Monthly Archives: November 2015

Estate planning overview update – key issues to consider for your wills & more

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Whether you’re updating an existing plan or starting from scratch, this overview presents the key issues to consider when designing and executing the best estate plan. The work does not stop at signing your estate plan documents; you must also complete the follow up work of beneficiary designations, memorandum to fiduciaries, etc. The goal is to avoid the pitfall of having no plan and the disaster when wills and trusts are in place but the asset ownership and beneficiary designations frustrate the plan by having assets pass to the spouse and not the trust.

If you do nothing else after reading this, write and deliver a “Memorandum to Survivors” and review asset ownership, all as described at the end of this post. A comprehensive estate plan can accomplish many goals, such as providing for survivors, ensuring your children are cared for, determining the flow of your assets upon your death, and reducing the amount of taxes your estate will pay while administering your estate. The most important goal is that you have peace of mind knowing that your estate will be administered in accordance with your wishes.

Updating an Existing Plan
If you have a plan already in place, be sure to review it every couple of years. As you grow older, your life circumstances change and these changes may affect your wishes and plans for your estate. Events such as the emancipation of your children, divorce, lapsed relationships with fiduciaries will likely affect your estate plan. Keep these matters in mind when reviewing the remainder of this post. Your change of circumstances could change your pyramid level.

Estate Planning Pyramid
Constructing a pyramid can be helpful for understanding all that goes into an estate plan, much like nutrition and investments. Each level of the pyramid addresses a new level of complexity in your family and financial situation – that is, everyone needs level one, but not all need the later, more complex levels.

Pyramid: Level One
The first level of estate planning provides the most basic protections so it is most suitable to single individuals with no children and few assets. This level of estate plan typically includes the following forms:

  • Health Care Proxy: This document allows you to appoint people to make decisions about your health care and treatment when you are not capable of doing so. You typically select the surviving spouse and then have a first and second alternate if you wish. Some states call such documents “medical directives” or “medical powers of attorney.”
  • Living Will: This makes your wishes clear as to whether or not you want to have heroic means used to prolong your life.
  • Anatomical Gift Instrument: This allows you to have a hospital use organs and other body parts for others in need of a transplant.

Pyramid: Level Two
The second level is most appropriate for individuals in committed relationships. This level includes all the forms listed in the first level, but adds a durable power of attorney. This document grants a power of attorney to the other to manage your financial affairs if you are absent or you become incapacitated.

Pyramid: Level Three
When you have children, you want to ensure that they will be both cared for and provided for in the manner you wish. To achieve this, you need a will to appoint a guardian, for the “care,” and create a trust to manage assets, for the “providing.”

  • A will is a formal document that designates your personal representative or executor, any alternates, plus a guardian and any alternates for children under age 18, then instructs your personal representative to pay off your debts, and distribute your estate per your wishes.
  • A trust is an entity that you create and can be used for many purposes. The trustee acts as the owner of what the trust holds, while the beneficiaries get all the benefits from what the trust holds. For estate planning, trusts are used to reduce estate taxes in various ways. Trust vehicles can also describe how and when assets are distributed. For example, the grantor of a trust could insist that assets not go to children until they are age thirty-five. The trust vehicle could also provide where assets flow if all family members die without issue. For example, assets could flow to a charity or educational institution.

  Providing for Survivors: You need to address how your assets and any life insurance flow after your death in order to ensure that your resources allow those who survive you to maintain the same standard of living, during their life expectancies, that you all had during your life. If your investments are not sufficient, even after making liquid certain kinds of personal property (e.g., a second home), then there is a need for life insurance.

Life Insurance: Term insurance, providing only a death benefit, funds the shortfall between assets required to maintain the lifestyle of the survivors and actual assets available. Whole life, variable or other types of insurance should only be used when permanent insurance is required, as in the case of maintaining estate liquidity throughout your lifetime.

Flow of Assets: After you determine the assets required to support the lifestyle of the survivor, you determine to whom the assets flow. For example, at Levels One and Two, you can leave everything directly to survivors, while at Levels Three to Six, you use a trust, and at Level Six you may even separate some portion of the assets by gift now.

