Another Good Reason to Update Your Estate Plan: Taxes

Gift, estate and generation-skipping transfer tax (GST) exemptions have doubled as a result of the Federal Tax Cut and Jobs Act, raising them to historic highs. The exemptions, which are all linked in a unified estate and gift tax, had been scheduled to increase to $5.6 million per person in 2018, but they were modified to reach the current level of $11.2 million per person, or $22.4 million per couple. The inflation-adjusted exemption for 2019 is $11.4 million per person or $22.8 million per couple.

In the article “Updating estate plan could save heirs in taxes,” the Atlanta Business Chronicle asks why this matters to an individual or couple whose net worth is nowhere near these levels.

When the most that could be transferred to heirs was under a million dollars, everyone worried about the estate tax. Since the estate tax was so much higher than the capital gains tax, it was never considered a big deal if a person paid the capital gains tax on selling, because it was less costly than paying the estate tax.

Now with the new exemption, trying to move assets out of estates and into trusts may not be the best solution to preserve wealth and minimize taxation.

In the past, a trust would be created, and the maximum amount of funds placed into the trust for use when the grantor (the person who created the trust) died. The goal was to provide income for the spouse until the spouse’s death, at which point the money bypassed the estate and went directly to the beneficiaries, who would pay income tax on the funds.

If a person owned $10,000 worth of stock at their death and the trust required it to be placed into a bypass trust instead of transferring it to the spouse, the heirs would pay taxes on gains upon the sale of stock. In a case where the stock held in the bypass trust increased to $100,000, then $90,000 of that would be considered taxable gain. If, instead, the stock was transferred to the surviving spouse and it was sold upon the spouse’s death, that stock would receive a stepped-up basis of $100,000 and there would be no income tax on the sale of the stock.

Note that the law creating the present $11.4 million limit is currently set to end at the end of 2025 when the tax exemption will return to $5 million (adjusted for inflation).

Another aspect of estate tax planning relates to the source and account types of the inheritance. For instance, heirs who receive money from Individual Retirement Accounts (IRAs) have to pay taxes when they withdraw funds from the account. IRA money is not taxed when it goes into the account, but the growth is taxed when the money is taken out.

As an alternative, IRAs could be converted to Roth IRAs, although they would be taxed immediately on conversion. If the Roth IRA is held for five years, funds withdrawn are tax-free and can be taken out whenever the owner wishes.

However, because current exemption amounts may not be available after 2025, or if further changes to tax laws are made, another strategy for individuals who wish to make significant lifetime gifts is to make those gifts with the current high levels. Because of the way the transfer tax systems interact, those lifetime gifts will not be taxed at death if the total of taxable gifts is less than the exemption amount in the year the gift is made.

Some experts advise that wealth be distributed between tax-deferred accounts, like 401(k)s, after-tax money, like the Roth IRA and taxable accounts, which include brokerage accounts. The goal is to be able to respond when changes are made to the tax code.

Reference: Atlanta Business Chronicle (May 31, 2019) “Updating estate plan could save heirs in taxes”

How Does the IRS Know if I Give My Grandchildren Money?

A recent nj.com recent post asks, “Will the IRS know if I gift money to my grandchildren?” The article explains that federal and state tax agencies do not have any direct way of knowing how much is being gifted. They rely on taxpayers self-reporting gifts. It’s the honor system.

However, the tax authorities may discover these transfers when you or the recipient are audited, by matching transactions reported for certain assets, or because banks are required to report cash transfers in excess of $10,000. Because it’s pretty simple to avoid paying gift tax, it doesn’t seem worth the risk of getting caught trying to skirt the rules. Understanding the gift tax and working within the system is the best way to avoid issues.

The IRS stipulates that a gift is “the transfer of property by one individual to another while receiving nothing, or less than full value, in return.” A gift is never taxable to the recipient, so only the person making the gift has to consider the gift tax.

The amount you can give will not be subject to gift tax if the gift amounts are less than the annual and lifetime exemptions. The annual gift exemption is currently $15,000 per recipient, which means that you can give up to $15,000 each year to an unlimited number of people with no reporting requirement at all.

You’re supposed to complete a U.S. Gift Tax Return (IRS Form 709) if you exceed the exemption, but don’t panic. Although you are required to file a gift tax return, it is highly unlikely any gift tax will be due. That’s because gifts in excess of the annual exemption must first offset your lifetime exemption before any gift tax is due.

