Category Archives: Estate Planning

Have you coordinated your payable-on-death accounts with your estate plan?

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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

If you’re planning to move oversees, it’s time for an estate plan review

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Whether you’re moving to another country for work-related reasons, retirement or simply want an opportunity to experience a new culture, it’s important to understand the potential tax and estate planning implications. If you don’t, you could be hit with some unpleasant surprises. Here are three possible pitfalls:

Double taxation. If you’re a citizen of the United States, U.S. taxes will apply even after you move to another country. So if your estate is large, you might be subject to gift and estate taxes in your new country and in the United States (possibly including state taxes if you maintain a residence in a U.S. state). You also could be subject to estate taxes abroad even if your estate isn’t large enough to be subject to U.S. estate taxes. In some cases, you can claim a credit against U.S. taxes for taxes you pay to another country, but these credits aren’t always available.

One option for avoiding U.S. taxes is to relinquish your U.S. citizenship. But this strategy raises a host of legal and tax issues of its own, including potential liability for a one-time “expatriation tax.”

Real estate issues. If you wish to purchase a home in a foreign country, you may discover that your ability to acquire property is restricted. Some countries, for example, prohibit foreigners from owning real estate that’s within a certain distance from the coast or even throughout the country. It may be possible to bypass these restrictions by using a corporation or trust to hold property, but this can create burdensome tax issues for U.S. citizens.

Unfamiliar inheritance rules. If you own real estate or other property in a foreign country, your heirs may run up against unusual inheritance rules. In some countries, for example, your children have priority over your spouse, regardless of the terms of your will.

Review before you relocate

If you’re considering a move overseas, discuss your plans with us before making a move. We can review your estate plan and finances and make recommendations to help avoid tax pitfalls after you relocate.

© 2020 Covenant CPA

Take steps to curb power of attorney abuse

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A financial power of attorney can be a valuable planning tool. The most common type is the durable power of attorney, which allows someone (the agent) to act on the behalf of another person (the principal) even if the person becomes mentally incompetent or otherwise incapacitated. It authorizes the agent to manage the principal’s investments, pay bills, file tax returns and handle other financial matters if the principal is unable to do so as a result of illness, injury, advancing age or other circumstances.

However, a disadvantage of a power of attorney is that it may be susceptible to abuse by scam artists, dishonest caretakers or greedy relatives.

Watch out for your loved ones

A broadly written power of attorney gives an agent unfettered access to the principal’s bank and brokerage accounts, real estate, and other assets. In the right hands, this can be a huge help in managing a person’s financial affairs when the person isn’t able to do so him- or herself. But in the wrong hands, it provides an ample opportunity for financial harm.

Many people believe that, once an agent has been given a power of attorney, there’s little that can be done to stop the agent from misappropriating money or property. Fortunately, that’s not the case.

If you suspect that an elderly family member is a victim of financial abuse by the holder of a power of attorney, contact an attorney as soon as possible. An agent has a fiduciary duty to the principal, requiring him or her to act with the utmost good faith and loyalty when acting on the principal’s behalf. So your relative may be able to sue the agent for breach of fiduciary duty and obtain injunctive relief, damages (including punitive damages) and attorneys’ fees.

Take steps to prevent abuse

If you or a family member plans to execute a power of attorney, there are steps you can take to minimize the risk of abuse:

  • Make sure the agent is someone you know and trust.
  • Consider using a “springing” power of attorney, which doesn’t take effect until certain conditions are met, such as a physician’s certification that the principal has become incapacitated.
  • Use a “special” or “limited” power of attorney that details the agent’s specific powers. (The drawback of this approach is that it limits the agent’s ability to deal with unanticipated circumstances.)
  • Appoint a “monitor” or other third party to review transactions executed by the agent and require the monitor’s approval of transactions over a certain dollar amount.
  • Provide that the appointment of a guardian automatically revokes the power of attorney.

Some state laws contain special requirements, such as a separate rider, to authorize an agent to make large gifts or conduct other major transactions.

Act now

If you’re pursuing legal remedies against an agent, the sooner you proceed, the greater your chances of recovery. And if you wish to execute or revoke a power of attorney for yourself, you need to do so while you’re mentally competent. Contact us with questions.