Control Over Assets: In Levels One and Two, the survivors have complete control over the assets. At higher Levels, trust vehicles are used for the estate tax savings. However, you also gain a heightened level of attention on the assets: you have engaged a trustee to focus on providing for the surviving spouse, maintaining his or her lifestyle, while still attending to the interests of other beneficiaries, such as children. In this way, the trustee will try to preserve the trust assets in the best way possible for the longest duration. Finally, the trustee must distribute the assets per your instructions; if assets went to a survivor, they are not bound in any way to follow your wishes, so you may not achieve your estate planning goals.

Fiduciaries: In designing the estate plan, many choices revolve around the fiduciary that you select for a particular role.

  • Personal Representative or Executor: This is the person who “marshals” all assets of the estate together, pays death expenses and transfers ownership of property to the surviving spouse or trust. This is approximately a nine-month task.
  • Guardian: This is the person whom you select to love and care for your children in your absence. The spouse selects the surviving spouse and then a second or third choice beyond that. This job lasts until each child has reached majority (age eighteen).
  • Trustee: This person has potentially the longest-term job because he or she must manage the trust assets and make distributions of income and sometimes principal to the surviving spouse, children and even grandchildren. Depending on the terms of the trust, this job could last until the children are young adults.
  • Beneficiary Designations and Ownership: ownership and how life insurance proceeds and retirement plan assets flow is described below.

Pyramid: Level Four
This level of planning addresses state taxes. When the potential combined estate of a husband and wife exceeds $1 million, and they have other beneficiaries for whom they want to maximize the estate after taxes, then trusts are typically used. States such as Massachusetts impose an estate tax over $1 million. Other states have similar amounts, but many are increasing, such as New York which will match the federal credit in 2019. Therefore, additional planning is required if you reside in a state with an estate tax.

Pyramid: Level Five
The fifth level contains trusts that address federal estate taxes, as well as state. Congress has retained the unified gift and estate tax credit, now at approximately $11.4 million (inflation adjusted) with a 40% estate tax rate. In addition, the unused portion of the estate tax credit of a deceased spouse is “portable”, allowing it to pass to the estate of surviving spouse.

With the trust structure, sub-trusts can be created so that both the credit and the marital deduction are used. This structure takes advantage of the credit at the first and second deaths. In contrast, wills that pass all assets outright to the surviving spouse would only take advantage of the credit at the second death. The total tax savings for an estate of $10 million or more is excess of $1.75 million for the combined estates.

  • Life Insurance Trust: You can also make an irrevocable trust the owner of any insurance on your life to exclude all proceeds at death from both estates, avoiding estate taxes. That is, the proceeds are completely estate tax free. However, this requires an irrevocable transfer to the trust; you cannot get the insurance back out. You can use this trust to receive insurance proceeds that can pay for estate taxes, thereby preserving more of your estate after taxes without increasing the taxable estate.

Pyramid: Level Six
The final level is for complex estate planning that minimizes federal and state estate taxes through multiple generations. An example of this is a generation-skipping trust. These trusts transfer assets from the grantor’s estate to his or her grandchildren. This is what allows the grantor’s estate to avoid taxes that would apply if the assets were transferred directly to his or her children. The grantor’s children can still enjoy financial benefits of the trust by accessing any income that is generated by the trust while leaving the assets in trust for grantor’s grandchildren.

  • Other entities: Separating assets by gift now would be important if you wanted to ensure some minimum funding for children, such as guaranteeing coverage for their college expenses.
  • 529 Plans: you can use 529 plans or trusts for gifting to cover college costs of a child.

After the Plan has been Executed – Ownership and Beneficiary Designations
Once the documents and insurance are in place, make sure to review and complete the following:

Qualified Plans (IRA’s, 401k plans, etc.):

  • Primary Beneficiary – to the surviving spouse (so he or she can roll over the proceeds to an IRA and thereby defer income taxes); and
  • Secondary Beneficiary – to your children (or your own revocable, depending on whether you want the assets controlled or available to children).

Life Insurance and Annuities:

  • Primary Beneficiary – when not owned by an irrevocable trust, such as group term, to your own revocable trust (for estate tax benefits, e.g., using credit at first death); and
  • Secondary Beneficiary – to the surviving spouse (in case of trust has been terminated for some reason).

Other Assets
Consider changing ownership of any jointly held assets to ownership by one of you. Any assets held as joint tenants with rights of survivorship will go to the survivor by operation of law and never get to your revocable trust. (You want to be sure that you have sufficient assets going to the trust to realize the full tax reduction effect.)

