferring include real estate, bank accounts, certificates of deposit, stocks and other investments, partnership and business interests, vehicles, and personal property (such as furniture and collectibles).

Be aware that moving an IRA or qualified retirement plan to a revocable trust can trigger unwanted tax consequences. Rather than transfer these assets to the trust, be sure that the trust is properly designed to allow you to designate the trust as beneficiary and enjoy the tax benefits of doing so. For insurance policies and annuities, you can either transfer ownership or change the beneficiary designation. In some cases, it may be advisable to hold a life insurance policy in an irrevocable life insurance trust to shield the proceeds from estate taxes.

Avoiding a pitfall

Most people are diligent about funding a trust at the time they sign the trust documents. But trouble can arise when they acquire new assets after the trust is established. Unless you transfer new assets to your trust, or designate the trust as beneficiary, they won’t enjoy the trust’s benefits.

So to make the most of a revocable trust, be sure that each time you acquire a significant asset, you take steps to transfer it to the trust or complete the appropriate beneficiary designation. A living trust is a key component of many people’s estate plan. Contact us to help ensure yours is properly funded at 205-345-9898 or email us at [email protected].

© 2019 CovenantCPA

Life insurance can be a powerful estate planning tool for nontaxable estates

Posted on by

For years, life insurance has played a critical role in estate planning, providing a source of liquidity to pay estate taxes and other expenses. Today, the gift and estate tax exemption has climbed to $11.4 million, so estate taxes are no longer a concern for the vast majority of families. But even for nontaxable estates, life insurance continues to offer estate planning benefits.

Replacing income and wealth

Life insurance can protect your family by replacing your lost income. It can also be used to replace wealth in a variety of contexts. For example, suppose you own highly appreciated real estate or other assets and wish to dispose of them without generating current capital gains tax liability. One option is to contribute the assets to a charitable remainder trust (CRT).

As a tax-exempt entity, the CRT can sell the assets and reinvest the proceeds without triggering capital gains tax. In addition, you and your spouse will enjoy an income stream and charitable income tax deductions. Typically, distributions you receive from the CRT are treated as a combination of ordinary taxable income, capital gains, tax-exempt income and tax-free return of principal.

After you and your spouse die, the remaining trust assets pass to charity. This will reduce the amount of wealth available to your children or other heirs. But you can use life insurance (a cost-effective second-to-die policy, for example) to replace that lost wealth.

You can also use life insurance to replace wealth that’s lost to long term care (LTC) expenses, such as nursing home costs, for you or your spouse. Although LTC insurance is available, it can be expensive, especially if you’re already beyond retirement age. For many people, a better option is to use personal savings and investments to fund their LTC needs and to purchase life insurance to replace the money that’s spent on such care. One advantage of this approach is that, if neither you nor your spouse needs LTC, your heirs will enjoy a windfall.

Finding the right policy

These are just a few examples of the many benefits provided by life insurance. We can help determine which type of life insurance policy is right for your situation. 205-345-9898 or [email protected].

© 2019 CovenantCPA

Companion piece: Create a “road map” for your estate plan

Posted on by

No matter how much effort you’ve invested in designing your estate plan, your will, trusts and other official documents may not be enough. Consider creating a “road map” — an informal letter or other document that guides your family in understanding and executing your plan and ensuring that your wishes are carried out.

Navigating your world

Your road map should include, among other things:

  • A list of important contacts, including your estate planning attorney, accountant, insurance agent and financial advisors,
  • The location of your will, living and other trusts, tax returns and records, powers of attorney, insurance policies, deeds, stock certificates, automobile titles, and other important documents,
  • A personal financial statement that lists stocks, bonds, real estate, bank accounts, retirement plans, vehicles and other assets, as well as information about mortgages, credit cards, and other debts,
  • An inventory of digital assets — such as email accounts, online bank and brokerage accounts, online photo galleries, digital music and book collections, and social media accounts — including login credentials or a description of arrangements made to provide your representative with access,
  • Computer passwords and home security system codes,
  • Safe combinations and the location of any safety deposit boxes and keys,
  • The location of family heirlooms or other valuable personal property, and
  • Information about funeral arrangements or burial wishes.

