Tag Archives: estate plan

Beware of the “reciprocal trust” doctrine

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If you and your spouse have similar irrevocable trusts that benefit each other, it’s important to know that the trusts might be subject to the “reciprocal trust” doctrine. In a nutshell, the doctrine prohibits tax avoidance through trusts that are interrelated and place both spouses in the same economic position as if they’d each created trusts naming themselves as life beneficiaries.

Avoid this scenario

Let’s suppose that your and your spouse’s estates will trigger a substantial tax bill when you die. You transfer your assets to an irrevocable trust that provides your spouse with an income interest for life, access to principal at the trustee’s discretion and a testamentary, special power of appointment to distribute the trust assets among your children.

Ordinarily, assets transferred to an irrevocable trust are removed from your taxable estate (though there may be gift tax implications). But let’s say that two weeks later, your spouse establishes a trust with a comparable amount of assets and identical provisions, naming you as life beneficiary. This arrangement would violate the reciprocal trust doctrine, so for tax purposes the transfers would be undone by the IRS and the value of the assets you transferred would be included in your respective estates.

In this example, the intent to avoid estate tax is clear: Each spouse removes assets from his or her taxable estate but remains in essentially the same economic position by virtue of being named life beneficiary of the other spouse’s estate.

Create two substantially different trusts

There are many ways to design trusts to avoid the reciprocal trust doctrine, but essentially the goal is to vary factors related to each trust, such as the trust assets, terms, trustees, beneficiaries or creation dates, so that the two trusts aren’t deemed “substantially similar” by the IRS. Contact us to learn more.

© 2021 Covenant CPA

Making an estate plan? How to avoid fraudulent transfers

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If you have an estate plan and also have creditors, you could be a fraud perpetrator — without knowing it or intending to defraud anyone. In some circumstances, creditors can challenge gifts, trusts and other strategies for leaving assets to heirs as fraudulent transfers. Here’s how to keep your estate plan from running into trouble.

2 types

Most states have adopted the Uniform Fraudulent Transfer Act (UFTA). The law allows creditors to challenge transfers involving two types of fraud:

  1. Actual fraud. This means making a transfer or incurring an obligation “with actual intent to hinder, delay or defraud any creditor,” including current creditors and probable future creditors.
  2. Constructive fraud. This is a more significant threat for most people because it doesn’t involve intent to defraud. Under UFTA, a transfer or obligation is constructively fraudulent if you made it without receiving a reasonably equivalent value in exchange for the transfer or obligation and you either were insolvent at the time or became insolvent as a result of the transfer or obligation.

“Insolvent” means that the sum of your debts is greater than all of your assets, at a fair valuation. You’re presumed to be insolvent if you’re not paying debts as they become due. Generally, constructive fraud rules protect only present creditors or those whose claims arose before the transfer was made or obligation incurred.

Know your net worth

When it comes to actual fraud, you may not be safe just because you weren’t purposefully trying to defraud creditors. A court can’t read your mind, and it will consider the surrounding facts and circumstances to determine whether a transfer involves fraudulent intent. So before you make gifts or place assets in a trust, consider how a court might view the transfer.

Constructive fraud is a greater risk because of how insolvency is defined and gifts are made. When you make a gift, either outright or in trust, you don’t receive reasonably equivalent value in exchange. If you’re insolvent at the time, or the gift you make renders you insolvent, you’ve made a constructively fraudulent transfer. This means a creditor could potentially undo the transfer.

To avoid this risk, calculate your net worth carefully before making substantial gifts. Even if you’re not having trouble paying your debts, it’s possible you might meet the technical definition of insolvency. Also keep in mind that fraudulent transfer laws vary from state to state. Therefore, you should consult an attorney about the law where you live.

Build a better plan

Besides knowing the law, you can protect your estate plan in several ways. Work with a professional estate planner and be sure to reveal everything about your financial situation that might be relevant to building a creditor-resistant plan. Also manage any debts by working with creditors to negotiate reasonable repayment plans. We can help if you’re still having trouble balancing your budget or managing your assets.

© 2021 Covenant CPA

Because of COVID-19, college-aged children need a basic estate plan

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It’s August, and that means it’s time to get ready to go back to school for many students. If your child recently graduated from high school and is heading to college in the next few weeks, besides assembling the essentials — such as clothing, toiletries, bedding and a laptop — consider having your child “pack” a few estate planning documents that he or she may need at this stage of life.

Needless to say, having all the necessary financial and medical documents may be more important than ever because of the COVID-19 pandemic. And even if your student is staying home to participate in online learning this year, having these documents prepared now can provide peace of mind when he or she returns to campus.

