The net investment income tax is alive and well: How it can affect your estate plan

Posted on November 1, 2019November 1, 2019 by CCG

The Tax Cuts and Jobs Act (TCJA) reduced individual income tax rates, but it left the 3.8% net investment income tax (NIIT) in place. It’s important to address the NIIT in your estate plan, because it can erode your earnings from interest, dividends, capital gains and other investments, leaving less for your heirs.

How it works

The NIIT applies to individuals with modified adjusted gross income (MAGI) over $200,000. The threshold is $250,000 for joint filers and qualifying widows or widowers and $125,000 for married taxpayers filing separately. The tax is equal to 3.8% of 1) your net investment income, or 2) the amount by which your MAGI exceeds the threshold, whichever is less.

Suppose, for example, that you’re married filing jointly and you have $350,000 in MAGI. Presuming $125,000 in net investment income, your NIIT is 3.8% of $100,000 (the excess of your MAGI over the threshold, which is less than your net investment income), or $3,800.

Nongrantor trusts — with limited exceptions — are also subject to the NIIT, and at a much lower threshold: For 2019, the tax applies to the lesser of 1) the trust’s undistributed net investment income or 2) the amount by which the trust’s AGI exceeds $12,751.

Reducing the tax

You can reduce or eliminate the NIIT by lowering your MAGI, lowering your net investment income, or both. Techniques for doing so include:

Reducing this year’s MAGI by deferring income, accelerating expenses or maxing out contributions to retirement accounts,
Selling poor-performing investments to offset the losses against investment gains you’ve realized during the year, or
Reducing net investment income by investing in tax-exempt municipal bonds or in growth stocks that generate little or no current income.

If you own an interest in a business, you may be able to reduce NIIT by increasing your level of participation. Income from a business in which you “materially participate” isn’t considered net investment income. (But keep in mind that increasing your participation may, in certain cases, trigger self-employment tax liability.)

For trusts, you can reduce or eliminate the NIIT by:

Structuring them as grantor trusts,
Distributing the trust’s income to its beneficiaries (remember, the NIIT applies only to undistributed income), or
Shifting the trust’s investments into tax-exempt municipal bonds, growth stocks or tax-deferred investments (such as life insurance).

Keep in mind that, if you use a grantor trust, its income will be passed through to you as grantor, potentially increasing your personal liability for NIIT.

Review your plan

The NIIT can affect the financial performance of your personal investments as well as your trusts. To maximize the amount of wealth available for your heirs, be sure to consider strategies for reducing the impact of this tax. Contact us with any questions.

Don’t worry! A broken trust can be fixed

Posted on October 25, 2019October 25, 2019 by CCG

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.

Who needs an estate plan? You do!

Posted on October 18, 2019October 18, 2019 by CCG

Despite what you might think, estate planning isn’t limited to only the rich and famous. In fact, your family is likely to benefit from a comprehensive plan that divides your wealth, protects your well-being and provides a compass for your family’s future.

Dividing your wealth

Estate planning is often associated with the division of your assets, and this is certainly a key component. It’s typically accomplished, for the most part, by drafting a will, which is the foundation of an estate plan.

With a valid will, you determine who gets what. It can cover everything from the securities in your portfolio to personal property, such as cars, artwork or other family heirlooms.

In contrast, if you die without a will — referred to as dying “intestate” — state law will control the disposition of your assets. This may result in unintended consequences. For example, children from a prior marriage may be excluded if state law dictates that all assets are to go to a surviving spouse.

In addition, you’ll need to name the executor of your estate. He or she will be responsible for carrying out your wishes according to your will. Your executor may be a professional, a family member or a friend. Also, designate a successor in case your first choice is unable to handle the duties.

Understanding probate

If your estate plan includes only a will, your estate will most likely have to go through probate. Probate is a court-supervised process to protect the rights of creditors and beneficiaries and to ensure the orderly and timely transfer of assets. The complexity and duration of probate depends on the size of your estate and state law.

If you transfer assets to a living trust, those assets are exempt from the probate process. Thus, a living trust may supplement a will, giving heirs fast access to funds.