You may even want to fund your trusts, moving investment accounts over to your own revocable trust. This has no impact on your income taxes. You can also choose to fund your revocable trust now. This will save a significant amount of time for the executor, and the attorney he or she hires, as this will need to be done after your death otherwise.

Memorandum to Survivors
Compile a reference book or add to your financial plan book photocopies of important papers, identifying where the originals are, then adding a list of important contacts, instructions to your executor and trustee and other important notes for family and friends. You would update this at least annually with new asset statements (consider this as you gather information for preparing your taxes). To be more specific, the list (and copies) should include:

  • Location of original will, trust, etc.;
  • Location of health care proxy and durable power of attorney;
  • List of professionals with contact information: doctor, attorney, CPA, etc.;
  • List of fiduciaries with contact information: health care proxy, guardians, executors and trustees, attorney-in-fact for durable power of attorney, etc.;
  • Location of insurance policies and valuables such as original titles, etc.;
  • Location of safe deposit box for valuables and items in #5 or 7;
  • List of all bank and investment accounts and location of any stock certificates or other documentation for investments;
  • List of all mortgages, loans and credit card accounts;
  • Any appraisals or other listing of items by value;
  • All automatic debits that need to be addressed (stopped, changed); and
  • List of all password protected accounts (e-mail, on line banking and credit cards, etc.) and where to locate the passwords… and the password to access the password.

Please see planning-for-the-inevitable-end-of-life-services for more ideas on such memoranda. Also, after you review this overview, let us know how we can help you get your estate plan in order.

Your family will appreciate it.

Year-end tax planning – how to minimize the total tax paid in 2015 and 2016

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To act or not to act? That is the question.

You still have time as year-end approaches to finalize your tax planning for 2015. With that in mind, this post separates areas where you may be able to act and provides more detail on the rules affecting how you act. If any of this is not clear, just ask questions, please.

  • Look through the list below to see if there are any items in your 2015 and 2016 finances that you can change in any way – moving from one year to the other, or delaying further.
  • Determine what impact each of these has and then the impact of all of them in concert:
    • This includes the alternative minimum tax (“AMT”), which is the 28% flat rate as opposed to the marginal rate of up to 39.6%.
    • If your deductions bring the regular tax down too low, the AMT kicks in, so that the deductions are wasted and need to be moved to another year, if possible, or income for that year increased to “pull you out of the AMT.” The AMT exemptions amounts for 2015 are $53,600 for individuals and $83,400 for married couples filing jointly.
  • Be sure to prepare tax projections for both tax years to determine which changes have the best results so that the total tax paid in the two years is minimized.

Not easy!

What do you act on?
To get started, it is helpful to know the current tax rates. Here are the new rates for 2015: Federal Tax Rates for 2015. Also, note that the Standard Deductions rises to $6,300 for single taxpayers and married taxpayers filing separately, $12,600 for married couples filing jointly, and $9,250 for heads of household.

3.8% Medicare surtax
This affects all income for 2015 and beyond, but only to the extent of the lesser of:

  • Net investment income, or
  • The excess of modified adjusted gross income (“AGI”) over the threshold, which is $250,000 ($200,000 for single taxpayers).

Investment income includes interest, dividends, capital gains, annuities, royalties and passive rental income but excludes pensions and IRA distributions.

N.B. – the 3.8% surtax must be covered with your withholdings and estimated payments. See our post Update on the impact of the 3.8% Medicare surtax .

Wages – Can you defer or accelerate between years or even convert income into deferred income, such as stock options, or income to be received at retirement? Can you convert compensation into tax-free fringe benefits?

Stock options – can you exercise a non-qualified option (“NQ”), which is treated as ordinary income, or instead of as an ISO, which can be investment income? Disqualifying an ISO converts it into a NQ, so that you have control over the type and timing of the income.

Schedule C income and expenses – can you defer or accelerate income and deductions between years so that the net income falls in the best year?

Schedule A itemized deductions – like income, can you deductions for the maximum benefit, given the income-based deduction thresholds?

Medical – only the amount above 7.5% (10% above certain income levels) of qualified medical expenses, which include amounts paid for prescriptions, doctor co-pays, long-term care insurance premiums, and glasses, are allowed on Schedule A.

Miscellaneous – only the amount above 2% is allowed on Schedule A. Miscellaneous expenses include unreimbursed employee expenses, tax preparation fees and investment-related expenses.