© 2020 Covenant CPA

Inheriting property? Be aware of the basis consistency rules

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If you’re in line to inherit property from a parent or other loved one, it’s critical to understand the basis consistency rules. Current tax law, passed in 2015, provides that the income tax basis of property received from a deceased person can’t exceed the property’s fair market value (FMV) as finally determined for estate tax purposes.

Prior law

Before the 2015 tax law change, estates and their beneficiaries had conflicting incentives when it came to the valuation of a deceased person’s property. Executors had an incentive to value property as low as possible to minimize estate taxes, while beneficiaries had an incentive to value property as high as possible to minimize capital gains, if they decided to sell the property.

Current law

The 2015 law requires consistency between a property’s basis reflected on an estate tax return and the basis used to calculate gain when it’s sold by the person who inherits it. It provides that the basis of property in the hands of a beneficiary may not exceed its value as finally determined for estate tax purposes.

Generally, a property’s value is finally determined when:

  • Its value is reported on a federal estate tax return and the IRS doesn’t challenge it before the limitations period expires,
  • The IRS determines its value and the executor doesn’t challenge it before the limitations period expires, or
  • Its value is determined according to a court order or agreement.

But the basis consistency rule isn’t a factor in all situations. The rule doesn’t apply to property unless its inclusion in the deceased’s estate increased the liability for estate taxes. So, for example, the rule doesn’t apply if the value of the deceased’s estate is less than his or her unused exemption amount.

Beware of failure-to-file penalties

Current law also requires estates to furnish information about the value of inherited property to the IRS and the person who inherits it. Estates that fail to comply with these reporting requirements are subject to failure-to-file penalties.

An accurate valuation is key

The basis consistency rules can be complex. The bottom line is that if you inherit property from a person whose estate is liable for estate tax, it’s important that the property’s value be accurately reported on the deceased’s estate tax return. Contact us with any questions.

© 2020 Covenant CPA

Time passages: Estate planning through the years

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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

Use nongrantor trusts to bypass the SALT deduction limit

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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

Qualified Opportunity Funds: A new weapon in the estate planning arsenal

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The Tax Cuts and Jobs Act created a new program to encourage investment in economically distressed areas through generous tax incentives. The Qualified Opportunity Zone (QOZ) program relies on investments in Qualified Opportunity Funds (QOFs) — funds that can provide wealthy taxpayers with some new avenues for estate planning.

3 big tax benefits

Investors in QOFs stand to reap three significant tax breaks:

  1. They can defer capital gains on the disposition of appreciated property by reinvesting the gains in a QOF within 180 days of disposition. The tax is deferred until the QOF investment is sold or Dec. 31, 2026, whichever is earlier.
  2. Depending on how long they hold their QOF investment, they can eliminate 10% to 15% of the tax.
  3. After 10 years, post-acquisition appreciation on the investment is tax-exempt.

By incorporating QOFs in your estate planning, you can reduce both capital gains and transfer tax liabilities.

Estate planning implications

Proposed regulations make clear that a QOF investor’s death isn’t an “inclusion event” that would trigger tax on the deferred gains. In addition, most of the activities involved in administering an estate or trust (for example, transferring the interest to the estate or distributing the interest) won’t trigger the gain. But the sale of the QOF interest by the estate, the trust or a beneficiary would. Gifts of QOF interests also are generally considered inclusion events that make the deferred gains immediately taxable.

You could avoid this, though, by gifting your interest to a grantor trust. Both revocable living trusts and irrevocable grantor trusts qualify. However, transfers to the latter are completed gifts and therefore produce greater potential tax savings in situations where the income and gains of the trust are taxed to the grantor, in turn reducing the grantor’s estate by the amount of income taxes paid. (Note, though, that the termination of grantor trust status for reasons other than the grantor’s death is treated as an inclusion event.)

For example, you could transfer a highly appreciated asset to an irrevocable trust with no gift tax under the federal gift and estate tax exemption ($11.40 million for 2019 and $11.58 million for 2020). The trust could sell the asset and defer the gains into a QOF investment.

Another option for transferring QOF interests is the grantor retained annuity trust (GRAT), which allows you to make a gift to a trust and receive an annuity interest roughly equal to the fair market value of the gift. Any appreciation beyond the amount required to pay the annuity also passes to the beneficiaries without gift tax.

Contact us for additional information.