Protecting your well-being

An estate plan can help ensure that your long-term health care is handled in the way that you wish. Notably, you can create a health care power of attorney. It grants another person — for example, a family member or a friend — the right to act on your behalf in the event you’re incapacitated. A power of attorney may be coordinated with a living will specifying your wishes in end-of-life situations, along with other health care directives.

Providing a compass

Finally, an estate plan can accomplish a variety of other objectives, depending on your preferences and circumstances. If you have minor children, you can name a guardian in your will in the event of your premature death. Without such a provision, the courts will appoint a guardian, regardless of your intent.

Your estate plan can also protect against creditors, primarily through trusts designed for these purposes. Accordingly, while trusts were often seen mainly as tax-saving devices in the past, they can fulfill a multitude of other roles.

Let the planning begin

Now that the need for an estate plan is clear, don’t delay any longer. Contact us to begin the process or if you have any questions.

Sec. 6166: Estate tax relief for family businesses

Posted on October 2, 2019October 2, 2019 by CCG

Fewer people currently are subject to transfer taxes than ever before. But gift, estate and generation-skipping transfer (GST) taxes continue to place a burden on families with significant amounts of wealth tied up in illiquid closely held businesses, including farms.

Fortunately, Internal Revenue Code Section 6166 provides some relief, allowing the estates of family business owners to defer estate taxes and pay them in installments if certain requirements are met.

Sec. 6166 benefits

For families with substantial closely held business interests, an election to defer estate taxes under Sec. 6166 can help them avoid having to sell business assets to pay estate taxes. It allows an estate to pay interest only (at modest rates) for four years and then to stretch out estate tax payments over 10 years in equal annual installments. The goal is to enable the estate to pay the taxes out of business earnings or otherwise to buy enough time to raise the necessary funds without disrupting business operations.

Be aware that deferral isn’t available for the entire estate tax liability. Rather, it’s limited to the amount of tax attributable to qualifying closely held business interests.

Sec. 6166 requirements

Estate tax deferral is available if 1) the deceased was a U.S. citizen or resident who owned a closely held business at the time of his or her death, 2) the value of the deceased’s interest in the business exceeds 35% of his or her adjusted gross estate, and 3) the estate’s executor or other personal representative makes a Sec. 6166 election on a timely filed estate tax return.

To qualify as a “closely held business,” an entity must conduct an active trade or business at the time of the deceased’s death (and only assets used to conduct that trade or business count for purposes of the 35% threshold). Merely managing investment assets isn’t enough.

In addition, a closely held business must be structured as:

A sole proprietorship,
A partnership (including certain limited liability companies taxed as partnerships), provided either 1) 20% or more of the entity’s total capital interest is included in the deceased’s estate, or 2) the entity has a maximum of 45 partners, or
A corporation, provided either 1) 20% or more of the corporation’s voting stock is included in the deceased’s estate, or 2) the corporation has a maximum of 45 shareholders.

Several special rules make it easier to satisfy Sec. 6166’s requirements. For example, if an estate holds interests in multiple closely held businesses, and owns at least 20% of each business, it may combine them and treat them as a single closely held business for purposes of the 35% threshold. In addition, the section treats stock and partnership interests held by certain family members as owned by the deceased.

On the other hand, the interests owned by corporations, partnerships, estates and trusts are attributed to the underlying shareholders, partners or beneficiaries. This can make it harder to stay under the 45-partner/shareholder limit.

Control how your charitable gifts are used by adding restrictions

Posted on September 6, 2019September 6, 2019 by CCG

If philanthropy is an important part of your estate planning legacy, consider taking steps to ensure that your donations are used to fulfill your intended charitable purposes. Outright gifts can be risky, especially large donations that will benefit a charity over a long period of time.

Even if a charity is financially sound when you make a gift, there are no guarantees it won’t suffer financial distress, file for bankruptcy protection or even cease operations down the road. The last thing you probably want is for a charity to use your gifts to pay off its creditors or for some other purpose unrelated to the mission that inspired you to give in the first place.