Keep in mind, however, that the IRS can impose penalties if they discover that you failed to file a gift tax return, even if no gift tax was due. Also note that the gift tax is integrated with the estate tax, which applies to amounts transferred upon your death in excess of your remaining lifetime exemption.

If you’re planning on making a gift to help pay a grandchild’s college costs or medical expenses, make the payment directly to the educational or healthcare institution. By making the payment directly to the institution, that payment will not be considered a gift and will not go towards the $15,000 exemption and also will not decrease your lifetime exemption.

Ask your estate planning lawyer about any state gift, estate and inheritance tax implications for any significant transfers you want to make.

Reference: nj.com (October 1, 2019) “Will the IRS know if I gift money to my grandchildren?”

You’ve Received an Inheritance. Now What?

Inheriting money puts a whole new spin on your outlook on money, says The Kansas City Star in its article “Coming into some money? Be wise with it.”

The first thing you should look at is, do you have debts? Make a list of your debt balances and their interest rates. If the interest rate is high, pay it off. If it’s low, you may be better off investing the funds.

Next, check on your emergency fund. If you don’t have three to six months’ worth of living expenses on hand, use your inheritance to ramp up that fund. Yes, you can use credit cards sometimes. However, having at least two months’ worth of living expenses in cash is critical and can make a big difference when an unexpected circumstance arises.

The third step is to contribute the most you can to a health savings account (HSA), particularly if your employer does not contribute to it and if you have a qualifying health plan. That’s $3,500 if you are single, $7,000 for families and an additional $1,000 if you are over 55. This gets you a nice tax deduction and withdrawals are tax-free, as long as they are used for qualified medical expenses.

If you still have money left over after these three big categories have been addressed, then it might be time to “tax-shift” your portfolio.

Let’s say you regularly contribute $3,000 to a 401(k). If you can, increase that amount by $22,000, to the maximum, if you’re 50 and older. Since your paycheck decreases, so does your tax. If your tax rate is currently 22%, you’ll only need to add $17,160 from your inherited account to reach the same spendable dollars. The tax-deferred account in your portfolio will grow faster, while the current taxable account shrinks.

Another thing to think about is whether to commingle funds with your significant other or not. You can spend it on joint assets now, maybe to pay down your house. Let’s say you and your spouse have a retirement portfolio. The inheritance may also help you to retire earlier. An alternative is to save the inheritance and keep it in a separate account with only your name on it, in which case it remains your asset alone in case of a divorce. Most states will consider this money a non-marital asset, and not subject to division between divorcing parties.

One smart way to use the inheritance is as a way to avoid tapping into retirement accounts for a longer period of time. Withdrawals from IRAs are taxable. If you’re not worried about commingling funds or investment gains, then use the inherited account to minimize the tax losses from retirement accounts. Most people don’t have enough saved to keep spending during retirement as they did while working. Skip the spending spree that often follows an inheritance and enjoy the money over an extended period of time.

Receiving an inheritance is one of the times when a review of your estate plan becomes a wise move. A new financial position may require more tax planning and more legacy planning.

Reference: The Kansas City Star (June 27, 2019) “Coming into some money? Be wise with it”

Details of the New SECURE Act

You may have heard some talk about the new SECURE Act. But what are the details and how does it impact you?

The SECURE Act proposes a number of changes to retirement savings. These include changes to parts of IRAs and 401(k)s. Although it is still under review, the Act is expected to be passed in some form after revisions. Some of the changes that the Act makes look to be common sense, like broadening access to IRAs and 401(k)s, as well as including updating the rules to reflect that retirement is now a longer period of life. However, with these changes come potential limitations with stretch IRAs.

Forbes asks in its recent article “Are Concerns Over Stretch IRAs And The SECURE Act Justified?” In general, an IRA is a tax-wrapper for your investments. While the investments stay in the IRA, you do not have to pay any tax on income made from those investments. A traditional IRA is where your contributions can be made tax-free for the time being, with tax due upon withdrawal. Alternatively, you can contribute after-tax dollars and have your distributions be tax-free if you use a Roth IRA. The SECURE act isn’t changing this fundamental process during the lifetime of the person who contributed to the IRA. Instead, it is altering what happens when that person, still has an IRA balance at death.