Laying out your intentions

Your road map can also be a good place to explain to loved ones the reasoning behind certain estate planning decisions. Perhaps you’re distributing your assets unequally, distributing specific assets to specific heirs or placing certain restrictions on an heir’s entitlement to trust distributions. There are many good reasons for these strategies, but it’s important for your family to understand your motives to help avoid hurt feelings or disputes.

Finally, like other estate planning documents, your road map won’t be effective unless your family knows where to find it, so it’s a good idea to leave it with a trusted advisor (and consider giving copies to other trusted parties). Please contact us if you’d like help drafting your road map. 205-345-9898 or [email protected].

© 2019 CovenantCPA

Moving a trust over state lines can offer tax savings and other benefits

Posted on by

People who live in states with high income taxes sometimes relocate to a state with a more favorable tax climate. A similar strategy can be available for trusts. If a trust is subject to high state income taxes, you may be able to change its residence — or “situs” — to a state with low or no income taxes.

What can a “trust-friendly” state offer?

In addition to offering low (or no) tax on trust income, some states:

  • Authorize domestic asset protection trusts, which provide added protection against creditors’ claims,
  • Permit silent trusts, under which beneficiaries need not be notified of their interests,
  • Allow perpetual trusts, enabling grantors to establish “dynasty” trusts that benefit many generations to come,
  • Have directed trust statutes, which make it possible to appoint an advisor or committee to direct the trustee with regard to certain matters, or
  • Offer greater flexibility to draft trust provisions that delineate the trustee’s powers and duties.

If another state’s laws would be more favorable than your own state’s, you might benefit from moving a trust to that state — or setting up a new trust there.

Take states’ laws into consideration

It’s important to review both states’ laws for determining a trust’s “residence” for tax and other purposes. Typically, states make this determination based on factors such as:

  • The grantor’s home state,
  • The location of the trust’s assets,
  • The state where the trust is administered (that is, where the trustees reside or the trust’s records are kept), and
  • The states where the trust’s beneficiaries reside.

Keep in mind that some states tax income derived from in-state sources even if earned by an out-of-state trust.

Making the right move

To enjoy the advantages of a trust-friendly state, establish the trust in that state and take steps to ensure that your choice of residence is respected (such as naming a trustee in the state and keeping the trust’s assets and records there). It may also be possible to move an existing trust from one state to another.

We can assist you in determining if setting up trusts in another state would help you achieve your estate planning goals. Contact us at 205-345-9898 or [email protected].

© 2019 CovenantCPA

Using knowledge management to develop your succession plan

Posted on by

As the old saying goes, “Knowledge is power.” This certainly rings true in business, as those who best understand their industries and markets tend to have a knack for staying on top. If that person is a company’s owner, however, great knowledge can turn into a vulnerability when he or she decides to retire or otherwise leave the business.

As you develop your succession plan, consider how to mitigate the loss of pure know-how that will occur when you step down. One way to tackle this risk is to implement a knowledge management strategy.

Two types of knowledge

Knowledge management is a formal process of recognizing and treating knowledge as an asset that your company can identify, maintain and share. Generally, a business can subdivide knowledge into two types:

1. Explicit knowledge. This exists in the tangible world and typically includes company reports, financial statements and databases. These items are usually easy to access, extrapolate from and append. For your succession plan, however, you may need to dig deeper into your own confidential files, memos or emails.

2. Tacit knowledge. This is information that resides solely between the ears of a business’s leadership, employees and perhaps even service providers. As such, it’s not easily retrievable. In terms of succession planning, this may be the stuff that you haven’t written down or even talked about much.

Typical categories

Typical knowledge management categories include:

  • Taxes and accounting,
  • Financial management,
  • Strategic planning,
  • HR, payroll and employment practices,
  • Sales and marketing,
  • Customers,
  • Production, and
  • Technology.

