Too often, we find clients have not matched their asset ownership and beneficiary designations to their estate plan documents or not updated those documents for changes in circumstances. This can cause problems, like having to file with the probate court at death, having the wrong person in a key role or even paying unnecessary estate taxes.
Here is an example on an ownership error: the couple owns most assets jointly. This means that their revocable trusts are never funded so they will fail to use the available estate tax credits at the first death, and they will probably pay more estate taxes at the second death than they could have. Having assets pass to a spouse may simplify their life but that may cost their children more in estate taxes.
Another example would be owning assets individually rather than in a revocable trust. This means the personal representative must file with the probate court to transfer assets. If all assets were owned by the trust instead, the time and expense of a probate court filing would be avoided, and survivors would have the benefit of the assets in the trust immediately. An alternative would be placing transfer on death or TOD instructions on bank and investment accounts, much as one provides beneficiary designations on IRAs.
Finally, if your relationships with the people named in your will and trust have changed, not updating could mean the wrong people are involved in your estate when you die, leaving a mess for your survivors.
As we mentioned in a prior e-mail, Massachusetts changed the estate tax law last year, so we now have a true exemption of $2 million. This may tilt your approach more toward planning to avoid capital gains rather than estate taxes. Regardless, please be sure that your asset ownership and designations work with your documents.
As we gear up for tax season, here is a collection of thoughts and suggestions:
As noted previously, the TCJA expires after 2025, so we encourage planning for all those changes. For some ideas, see our post on turn tax planning on its head for income taxes and see this post on estate planning.
When you work on your IRS form 1040 for 2023, how do you plan to answer the question on digital assets? That question has changed over the years and now reads:
At any time during 2023, did you: (a) receive (as a reward, award or payment for property or services); or (b) sell, exchange, gift or otherwise dispose of a digital asset (or a financial interest in a digital asset)?
2023 form 1040
Some tax pros think this question covers items such as a ticket for events like the Super Bowl, as these are non-fungible tokens, or NFTs, being unique and recorded in digital ledgers. Therefore, if you purchased such an NFT, you need to answer “yes.” When in doubt, saying yes may be the best response.
We reported that the SECURE Act 2.0 allows for unused 529 plan contributions to go into a Roth IRAs. Here is a planning suggestion for parents and grandparents: start early with 529 plan contributions so that there is a surplus over college costs that can be converted to a Roth later, within the limits.
There are also some significant cases before the Supreme Court we are watching, including the Moore case on unrealized income.
The IRS continues to deal with a huge backlog of mail to process, including many amended returns. They say that this is due to prioritizing answering calls over processing during the Pandemic.
And the IRS warns again to be wary of phishing attempts by phone, e-mail and text. They have a page on phishing and how to respond.
First, some reminders: income tax rates are likely to rise over the next several years and the TCJA rules expire after 2025, when we revert to pre-2018 tax laws.
Second, be practical: start with reviewing what items you are able to change – for example, paying real estate taxes in one year may be better than another, but that is very hard to accomplish if you have escrow withholding on your mortgage payments. On the other hand, you may be able to incur medical expenses all in one year, so you exceed the limit and are able to deduct a portion.
Two-year goal: usually the goal is to reduce the total tax for the two years combined, some may benefit from increasing 2023 income to avoid higher future taxes. One way to increase income that we have discussed before is a Roth conversion.
2023 changes: There are a number of changes for this year, including rules for electric vehicles (EVs), energy efficient improvements, and other items, along with the impact of inflation on thresholds and exemptions for some items.
If you are considering energy efficient windows, doors, etc., the limits for the Energy Efficient Home Improvement Credit for 30% of the cost increased for 2023. As for solar panels, fuel cells, battery storage, there is the Residential Energy Clean Property Credit of 30% of the cost of materials and installation. Check to see if your anticipated improvements qualify and then retain the information needed to file for the credit.
As we noted previously, the clean vehicle credit for new and used EV purchases has changed, with vehicle price and income limits. So, again, check to see if you qualify and then be sure to retain the information needed to file for the credit.