If you’ve ever spoken with someone who inherited an IRA, you have probably heard of the Stretch IRA. A Stretch IRA can be a great estate planning tool. Here’s how it works: you give the IRA to a young beneficiary in your family. The tax shield function of the IRA is then “stretched,” for what can be decades because the length of the IRA will now extend to the end of the beneficiary’s lifetime. This is important because the longer the IRA lasts, the more your investments can continue to grow. In a sense, this will protect that growth from taxes for a longer period of time.

However, the SECURE Act could change that: instead of IRA funds being spread and distributed to the beneficiary over the lifetime of the beneficiary, they’d be spread and distributed over a much shorter period. Based on the provisions of the SECURE Act as it stands, that period will likely be 10 years. That’s a big change for estate planning because a beneficiary will now have to withdraw that investment within a shorter period of time, be taxed on that income sooner, and lose out on the benefits of letting the investments grow for longer.

It’s good to keep in mind, though, that for a person who uses their own IRA throughout retirement and uses it up or passes it to their spouse as an inheritance—the SECURE Act changes almost nothing. In fact, IRAs are slightly improved for these individuals due to the new ability to continue to contribute after age 70½ and other small improvements. Therefore, most typical IRA holders will be unaffected or benefit to some degree. For many people, the bulk of IRA funds will be used in retirement and the Stretch IRA is less relevant. If you are planning to use the IRA as a distribution for your children or other people to inherit, however, talk to a tax advisor or attorney to understand how the SECURE Act will impact your estate plan.

Reference: Forbes (July 16, 2019) “Are Concerns Over Stretch IRAs And The SECURE Act Justified?”

Filing Taxes for a Deceased Family Member

If you are the executor of a loved one’s estate, and if they were well-off, there are several tax issues that you’ll need to deal with. The article “How to file a loved one’s taxes after they’ve passed away” from Market Watch gives a general overview of estate tax liabilities.

Winding down the financial aspects of the estate is one of the tasks done by the trustee or executor. That person will most likely be identified in the decedent’s trust or will. If the family trust holds the assets on behalf of the deceased, the trust document will name a trustee. If the person died without a will or trust, also known as “intestate,” the probate court will appoint an administrator.

The executor is responsible for filing the federal income tax for the decedent’s estate in cases where a return needs to be filed. Income generated by the estate, even after the death of your loved one, is subject to income tax. The estate’s first federal income tax year starts immediately after the date of death. The tax year-end date can be December 31 or the end of any other month that results in a tax year of 12 months or less. The IRS form 1041 is used for estates and trusts and the due date is the 15th day of the fourth month, after the fiscal tax year-end.

For example, if a person died in 2019 and the trustee chooses December 31, 2019 date as the tax year-end, the estate tax return deadline is April 15, 2020. An extension is available, but it’s only for five and a half months. In this example, an extension could be granted for September 30.

There is no need to file a Form 1041 if all of the decedent’s income producing assets are directly distributed to the spouse or other heirs and bypass probate or trust administration. This is the case when property is owned as joint tenants with right of survivorship, as well as with IRAs and retirement plan accounts and life insurance proceeds with designated beneficiaries.

The trustee also needs to keep in mind transfer tax issues, such as the estate tax and the gift tax. For recent years, this is not as much of a concern because no federal estate tax will be due unless the estate is valued at more than $11.2 million for a person who passed in 2018 or $11.4 million in 2019.

However, the trustee also needs to find out if there were large gifts given. That means gifts larger than $15,000 in 2018-2019 to a single person, $14,000 for gifts in 2013-2017; $13,000 in 2009-2012, $12,000 for 2006-2008; $11,000 for 2002-2005 and $10,000 for 2001 and earlier. If these gifts were made, the excess over the applicable threshold for the year of the gift must be added back to the estate, to see if the federal estate tax exemption has been surpassed. Check with the estate attorney to ensure that this is handled correctly.

Whether or not a person died leaving property to a spouse also impacts whether or not tax will be due. The unlimited marital deduction privilege permits any amount of assets to be passed to the spouse, as long as the decedent was married, and the surviving spouse is a U.S. citizen. However, the surviving spouse will need good estate planning to pass the family’s wealth to the next generation without a large tax liability.

While the tax consequences and tax planning strategies are more complex where significant assets are involved, an estate planning attorney can strategically plan to protect family assets, when the assets are not so grand. In fact, estate planning is more important for those with modest assets, as there is a greater need to protect the family and less room for error.