In addition, knowledge management should account for your company’s intellectual property — trade secrets, for example. Many business owners keep such details close to their vests and even managers may not know the full value of the company’s intellectual property. This could put your business at risk following your departure.

A comprehensive knowledge management effort related to your succession plan will call on you to undertake a full inventory of every category listed above and perhaps others. Gathering your explicit knowledge may entail compiling years’, even decades’, worth of documents, files and writings. This may not be an easy task, but it’s still a matter of straight research.

You’ll likely find capturing your tacit knowledge somewhat more challenging. One idea is to ask a suitable employee or engage an outside consultant to interview you regarding all the pertinent categories. Many business owners find these conversations arduous at first but eventually enlightening and enjoyable.

A legacy preserved

A solid succession plan is imperative to maintaining the future stability and success of your company. Knowledge management can strengthen that plan and help preserve the legacy you’ve worked so hard to build. Contact us for further information and for help identifying knowledge related to your tax filings, accounting methods and other financial matters. 205-345-9898 or [email protected].

© 2019 CovenantCPA

No, it’s not unusual to include your pet in your estate plan

Posted on by

An unexpected outcome of the recent death of designer Karl Lagerfeld is that the topic of estate planning for pets has been highlighted. Lagerfeld’s beloved cat, Choupette, played a major role in his brand. The feline was the subject of a coffee table book and has a large Instagram following. Before his death, Lagerfeld publicly expressed his wishes to have his ashes, and those of his cat if she had died before him, to be scattered with those of his mother’s. It’s unknown if Lagerfeld accounted for his beloved Choupette in his estate plan, but one vehicle he could have used to do so is a pet trust.

Another celebrity who famously set up a pet trust for her dog was hotel heiress Leona Helmsley. She left $12 million in a trust for her white Maltese, Trouble. (A judge later reduced the trust to $2 million and ordered the remainder to go to Helmsley’s charitable foundation.) Thanks to the pet trust, Trouble lived a luxurious life until she died in 2011, four years after Helmsley’s death.

ABCs of a pet trust

A pet trust is a legally sanctioned arrangement in all 50 states that allows you to set aside funds for your pet’s care in the event you die or become disabled. After the pet dies, any remaining funds are distributed among your heirs as directed by the trust’s terms.

The basic guidelines are comparable to trusts for people. The “grantor” — called a settlor or trustor in some states — creates the trust to take effect during his or her lifetime or at death. Typically, a trustee will hold property for the benefit of the grantor’s pet. Payments to a designated caregiver are made on a regular basis.

Depending on the state in which the trust is established, it terminates upon the death of the pet or after 21 years, whichever occurs first. Some states allow a pet trust to continue past the 21-year term if the animal remains alive. This can be beneficial for pets that have longer life expectancies than cats or dogs, such as parrots or turtles.

Specify your wishes

Because you know your pet better than anyone else, you may provide specific instructions for its care and maintenance (for example, a specific veterinarian or brand of food). The trust can also mandate periodic visits to the vet and other obligations. Feel more secure knowing that your pet’s care is forever ensured — legally. Contact us for additional details at 205-345-9898 or [email protected].

© 2019 CovenantCPA

What you need to know about filing gift and estate tax returns

Posted on by

Have you made substantial gifts of wealth to family members? Or are you the executor of the estate of a loved one who died recently? If so, you need to know whether you must file a gift or estate tax return.

Filing a gift tax return

Generally, a federal gift tax return (Form 709) is required if you make gifts to or for someone during the year (with certain exceptions, such as gifts to U.S. citizen spouses) that exceed the annual gift tax exclusion ($15,000 for 2018 and 2019); there’s a separate exclusion for gifts to a noncitizen spouse ($152,000 for 2018 and $155,000 for 2019).

Also, if you make gifts of future interests, even if they’re less than the annual exclusion amount, a gift tax return is required. Finally, if you split gifts with your spouse, regardless of amount, you must file a gift tax return.

The return is due by April 15 of the year after you make the gift, so the deadline for 2018 gifts is coming up soon. But the deadline can be extended to October 15.