Deductions – certain itemized deductions are phased out once your AGI exceeds $305,050 for married filing jointly ($254,200 for singles), so that your itemized deductions are reduced by 3%, on up to 80% of the deduction, for the excess of your AGI above $305,050 ($254,200 for single filers).

N.B. – many of the deductions affected by the phase-out are the ones not allowed in the AMT calculation. Also, investment interest expenses are not subject to reduction on Schedule A.

Investment income – can you shift interest, dividends, and capital gains? Can you use an installment sale to spread out a large gain or, if feasible, a like-kind exchange to defer the gain?

(An installment sale that spreads gain over several years; a like-kind exchanges involve investment property, which means you can swap, rent and later convert to residential.)

The tax rate on capital gains was as low as 0% in 2014, with a cap at 20% and those rates remained in place for 2015. The 20% rate applies in 2015 for AGI over:

  • Married filing jointly – $464,850;
  • Head of Household – $439,000;
  • Single – $413,200;
  • Married Filing Separately – $232,426; and
  • Trusts and Estates – $12,300.

You net losses against gains. If you have a loss, with up to $3,000 of the loss is allowed to shelter other income, with any remaining losses carried to the next year.

Investment Loss – Take advantage of tax-saving losses by selling depreciated stocks or mutual funds that are in a taxable account, not your 401(k) or IRA. However, if your traditional IRA has declined in value, you may want to consider converting some or all of the funds in it to a Roth.

Caution:

  • Purchasing mutual funds late in the year can lead to dividend and capital gains distributions where the mutual fund price changes but your investment does not. This means that you have no economic gain for the distribution on which you pay taxes – you are effectively pre-paying taxes because you did not purchase after the declared distribution date.
  • If you sell to recognize a loss, and want to hold the stock again, be aware of the wash sale rule which bars recognition of the loss if you re-purchase substantially the same security within 30 days – which applies to different accounts you own, including repurchasing in your IRA. An example of what works: a bond swap with the same issuer, where the maturity or interest rate is different, is a way to recognize a loss without being affected by the rule.

Investment income also includes passive income and losses (rental property, limited partnerships and LLCs).

If you can re-characterize any activities as material participation rather than passive by grouping together to meet the material participation rules, you have a one-time election to regroup.

N.B. – Gains include the sale of a primary residence (above the $250,000 per owner shelter).

Roth conversions – can you convert an IRA to a Roth IRA, so that future distributions are not subject to tax? Be sure to pay the tax with funds outside of the IRA so that the conversion has maximum benefit.

Health Insurance – It’s the time of year to choose your health insurance for next year and your decision could affect your 2015 tax filing:

  • Choosing to opt out of buying health insurance could be a costly decision. The new penalty is $695 per adult and $347.50 per child, with a family maximum of $2,085. Those whose income is too low or for whom insurance is too costly may qualify for an exemption from this penalty;
  • If you purchase insurance on an exchange, you may qualify for a tax subsidy if your income is between 100% and 400% of the federal poverty level; and
  • The subsidy will be based on your expected 2016 income. However, if your income is higher than the estimated income, your credit may factor into your tax filing for that year.

Required Minimum Distribution (RMD) – If you are 70 ½ or older, you must take a withdrawal by the end of the year from your traditional IRA or face a significant penalty. To calculate your RMD, take your year-end IRA balances as of December 31, 2014, and divide each one by the factor for your age, which can be found in IRS Pub. 590-B. If you turned 70 ½ this year, you can delay your payout until April 1, 2016. If you opt to take your distribution 2016, you will be taxed on two IRA distributions in 2016.

Federal Estate Tax Exemption – the exclusion amount for estates of decedents who die in 2015 is $5,430,000, up from a total of $5,340,000 in 2014.

Gifting – can you shift assets by gifting within the $14,000 per year/per person annual gift tax exclusion, or even by filing a gift tax return to use some of your unified credit now, so that income is in the lower tax bracket of new owner?

If you’re looking to shift more than $14,000 per year per person, amounts directly paid to college tuition and medical services are exempt from gift-tax rules.

Inherited IRA – be sure to divide an inherited IRA among beneficiaries to get the maximum life expectancy for RMD calculations for each

If you made it this far, I hope you have a good idea of your 2015-2016 tax plan, or else a set of questions to ask so we can help devise one for you! Please Contact Us.