One way to help preserve your charitable legacy is to place restrictions on the use of your gifts. For example, you might limit the use of your funds to assisting a specific constituency or funding medical research. These restrictions can be documented in your will or charitable trust or in a written gift or endowment fund agreement.

Depending on applicable federal and state law and other factors, carefully designed restrictions can prevent your funds from being used to satisfy creditors in the event of the charity’s bankruptcy. If these restrictions are successful, the funds will continue to be used according to your charitable intent, either by the original charity (in the case of a Chapter 11 reorganization) or by an alternate charity (in the case of a Chapter 7 liquidation).

In addition to restricting your gifts, it’s a good idea to research the charities you’re considering, to ensure they’re financially stable and use their funds efficiently and effectively. One powerful research tool is the IRS’s Tax Exempt Organization Search (TEOS). TEOS provides access to information about charitable organizations, including newly filed information returns (Forms 990), IRS determination letters and eligibility to receive tax-deductible contributions. Access TEOS here: https://bit.ly/1RYWq2x

If you have questions regarding your charitable donations, please contact us.

Take intrafamily lending to the next level by establishing a family bank

Posted on August 29, 2019August 29, 2019 by CCG

One of the primary goals of estate planning is to put in writing how you want your wealth distributed to loved ones after your death. But what if you’d like to use that wealth to help a family member in need while you’re still alive? One way to do so is through intrafamily lending. If you’re considering making an intrafamily loan to your children or other family members, it’s worth a look at establishing a “family bank.”

Loan structure is important

Lending can be an effective way to provide your family financial assistance without triggering unwanted gift taxes. So long as a loan is structured in a manner similar to an arm’s-length loan between unrelated parties, it won’t be treated as a taxable gift.

This means, among other things:

Documenting the loan with a promissory note,
Charging interest at or above the applicable federal rate,
Establishing a fixed repayment schedule, and
Ensuring that the borrower has a reasonable prospect of repaying the loan.

Even if taxes aren’t a concern, intrafamily loans offer important benefits. For example, they allow you to help your family financially without depleting your wealth or creating a sense of entitlement. Done right, these loans can promote accountability and help cultivate the younger generation’s entrepreneurial capabilities by providing financing to start a business.

Too often, however, people lend money to family members with little planning or regard for potential unintended consequences. Rash lending decisions can lead to misunderstandings, hurt feelings, conflicts among family members and false expectations. That’s where the family bank comes into play.

Family bank professionalizes intrafamily lending

A family bank is a family-owned, family-funded entity — such as a dynasty trust, a family limited partnership or a combination of the two — designed for the sole purpose of making intrafamily loans. Often, family banks are able to make financing available to family members who might have difficulty obtaining a loan from a bank or other traditional funding sources or to lend at more favorable terms.

By “professionalizing” family lending activities, a family bank can preserve the tax-saving power of intrafamily loans while minimizing negative consequences. The key to avoiding family conflicts and resentment is to build a strong family governance structure that promotes communication, group decision making and transparency.

Establishing clear guidelines regarding the types of loans the family bank is authorized to make — and allowing all family members to participate in the decision-making process — ensures that family members are treated fairly and avoids false expectations.

Expanded 529 plans offer unique estate planning benefits

Posted on August 23, 2019August 23, 2019 by CCG

If you’re putting aside money for college or other educational expenses, consider a tax-advantaged 529 savings plan. Also known as “college savings plans,” 529 plans were expanded by the Tax Cuts and Jobs Act (TCJA) to cover elementary and secondary school expenses as well. And while these plans are best known as an educational funding vehicle, they also offer estate planning benefits.

What do 529 plans cover?

529 plans allow you to contribute a substantial amount of cash (lifetime contribution limits can reach as high as $350,000 or more, depending on the plan) to a tax-advantaged investment account. Like a Roth IRA, contributions are nondeductible, but funds grow tax-deferred and earnings may be withdrawn tax-free provided they’re used for “qualified education expenses.”

Qualified expenses include tuition, fees, books, supplies, equipment, room and board and, under the TCJA, up to $10,000 per year in elementary or secondary school expenses. Earnings used for other purposes are subject to income tax and a 10% penalty.