Let’s take a closer look at four such documents:

1. Health care power of attorney. With a health care power of attorney (sometimes referred to as a “health care proxy” or “durable medical power of attorney”), your child appoints someone — probably you or his or her other parent — to make health care decisions on his or her behalf should he or she be unable to do so. A health care power of attorney should provide guidance on how to make health care decisions. Although it’s impossible to anticipate every potential scenario, the document can provide guiding principles.

2. HIPAA authorization. To accompany the health care power of attorney, Health Insurance Portability and Accountability Act (HIPAA) authorization gives health care providers the ability to share information about your child’s medical condition with you. Absent a HIPAA authorization, making health care decisions could be more difficult.

3. Financial power of attorney. A financial power of attorney appoints someone to make financial decisions or execute transactions on your child’s behalf under certain circumstances. For example, a power of attorney might authorize you to handle your child’s financial affairs while he or she is out of the country studying abroad or, in the case of a “durable” power of attorney, incapacitated.

4. Will. Although your child is still in his or her upper teens or early twenties, he or she may not be too young to have a will drawn up. This is especially true if your child owns assets. A will is a legal document that arranges for the distribution of property after a person dies. It names an executor or personal representative who’ll be responsible for overseeing the estate as it goes through probate.

If you have questions about any of these documents, don’t hesitate to give us a call. We can help provide peace of mind that your child’s health and financial affairs are properly handled.

© 2020 Covenant CPA

Make health care decisions while you’re healthy

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Estate planning isn’t just about what happens to your assets after you die. It’s also about protecting yourself and your loved ones. This includes having a plan for making critical medical decisions in the event you’re unable to make them yourself. And, as with other aspects of your estate plan, the time to act is now, while you’re healthy. If an illness or injury renders you unconscious or otherwise incapacitated, it will be too late.

Without a plan that expresses your wishes, your family may have to make medical decisions on your behalf or petition a court for a conservatorship. Either way, there’s no guarantee that these decisions will be made the way you would want, or by the person you would choose.

2 documents, 2 purposes

To ensure that your wishes are carried out, and that your family is spared the burden of guessing — or arguing over — what you would decide, put those wishes in writing. Generally, that means executing two documents: 1) a living will and 2) a health care power of attorney (HCPA).

Unfortunately, these documents are known by many different names, which can lead to confusion. Living wills are sometimes called “advance directives,” “health care directives” or “directives to physicians.” And HCPAs may also be known as “durable medical powers of attorney,” “durable powers of attorney for health care” or “health care proxies.” In some states, “advance directive” refers to a single document that contains both a living will and an HCPA.

For the sake of convenience, we’ll use the terms “living will” and “HCPA.” Regardless of terminology, these documents basically serve two important purposes: 1) to guide health care providers in the event you become unable to communicate or are unconscious, and 2) to appoint someone you trust to make medical decisions on your behalf.

Living will

A living will expresses your preferences for the use of life-sustaining medical procedures, such as artificial feeding and breathing, surgery, invasive diagnostic tests, and pain medication. It also specifies the situations in which these procedures should be used or withheld.

Living wills often contain a do not resuscitate order (DNR), which instructs medical personnel to not perform CPR in the event of cardiac arrest.

HCPA

An HCPA authorizes a surrogate — your spouse, child or another trusted representative — to make medical decisions or consent to medical treatment on your behalf if you’re unable to do so. It’s broader than a living will, which generally is limited to end-of-life situations, although there may be some overlap.

An HCPA might authorize your surrogate to make medical decisions that don’t conflict with your living will, including consenting to medical treatment, placing you in a nursing home or other facility, or even implementing or discontinuing life-prolonging measures.

It’s a good idea to have both a living will and an HCPA or, if allowed by state law, a single document that combines the two. Contact us if you have questions regarding either document 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA

College financing may be an integral part of your estate plan

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The staggering cost of college makes it critical for families to plan carefully for this major expense, and in many cases grandparents want to play a role. As you examine the many financing options for your grandchildren, be sure to consider their impact on your estate plan.

Make direct payments

A simple, but effective, technique is to make tuition payments on behalf of your grandchild. So long as you make the payments directly to the college, they avoid gift and generation-skipping transfer (GST) tax without using up any of your $11.4 million gift or GST tax exemptions or your $15,000 annual gift tax exclusion.

A disadvantage of direct payments is that, if your grandchild is young, you have to wait until the student has tuition bills to pay. So there’s a risk that you’ll die before the funds are removed from your estate.