Retirement plans: The age for required minimum distributions (RMDs) is now 73, so taxpayers turning 73 in 2023 have until April 1, 2024 to take their first RMD. Tax planning on this is crucial, as taking the RMD before 2024 may result in a lower total tax for 2023 plus 2024 as you have the 2024 RMD due in 2024. That is, two RMDs in 2024 could push you into a higher tax bracket.
Charities: For charitable giving, see if you can donate appreciated assets directly and avoid the capital gains tax. Also, if you are considering a qualified charitable distribution (QCD), up to $100,000 counts for your RMD and you can send up to $50,000 to a charitable remainder annuity trust, charitable remainder unitrust or a charitable gift annuity. Many private colleges with charitable gift annuity programs have focused donation drives on QCDs.
Estates: As noted in a prior post, the annual exclusion for gifting is now $17,000. If you have plans to transfer wealth, keep this in mind.
Withholdings: As you adjust income and deductions, your tax due for each you will change, so be sure to review the safe harbor rules on withholdings and adjust or pay estimates as needed.
Some ways to shift income:
Roth Conversion – One way to increase income now, avoiding future income, is to convert part of an IRA to a Roth IRA, converting from taxable to non-taxable distributions in the future. Decide on the amount to convert by projecting the impact of the conversion on your marginal tax rate. Converting to a Roth also saves you from required minimum distributions in future years (but non-spouse beneficiaries still face the 10-year clean-out we discussed before as part of the SECURE Act).
Back-Door Roth – Along with converting, the “back-door Roth” is still available, at least for 2023, so you can put more retirement funds aside with no tax on future distributions. That is, for those who cannot contribute to a Roth due to income limits, they can contribute to a non-deductible IRA and then convert that IRA to a Roth IRA.
More income and deductions – Other ways to shift income include billing more in 2023 or delaying to 2024 for your S Corp., LLC or partnership, exercising stock options, and selling ESPP shares. Businesses can buy vehicles and other capital assets for bonus depreciation write-offs in 2023.
Capital gains – You probably do not want to accelerate capital gains, as those should still be taxed at a lower rate in future years. But you can utilize tax-loss harvesting to shelter gains already realized for 2023 by identifying any losses and realizing them in 2023. If you want to buy back these securities, watch out for the wash-sale rules.
On to other considerations – first, SALT deductions
The limit on state and local taxes, or SALT, has not increased, but, a number of states have created pass-through entity elections so that the S Corp., LLC or partnership pays the tax and deducts it against the income of the shareholder/member/partner. This way, their net federal taxable income is reduced, and they get a credit for the payment on their personal tax returns.
Review the SALT portion of your itemized deduction strategy if you are bunching.
Check the details:
Declare Crypto – If you had any crypto currency transactions during the year, selling, buying or receiving, be sure to declare on your federal 1040 filing.
Unemployment tax – Remember, unemployment benefits are fully taxable for 2023, so be sure you withheld taxes or pay estimates.
IT PIN – If you are concerned about identity theft, consider obtaining an IT PIN as discussed in our post on IRS scams.
Flex accounts – Check to see if you have any flex account balances that expire that can still be used. And consider HSA contributions.
Qualified plans and IRAs – Make sure to max-out on your 401(k) and other plans and make an IRA contribution if you can.
Before you finish, check withholdings and estimates paid
Especially if you increase income in 2023, review your total paid to the IRS and state via withholdings and estimates to be sure that you meet the safe harbor rules. If not, you could owe interest for under-withholding.
IRS disaster relief
If you are in an area designated as a federal disaster area, this may affect your filing deadlines and ability to take casualty losses.
And remember your estate plan review
While you review your taxes, review your estate plan as well. The federal gift and estate tax credit is close to $13 million for 2023, but that may change in 2024. So, if you have excess wealth, you may want to gift while you can, especially if you want to use certain trusts, like a GRAT or QPRT, that may no longer be permitted in future years. For more on estate planning updates, see our estate planning checkup post.
If you do review your estate plan documents, also review beneficiary designations and asset ownership to make sure everything is current and flows correctly.
As you review your 2023-2024 tax planning, consider the impact of future tax rate increases: will bringing future income into 2023 avoid taxes on future income? Then follow through on the details.
Let us know if you have any questions.
Good luck and best wishes for happy and healthy holidays!