What are the estate planning benefits?

These plans are unique among estate planning vehicles. Ordinarily, to shield assets from estate taxes, you must permanently relinquish all control over them. But contributions to a 529 plan are considered “completed gifts” — which means the assets are removed from your taxable estate, together with all future earnings on those assets — even though you retain considerable control over the money. For example, unlike most other estate planning vehicles, you can control the timing of distributions, change beneficiaries, move the funds into another 529 plan, or even cancel the plan and get your money back (subject to taxes and penalties).

As a completed gift, a 529 plan contribution is eligible for the annual gift tax exclusion (currently $15,000). But unlike other vehicles, you can bunch up to five years’ worth of annual exclusions into one year. This allows you to contribute up to $75,000 in one year, without triggering gift or generation-skipping transfer (GST) taxes and without using up any of your lifetime exemption. There are implications, however, if you don’t survive the five years.

Why does it matter?

You might think that these benefits are of little value now that the TCJA has temporarily doubled the lifetime gift and estate tax exemption to an inflation-adjusted $10 million ($20 million for married couples who design their estate plans properly). This year, the exemption amount is $11.4 million ($22.8 million for married couples).

After all, few families are currently affected by these taxes. But it’s still a good idea to shield wealth from potential estate taxes and to make the most of your annual exclusion. This is because the new exemptions are scheduled to return to their previous levels after 2025 and there’s nothing to stop lawmakers from reducing the exemption in the future. 529 plans and other traditional estate planning tools provide some insurance against future estate tax changes.

A poorly worded apportionment clause can upend an estate plan

Posted on August 19, 2019August 19, 2019 by CCG

Federal estate tax liability is no longer an issue for many families, now that the gift and estate tax exemption stands at $11.4 million for 2019. But there are still affluent individuals whose estates may be subject to hefty estate tax bills. If you expect your estate to have significant estate tax liability at your death, it’s critical to include a tax apportionment clause in your will or revocable trust.

An apportionment clause specifies how the estate tax burden will be allocated among your beneficiaries. Omission of this clause, or failure to word it carefully, may result in unintended consequences.

How to apportion estate taxes

There are many ways to apportion estate taxes. One option is to have all of the taxes paid out of assets passing through your will. Beneficiaries receiving assets outside your will — such as IRAs, retirement plans or life insurance proceeds — won’t bear any of the tax burden.

Another option is to allocate taxes among all beneficiaries, including those who receive assets outside your will. And yet another is to provide for the tax to be paid from your residuary estate — that is, the portion of your estate that remains after all specific gifts or requests have been made and all expenses and liabilities have been paid.

Omission of an apportionment clause

What if your will doesn’t have an apportionment clause? In that case, apportionment will be governed by applicable state law (although federal law covers certain situations).

Most states have some form of an “equitable apportionment” scheme. Essentially, this approach requires each beneficiary to pay the estate tax generated by the assets he or she receives. Some states provide for equitable apportionment among all beneficiaries while others limit apportionment to assets that pass through the will or to the residuary estate.

Often, state apportionment laws produce satisfactory results, but in some cases, they may be inconsistent with your wishes.

Avoid surprises

If you ignore tax apportionment when planning your estate, your wealth may not be distributed in the manner you intend. To avoid unpleasant surprises for your beneficiaries, be sure to include an apportionment clause that clearly spells out who will bear the burden of estate taxes. Contact us with any questions regarding taxes or estate planning.

Understanding the contents of a will

Posted on August 13, 2019August 13, 2019 by CCG

You probably don’t have to be told about the need for a will. But do you know what provisions should be included and what’s best to leave out? The answers to those questions depend on your situation and may depend on state law.

Basic provisions

Typically, a will begins with an introductory clause, identifying yourself along with where you reside (city, state, county, etc.). It should also state that this is your official will and replaces any previous wills.

After the introductory clause, a will generally explains how your debts and funeral expenses are to be paid. The provisions for repaying debt generally reflect applicable state laws.