Being required to file a form doesn’t necessarily mean you owe gift tax. You’ll owe tax only if you’ve already exhausted your lifetime gift and estate tax exemption ($11.18 million for 2018 and $11.40 million for 2019).

Filing an estate tax return

If required, a federal estate tax return (Form 706) is due nine months after the date of death. Executors can seek an extension of the filing deadline, an extension of the time to pay, or both, by filing Form 4768. Keep in mind that the form provides for an automatic six-month extension of the filing deadline, but that extending the time to pay (up to one year at a time) is at the IRS’s discretion. Executors can file additional requests to extend the filing deadline “for cause” or to obtain additional one-year extensions of time to pay.

Generally, Form 706 is required only if the deceased’s gross estate plus adjusted taxable gifts exceeds the exemption. But a return is required even if there’s no estate tax liability after taking all applicable deductions and credits.

Even if an estate tax return isn’t required, executors may need to file one to preserve a surviving spouse’s portability election. Portability allows a surviving spouse to take advantage of a deceased spouse’s unused estate tax exemption amount, but it’s not automatic. To take advantage of portability, the deceased’s executor must make an election on a timely filed estate tax return that computes the unused exemption amount.

Preparing an estate tax return can be a time consuming, costly undertaking, so executors should analyze the relative costs and benefits of a portability election. Generally, filing an estate tax return is advisable only if there’s a reasonable probability that the surviving spouse will exhaust his or her own exemption amount.

Seek professional help

Estate tax rules and regulations can be complicated. If you need help determining whether a gift or estate tax return needs to be filed, contact us at 205-345-9898.

© 2019 Covenant CPA

Building an on-off switch into your estate plan

Posted on by

The right estate planning strategy for you likely is the one that will produce the greatest tax savings for your family. Unfortunately, there can be tension between strategies that save estate tax and ones that save income tax. This is especially true now that the Tax Cuts and Jobs Act nearly doubled the gift and estate tax exemption — but only temporarily. Through 2025, income tax might be a greater concern, but, after that, estate taxes might be a bigger issue.

Fortunately, it’s possible to build an “on-off switch” into your estate plan.

Why the conflict?

Generally, the best way to minimize estate taxes is to remove assets from your estate as early as possible (through outright gifts or gifts in trust) so that all future appreciation in value escapes estate tax. But these lifetime gifts can increase income taxes for the recipients of appreciated assets. That’s because assets you transfer by gift retain your tax basis, potentially resulting in a significant capital gains tax bill should your beneficiaries sell them.

Assets held for life, on the other hand, receive a stepped-up basis equal to their fair market value on the date of death. This provides an income tax advantage: Your beneficiaries can turn around and sell the assets with little or no capital gains tax liability.

Until relatively recently, estate planning strategies focused on minimizing estate taxes, with little regard for income taxes. Why? Historically, the highest marginal estate tax rate was significantly higher than the highest marginal income tax rate, and the estate tax exemption amount was relatively small. So, in most cases, the potential estate tax savings far outweighed any potential income tax liability.

Today, the stakes have changed. The highest marginal estate and income tax rates aren’t too different (40% and 37%, respectively). And, the gift and estate tax exemption has climbed to $11.40 million for 2019, meaning fewer taxpayers need to be concerned about estate taxes, at least for now.

Flipping the switch

With a carefully designed trust, you can remove assets from your taxable estate while giving the trustee the ability to direct the assets back into your estate should that prove to be the better tax strategy in the future. There are different techniques for accomplishing this, but typically it involves establishing an irrevocable trust over which you retain no control (including the right to replace the trustee) and giving the trustee complete discretion over distributions. This removes the assets from your taxable estate.

If it becomes desirable to include the trust assets in your estate because income taxes are a bigger concern, the trustee can accomplish this by, for example, naming you as successor trustee or granting you a power of appointment over the trust assets.

Of course, irrevocable trusts also have their downsides. Contact us to discuss what estate planning strategies make the most sense for you. Call us at 205-345-9898 or email us at [email protected].

© 2019 Covenant CPA