Draft a grantor trust

Trusts offer several important benefits. For example, a trust can be established for one grandchild or for multiple beneficiaries, and assets contributed to one, together with future appreciation, are removed from your taxable estate. In addition, the funds can be used for college expenses or for other purposes. Also, if the trust is structured as a “grantor trust” for income tax purposes, its income will be taxable to you, allowing the assets to grow tax-free for the benefit of the beneficiaries.

On the downside, for financial aid purposes a trust is considered the child’s asset, potentially reducing or eliminating the amount of aid available to him or her. So keep this in mind if your grandchild is hoping to qualify for financial aid.

Explore all of your options

Other college financing options include Sec. 529 college savings and prepaid tuition plans, savings bonds, retirement plan loans, Coverdell Education Savings Accounts, and various other tax-advantaged accounts. If you’d like to learn more about your options to help fund your grandchild’s education expenses, please contact us at 205-345-9898 or info@covenantcpa.com.

© 2019 CovenantCPA

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

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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 info@covenantcpa.com.

© 2019 CovenantCPA

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

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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 info@covenantcpa.com.

© 2019 CovenantCPA

Building an on-off switch into your estate plan

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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 info@covenantcpa.com.

© 2019 Covenant CPA

Sudden impact: When a spouse unexpectedly dies

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What if the unthinkable happens and your spouse dies unexpectedly? Would you be prepared to cope emotionally and financially? As the surviving spouse, you’ll face several tasks and challenges.

First steps first

By no means complete, the following are areas that will need to be addressed:

Death certificates. One of the first things to do is obtain death certificates, which you’ll need to provide for various dealings with financial institutions and others. While it may be difficult to estimate how many death certificates will ultimately be requested of you, you’ll probably want to start with at least a dozen.

Notifications. You must get the word out to other interested parties, including your spouse’s employer, if applicable; credit card companies; life insurance companies; retirement plan and IRA administrators; the state motor vehicle agency; the state office for inheritance tax, if applicable; and your attorney.

Social Security benefits. If your spouse was receiving benefits, consult with the Social Security Administration as to the benefits available to a surviving spouse. Frequently, modifications are required if the survivor was the lower-earning spouse. Even if your spouse wasn’t receiving benefits yet, you may be eligible for survivor benefits, depending on your age and other factors.

Insurance. Don’t assume that everything about your insurance will stay the same. Review your various policies to ensure that you’ll have the optimal coverage going forward. Make whatever beneficiary changes are required.

Retirement plans and IRAs. You may face important decisions regarding employer retirement plans, such as 401(k) plans, as well as traditional and Roth IRAs. For example, if your spouse had a traditional IRA, you can complete a timely rollover to an IRA of your own without owing any tax. Conversely, you might opt for a lump-sum payout from a 401(k) or IRA should you need the funds.

Investments. Review the investments that were owned solely by your spouse, as well as those you owned jointly. When you have time, sit down with your financial advisor to chart out a path for the future, focusing on changes in personal objectives, time horizon and risk tolerance.

Estate tax filing. Although federal estate tax returns generally are required for only the wealthiest individuals, you may choose to file a return to establish the value of inherited assets. Generally, the return is due within nine months of the date of the death.

Finally, review your estate plan

Once you’re over the initial shock of the death, sit down with your attorney and review your estate plan. You’ll likely need to make several revisions in areas where you named your spouse as beneficiary. If you need help during this difficult time, please turn to us at 205-345-9898.

© 2019 Covenant CPA

Have you had your annual estate plan checkup?

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An annual estate plan checkup is critical to the health of your estate plan. Because various exclusion, exemption and deduction amounts are adjusted for inflation, they can change from year to year, impacting your plan.

2019 vs. 2018 amounts

Here are a few key figures for 2018 and 2019:

Lifetime gift and estate tax exemption

  • 2018: $11.18 million
  • 2019: $11.40 million

Generation-skipping transfer tax exemption

  • 2018: $11.18 million
  • 2019: $11.40 million

Annual gift tax exclusion

  • 2018: $15,000
  • 2019: $15,000

Marital deduction for gifts to a noncitizen spouse

  • 2018: $152,000
  • 2019: $155,000

You may need to update your estate plan based on these changes. But the beginning of the year isn’t the only time for an estate plan checkup. Whenever there are significant changes in your family, such as births, deaths, marriages or divorces, it’s a good idea to revisit your estate plan. Your plan also merits a look any time your financial situation changes significantly.

Turn to us for help

If you haven’t yet had your annual estate plan checkup, please contact us at 205-345-9898. Or, if you don’t yet have an estate plan, we can help you create one.

© 2019 Covenant CPA