© 2019 Covenant CPA

IRS confirms large gifts now won’t hurt post-2025 estates

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The IRS has issued final regulations that should provide comfort to taxpayers interested in making large gifts under the current gift and estate tax regime. The final regs generally adopt, with some revisions, proposed regs that the IRS released in November 2018.

The need for clarification

The Tax Cuts and Jobs Act (TCJA) temporarily doubled the gift and estate tax exemption from $5 million to $10 million for gifts made or estates of decedents dying after Dec. 31, 2017, and before Jan. 1, 2026. The exemption is adjusted annually for inflation ($11.40 million for 2019 and $11.58 million for 2020). After 2025, though, the exemption is scheduled to drop back to pre-2018 levels.

With the estate tax a flat 40%, the higher threshold for tax-free transfers of wealth would seem to be great news, but some taxpayers became worried about a so-called “clawback” if they die after 2025. Specifically, they wondered if they would lose the tax benefit of the higher exemption amount if they didn’t die before the exemption returned to the lower amount.

The concern was that a taxpayer would make gifts during his or her lifetime based on the higher exemption, only to have their credit calculated based on the amount in effect at the time of death. To address this fear, the final regs provide a special rule for such circumstances that allows the estate to compute its estate tax credit using the higher of the exemption amount applicable to gifts made during life or the amount applicable on the date of death.

Examples

Let’s say that you made $9 million in taxable gifts in 2019, while the exemption amount of $11.40 million is in effect. But you die after 2025, when the exemption drops to $6.8 million ($5 million adjusted for inflation).

Under the new regs, the credit applied to compute the estate tax is based on the $9 million of the $11.4 million exemption used to compute the gift tax credit. In other words, your estate won’t have to pay tax on the $2.2 million in gifts that exceeds the exemption amount at death ($9 million less $6.8 million), and the credit to the estate tax will reflect the $2.4 million of the amount remaining after the gifts were made ($11.4 million less $9 million).

If, however, you made taxable gifts of only $4 million, the new regs won’t apply. The total amounts allowable as a credit when calculating the gift tax ($4 million) is less than the credit based on the $6.8 million exemption amount at death. So, the estate tax credit is based on the exemption amount at death, rather than the amount under the TCJA.

Act now

Even though the TCJA and the final regs provide a strong tax incentive to transfer assets, it’s important to remember that the offer is “use it or lose it.” The new regs apply only to gifts made during the 2018-2025 period, so contact us now to formalize your gifting strategies.

© 2019 Covenant CPA

Have you considered making direct payments of tuition and medical expenses?

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With the lifetime gift and estate tax exemption at $11.40 million for 2019 ($11.58 million for 2020), you may think you don’t have to worry about gift and estate taxes.

However, there are no guarantees that estate tax law won’t be revised in the future or that your accumulated assets won’t eventually exceed the available exemption (which is scheduled to drop significantly in 2026). Thus, there’s a need to investigate other tax-saving possibilities.

Beyond annual exclusion gifts

Under the annual gift tax exclusion, you can reduce your taxable estate without using up any of your lifetime exemption by giving each recipient gifts valued up to $15,000 a year. For example, if you have three children and seven grandchildren, you can give each one $15,000 tax free, for a total of $150,000 in 2019. If your spouse joins in the gifts, the tax-free total is doubled to $300,000.

But what if you want to give away more without dipping into your lifetime exemption? Then direct payments of medical expenses or tuition may be right for you.

Ins and outs of direct payments

If you pay medical expenses on behalf of someone directly to a health care provider, those payments are exempt from gift tax above and beyond any amount covered by the annual gift tax exclusion. The same is true for paying the tuition expenses of a student directly to the school.

For example, if you give your granddaughter $15,000 in 2019 and then pay her $35,000 tuition bill at an elite private college, the entire $50,000 is sheltered from gift tax. But remember that the gift must be made directly to the educational institution (or health care provider). If you give the money to your granddaughter and she uses it to pay the tuition, the amount won’t be eligible for the direct payment exemption.

On the other hand, direct payments of tuition can reduce a student’s eligibility for financial aid on a dollar-for-dollar basis, while with gifts made directly to the student, only 20% of the gifted assets would be counted as assets of the student for financial aid purposes. Accordingly, careful analysis of the trade-offs between the potential tax savings and impairment of financial aid eligibility should be considered. Contact us with any questions.

© 2019 Covenant CPA

Don’t be afraid of probate

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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.

Defining probate

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