Don’t include specific instructions for funeral arrangements. It’s likely that your will won’t be accessed in time. Spell out your wishes in a letter of instructions, which is an informal letter to your family.

A will may also be used to name a guardian for minor children. To be on the safe side, name a backup in case your initial choice is unable or unwilling to serve as guardian or predeceases you.

Specific bequests

One of the major sections of your will — and the one that usually requires the most introspection — divides up your remaining assets. Outside of your residuary estate, you’ll likely want to make specific bequests of tangible personal property to designated beneficiaries.

If you’re using a trust to transfer property, make sure you identify the property that remains outside the trust, such as furniture and electronic devices. Typically, these items won’t be suitable for inclusion in a trust. If your estate includes real estate, include detailed information about the property and identify the specific beneficiaries.

Once you’ve covered real estate and other tangible property, move on to intangible property, such as cash and securities. Again, you may handle these items through specific bequests where you describe the property the best you can.

Finally, most wills contain a residuary clause. As a result, assets that aren’t otherwise accounted for go to the named beneficiaries, often adult children, grandchildren or a combination of family members.

Naming an executor

Toward the end of the will, name the executor — usually a relative or professional — who is responsible for administering it. Of course, this should be a reputable person whom you trust. Also, include a successor executor if the first choice is unable to perform these duties. Frequently, a professional is used in this backup capacity.

Cross the t’s and dot the i’s

Your attorney will help you meet all the legal obligations for a valid will in the applicable state and keep it up to date. Sign the will, putting your initials on each page, with your signature attested to by witnesses. Include the addresses of the witnesses in case they ever need to be located. Don’t use beneficiaries as witnesses. This could lead to potential conflicts of interest. Contact us with questions.

Naming a trustee may be one of the most important decisions of your life

Posted on July 25, 2019July 25, 2019 by CCG

When it comes to estate planning, trusts are appealing for many reasons. They can enable you to hold and transfer assets for beneficiaries, avoid probate and reduce estate tax exposure. But they can be complicated to set up. One of the major decisions you’ll need to make when establishing a trust is who will act as your trustee. As the name implies, this individual or financial institution must be above reproach. But that’s just one quality of many that your trustee requires.

Both mundane and significant duties

Trustees have significant legal responsibilities, primarily related to administering the trust for the benefit of beneficiaries according to the terms of the trust document. But the role can require many different types of tasks. For example, even if a tax expert is engaged to prepare tax returns, the trustee is responsible for ensuring that they’re completed and filed correctly and on time.

One of the more challenging trustee duties is to accurately account for investments and distributions. When funds are distributed to cover a beneficiary’s education expenses, for example, the trustee should record both the distribution and the expenses covered by it. Beneficiaries are allowed to request an accounting of the transactions at any time.

The trustee needs to invest assets within the trust reasonably, prudently and for the long-term benefit of beneficiaries. And trustees must avoid conflicts of interest — that is, they can’t act for personal gain when managing the trust.

Finally, trustees must be impartial. They may need to decide between competing interests, while still acting within the terms of the trust document.

A tall order

Several qualities help make someone an effective trustee, including:

A solid understanding of tax and trust law,
Investment management experience,
Bookkeeping skills,
Integrity and honesty, and
The ability to work with all beneficiaries objectively and impartially.

And because some trusts continue for generations, trustees may need to be available for an extended period. For this reason, many people name a financial institution or professional advisor, rather than a friend or family member, as trustee.

Naming a friend or family member as a trustee may seem appealing because it appears to be a way to reduce or avoid the fees associated with an institutional trustee. But it’s important to recognize that taking on the responsibilities of a trustee requires an investment of time, energy and expertise, and that trustees deserve compensation. Even if trust documents don’t provide a fee for the trustee, many states allow for a “reasonable fee.” Before engaging a trustee, make sure you understand what services are included in the fee. But it’s generally not a good idea to try to avoid paying a trustee fee.

Consider all options

Naming a trustee is an important decision, as this person or institution will be responsible for carrying out the terms outlined in the trust documents. We can help you weigh the options available to you.