With the federal gift and estate tax exemption nearing $13 million, a married couple can have close to $26 million in their estates before any federal estate tax would be due. That leaves only a small percentage of people in the US who actually need estate plans focused on avoiding estate taxes. Those who are comfortably below the threshold can instead focus their plans on reducing income taxes.
Estates get a step up in basis at death, so that assets do not pay both estate and income taxes. For example, the house owned by a couple often has a low basis, so taxes will be due on sale. When they die, they get a step up in basis, eliminating that gain and the corresponding income tax that would be due at death.
To illustrate, here’s an example: a married couple own a house worth $2 million for which they paid $500,000, they have $2 million in retirement accounts and $5 million in broker accounts. Their combined estate of $9 million is well below the federal exemption of nearly $13 million per person, so no federal estate taxes will be due. They have $1.5 million of gain if they sell the house, of which $1 million would be taxed after applying the $500,000 exclusion on the sale of a principal residence.
If they have the standard estate plan, they will have revocable trusts that use the state and federal estate tax credits at both the first and second deaths. If proper elections are made, no estate taxes will be due at the first death and no federal estate taxes at the second death. They will also get the step up in basis.
But what if one spouse dies many years later? The half with the step up at the earlier death could now be subject to taxes on gain when the heirs direct the estate or trusts to sell. If the house is then worth $4 million, the half in the trust of the first to die has new gain of $1 million on which income taxes will be due.
If instead of having half the house counted at the first death, what if it is treated as passing to the survivor? Then there is a full step up at the second death, with no gain. And they have not traded capital gains for estate taxes. While assets are counted in the second estate, rather than using the exemption at the first death, the first estate can make proper use of the deceased spouse’s unused exemption or “DSUE.” Since 2012, federal law allows any portion of the gift and estate tax credit not used in the first estate tax filing to be carried to the second spouse’s death or “ported,” if the proper election is made. This “portability election” for the DSUE is made on the estate tax return.
But what happens when the federal credit drops back down in 2026 to the old amount as scheduled, which, after adjusting for inflation, is expected to be around $7 million? The estates for the couple in our example still avoid federal estate taxes, using the DSUE of up to $7 million from the first death and the $7 million credit at the second death.
Planning for state estate taxes may be necessary (for Massachusetts residents, the trusts can be used to shelter $1 million, the maximum credit). And you may want to use trusts to control who gets access to the estates and when. Also, you may need to plan for the generation skipping transfer tax or “GST” tax, which requires use of trusts and proper elections at death.
If your net worth is enough to need estate planning but you do not expect to owe federal estate taxes, then your plan can address avoiding capital gains and use the DSUE to ensure that estate taxes are still avoided.
Note that Massachusetts increased the estate the exemption from $1 million to $2 million as of January 1, 2023. This may affect your planning.
The SECURE Act of 2019 eliminated the “stretch IRA,” where children could continue to defer taxes on IRA balances inherited from parents, even passing them on to grandchildren. This had allowed for decades of tax-free asset growth. Congress decided to curtail the deferral past spouses by requiring that IRAs passed to non-spouses be fully distributed at the end of 10 years, with a few exceptions.
Confusion has arisen regarding whether all amounts must be withdrawn annually or “cleaned out” in year 10. The IRS added to the confusion by offering different interpretations after the law was enacted. To address this confusion, the IRS responded by not penalizing IRA beneficiaries who failed to take distributions while the rules are finalized.
The IRS proposed rules require that annual distributions continue if the original IRA owner had begun taking required minimum distributions (“RMDs”), while allowing beneficiaries of IRA owners who had not begun taking RMDs to choose to take some distributions or wait until the 10th year.
An heir will need to plan to minimize the tax hit. For example, they may be able to keep their total income in a lower tax bracket. The simplest approach may be to just take 1/10th each year, so they do not end up in a higher bracket. This may not be best if the beneficiary’s income has significant changes for bonuses, major stock sales, taking their own RMDs or starting social security. We reviewed possible strategies with Harold Hallstein IV of the Sankala Group who said that, surprisingly, someone in a low tax bracket who expects to be in a higher bracket in the future may benefit from taking the account balance right away, thereby availing themselves of long-term capital gains rates on future investment growth.
One note of caution: beneficiaries need to be sure to set up the inherited IRA account and not take a check, as that will be fully taxable.