Does your asset ownership work with your estate plan?

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. 

Let me know if you want to discuss anything. 

Thank you and be well.

Steven

Should your estate plan try to avoid income taxes rather than avoid estate taxes?

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. 

Let me know if you would like to discuss this.

Steven

Estate planning checkup: why you don’t, why you should

Why you don’t:

We have written previously stressing the need to have an estate plan, so you do not leave a mess, and why you may need life insurance to protect others.  Few people will disagree with the need to have a current plan and to provide for survivors, but not everyone acts.  

So, why is it that people fail to take action?  Rick Kahler wrote recently about Overcoming Client Procrastination with Financial Planning.  In his post, he lists factors that cause people to put off action that agree is important to address: 

  1. Avoidance.  Feelings of self-doubt, fear of pain or anxiety around the task, depression, fear of asking for help, lack of trust.
  2. Perfectionism.  Fear of failure, fear of being criticized (both externally by others and – often more powerfully – internally by parts of yourself).
  3. Ambiguity.  Lack of clarity about the task, feeling overwhelmed, difficulty prioritizing in the absence of a crises, being focused on immediate tasks.
  4. Narcissism.  Over-confidence in getting it done at the last minute. Needing chaos or pressure to provide adrenaline, the ability to focus to the exclusion of everything else, and a feeling of being fully alive.
  5. Physical Issues.  Fatigue, illness.
  6. Lack of knowledge.  Not knowing what you don’t know, unsure how to get needed help and information.
  7. Financial.  Not having the funds to take the necessary action.   

Do any of these apply to you?  If so, we can help so please contact us. 

Why you should:

One reason to review your estate plan is that the Biden administration may seek changes to the estate and income tax laws; you want to make sure your documents have the flexibility to address these changes.  The current federal gift and estate tax credit is close to $12 million.  However, it is scheduled to drop to between $5.5 and $6 million in 2025 and the administration may push for a lower credit to be imposed sooner.  Also, the administration may try to eliminate the step-up in basis at death.  We will continue to monitor any proposed law changes and post updates. 

There are other tax law changes to address, such as the elimination of the “stretch IRA.”  You may need to revise your beneficiaries.  Also, you will want your executor or personal representative to elect portability of your federal credit to minimize taxes and may want your documents to address the generation skipping transfer tax credit.

Another reason to act is to provide for your digital assets, something old documents may not address.  For example, you can give your attorney-in-fact under your durable power of attorney access to your digital assets and you can assign your digital assets to your revocable trust so your trustee has access.  Digital assets include e-mail and text messages, photographs, videos and other files on your computer, on-line accounts such as your investments and social media, or even intellectual property and patent rights.  You may also have collectibles that need to be addressed,

Another reason to act is to ensure that someone knows how to access all your passwords if something happens to you.  Create your own “Rosetta Stone,” a document telling them how to access your digital life, with IDs and passwords, and then make sure an immediate family member or close friend knows where to find it.  This way, they can locate all your important documents, find assets and insurance, and handle your social media if something happens.  You may also want to provide a memorandum to your personal representatives and trustees detailing your wishes, including thoughts on when to distribute to children, protecting from creditors, and even burial or cremation.

If you to take the time now to review and update your plan, be sure:

  • that you have documents that are in order,
  • that the documents are correctly executed,
  • that you provided adequate resources for survivors, including life insurance, and
  • that your beneficiary designations and asset ownership all coordinate with your documents.

When you do, you will have improved matters for you and your family! 

Contact our office if you have any questions or comments. And be well!

2017 year-end tax planning – a year of uncertainty (updated)

(as also seen online at IRIS)

The Republican Congress is in the process of passing the Tax Cut and Jobs Act, a new tax law. President Trump is expected to sign it by Christmas.

The law was created and passed hastily and affects many aspects of the federal tax code, so many details are still not clear. Furthermore, regulations have yet to be issued. Also, while the provisions affecting corporations are permanent, most affecting individuals expire in 2026. Thus, tax planning is complicated.

How do you plan? Very carefully – you need to augment your traditional year-end planning by anticipating the impact of the many changes.

Note: many proposed changes did not make the final law, so be sure you are referring to the final version when making your planning decisions!

Planning steps

First, be practical:

  • Determine what income and deductions you can move from 2017 to 2018 or vice versa.

Second, review the impact:

  • What happens if you shift any of these amounts of income and deductions to the other year?

Finally, watch for the impact of the Alternative Minimum Tax (“AMT”):

  • The exemption for the AMT and the threshold above which that exemption gets phased out both rise next year, so some deductions lost to the AMT in 2017 could have value in 2018. Others simply vanish next year, so you need to plan carefully!

Income

The new law lowers the tax brackets, so income will be generally subject to less tax in 2018.

Conclusion: You probably want to move income to next year if you can.

Exemptions and standard deduction

The new law eliminates personal exemptions and raises standard deductions to $12,000 for single filers and to $24,000 for married couples. These amounts will be indexed for inflation. The increased standard deduction may offset deductions that you lose, as discussed below. If you have children and others who are dependents, those tax credits are increased, which may help as well.

Conclusion: You probably want to move itemized deductions to 2017.

Itemized Deductions and Credits

The deduction for property taxes and for state and local income taxes is capped at $10,000.

Mortgage interest on new home purchases is deductible only for loans of up to $750,000 used to purchase your primary residence. Interest on home equity loans will not be deductible. (It is not clear if converting any part of home equity indebtedness that was used to purchase or improve your primary residence to a mortgage would make that interest deductible, subject to the cap.)

All miscellaneous deductions are eliminated. This includes investment and tax preparation fees, safe deposit box charges and unreimbursed employee expenses.

The casualty loss deduction is also eliminated and the bike to work exclusion ends.

Moving expenses will no longer be allowed (except for military personnel in certain cases).

The deduction of alimony will be eliminated for divorces occurring after 2018.

What survived? The deduction of student loan interest and medical expenses survived. The latter is subject to a 7.5% rather than a 10% floor. And, the new law repeals the reduction applied to itemized deductions for high-income taxpayers, which may help with some deductions.

Here are several items that were considered for limitation or elimination that remain unchanged:

Dependent care accounts, adoption expenses, tuition waivers and employer paid tuition, capital gains on the sale of your personal residence, the teacher deduction, electric car credit, Archer medical accounts and designating shares of stock or mutual funds sold.

Conclusion: you will want to move any of the eliminated deductions that you can prepay into 2017.

Note: a last-minute provision added to the new law makes prepaying 2018 income taxes in 2017 non-deductible.

Pass-through businesses

If you have income from a sole proprietorship, LLC, partnership or S Corporation, you may be able to deduct 20% of that income, subject to certain rules on wages and a phaseout beginning at $157,500 for singles and $315,000 for married taxpayers. These rules are designed to avoid abuse seen when Kansas enacted a similar law.  (Watch for a post on this soon.)

Conclusion: read the fine print (e.g. rules for personal service firms) to see if there are any opportunities you can exploit.

Estate taxes

The credit before estate or gift taxes are due is doubled to $10,000,000, indexed for inflation.

Conclusion: you may want to postpone your year-end gift planning.

Summary

Carefully review any income and deductions that you can still shift to see if moving will lessen the total taxes you pay for 2017 and 2018.

Good luck and best wishes for the holidays!

If you have any questions, please contact me.

Tax Law change under the new Trump Administration? Maybe, but too soon for planning

Enacting Major Changes Will Take Time

(as also appeared online in IRIS.xyz)

President Trump made tax reform a key issue in his campaign. He is now president and Republicans are in charge of the House and Senate, so the likelihood of overhauling the federal tax system is better than they have been for decades.

However, President Trump and Congress are trying to enact changes to the Affordable Care Act as well as addressing budget issues and foreign relations. Also, dealing with all the recent hearings involving the FBI have diverted attention. Finally, there are many details that need to be worked out, making it unlikely that major changes will happen until 2018.

Change in IRS Regulations

President Trump has already made changes in IRS regulations. On his first day in office, he temporarily froze tax regulations and then shortly thereafter, ordered that two existing regulations had to be removed for each one that was added. What is the impact?

  • The Trump administration has stated that the two-for-one exchange rule only applies to significant regulatory actions. The rule may not affect the many IRS regulations that are procedural in nature or are needed by taxpayers.
  • One new regulation that has been threatened is the Department of Labor’s new fiduciary rules for retirement advisers. This updated regulation requires retirement advisers to act in their clients’ best interests, which is a stricter standard than was previously required.
  • Also affected are the new partnership audit procedure. A 2015 law streamlined the exam process of large partnerships. The IRS released proposed regulations which implemented the regime on January 18. However, it later pulled the regulations in response to the freeze.

Possible Tax Law Changes – Lower Corporate Tax Rate

Currently, the corporate tax rate tops out at 35%. House Republicans want to lower it to 20% with 25% for businesses that pass income through their owners and for those that are self-employed. President Trump is calling for a 15% corporate tax. In 2014, nearly 25 million Americans filed taxes as sole proprietors (Schedule C), so the change affects many taxpayers.

Tax strategy: Under this change, individuals who are high-earning could become independent contractors or set up LLCs to shift income and advantage of the lower corporate tax rate. Additionally, those who own pass-through businesses could reduce their salaries and take higher profits.

This is how residents of Kansas responded to a similar state law. The state is now working to repeal a law passed in 2012 that exempted pass-through firms from state income tax. The result was that many individuals and businesses in the state restructured their business as pass-through entities or created new businesses to take advantage of the tax break. In just a few years, the number of pass-throughs in the state almost doubled. The state is now facing a large budget deficit as a result because the pass-through exemption is estimated to have cost the state $472 million in 2014 alone. The cost for 2015 was even higher.

The impact of this tax strategy on the 15% tax at the federal level would be expensive. It is estimated to cost up to $1.95 trillion in lost tax revenues over the next ten years. The Trump administration is considering ways to prevent abuse of this low tax rate but any attempt to prevent gaming the system will likely add more complexity to the tax code. Tax-savvy practitioners will likely still be able to find loopholes.

Tax only on Income Earned inside the US

Worldwide income is taxed presently, with credits for foreign taxes paid. The proposed law would generally tax only income that is earned within U.S.

Multinational Tax: A new, low tax on multinationals is part of the proposed tax, added to raise revenue to fund other rate reductions.

Estate Tax Repeal

Republicans would like to repeal the estate tax. President Trump would impose a tax on pre-death appreciation of assets, with a $10 million per couple exemption. There would be no step up in basis at death. And it is likely that gift tax rules would be retained.

Even if the federal estate tax law is repealed, many states will continue to impost a tax. Massachusetts only exempts $1 million of assets passing to someone other than a spouse, such as a trust. New York and other states have higher exemptions. Thus, planning is still important for most people.

Planning Opportunities

With the uncertainty of any change being enacted, this is not an easy year for planning. For example, this may not be the year for a Roth conversion, if tax rates will go down next year. It may not be the time for complex estate planning techniques involving irrevocable transfers, if the estate tax is eliminated in 2018.

We will keep monitoring this to assess any moves that do make sense and update this post when the likelihood of real changes becomes clear.