Reference: Market Watch (June 17, 2019) “How to file a loved one’s taxes after they’ve passed away”

Do I Need a Spendthrift Trust for a Relative?

Newsday’s recent article, “What to consider when creating a ‘spendthrift’ trust,” explains that a spendthrift trust can protect people from themselves. In particular, it can be great protection for those with an issue with drugs, alcohol, gambling or even a person who’s married to a wild spender.

A spendthrift trust—also called an “asset protection trust”—gives an independent trustee the power to make decisions as on how to spend the funds in the trust. The beneficiary might get trust benefits as regular payments or need to ask permission from the trustee to access funds at certain times.

A spendthrift trust is a kind of property control trust that restricts the beneficiary’s access to the money that a beneficiary might otherwise be able to access at his or her own will. This restriction protects trust property from a beneficiary who might waste the money, and also protects against collections by any of the beneficiary’s creditors.

Remember these other items about asset protection trusts:

  • Be sure that you understand the tax ramifications of a spendthrift trust.
  • If the trust is the beneficiary of retirement accounts, the trust must be designed to have the RMDs (required minimum distributions), at a minimum, flow through the trust down to the beneficiary.
  • If the trust accumulates the income, it could be taxable. In that case, the trust would have to pay the tax at a trust tax rate. That’s substantially higher than an individual rate.

It’s critical that you choose your trustee carefully. You may even think about going with a professional corporate trustee. If the wrong trustee is selected, he or she could keep the money from the beneficiary, even when the beneficiary legitimately needs it. If you have someone that you are thinking of taking care of who also has spending issues, be sure to talk to an estate planning attorney about creating a spendthrift trust.

Reference: Newsday (June 23, 2019) “What to consider when creating a ‘spendthrift’ trust”

Why Is a Revocable Trust So Valuable in Estate Planning?

A revocable trust is sometimes an investment that people are hesitant to make, but they are worth the time and money. There’s quite a bit that a trust can do to solve big estate planning and tax problems for many families.

As Forbes explains in its recent article, “Revocable Trusts: The Swiss Army Knife Of Financial Planning,” trusts are a critical component of a proper estate plan. There are three parties to a trust: the owner of some property (settlor or grantor), who turns it over to a trusted person or organization (trustee) under a trust arrangement to hold and manage for the benefit of someone (the beneficiary). A written trust document will spell out the terms of the arrangement.

One of the most useful trusts is a revocable trust (also known as an inter vivos trust) where the grantor creates a trust, funds it, manages it by themselves, and has unrestricted rights to the trust assets (corpus). The grantor has the right at any point to revoke the trust, by simply tearing up the document and reclaiming the assets, or perhaps modifying the trust to accomplish other estate planning goals.

After discussing trusts with your attorney, they will draft the trust document and re-title property to the trust. The assets transferred to a revocable trust can be reclaimed at any time. The grantor has unrestricted rights to the property. During the life of the grantor, the trust provides protection and management, if and when it’s needed.

Let’s examine the potential lifetime and estate planning benefits that can be incorporated into the trust:

  • Lifetime Benefits. If the grantor is unable or uninterested in managing the trust, the grantor can hire an investment advisor to manage the account in one of the major discount brokerages, or they can appoint a trust company to act for them.
  • Incapacity. A trusted spouse, child, or friend can be named as trustee to care for and represent the needs of the grantor/beneficiary. The trustee will manage the assets during incapacity, without having to declare the grantor incompetent and petitioning for a guardianship or conservatorship. This can be a stressful legal proceeding that makes the grantor a ward of the state. This proceeding can be expensive, public, humiliating, restrictive and burdensome. However, a well-drafted trust (along with powers of attorney) avoids this. If and when the grantor has recovered, they can resume the duties as trustee.
  • Estate Planning. A revocable trust is a great tool for estate planning because it bypasses probate, which can mean considerably less expense, stress and time. When creating your estate plan, make sure to think of more than just the trust. Ask your attorney about how the trust fits in with the rest of your estate plan: a will, powers of attorney, medical directives and other considerations.

Even though a trust is something that most people should consider, not anyone can create one. Your trust should be created by a very competent trust attorney, after a discussion about what you want to accomplish.

Reference: Forbes (February 20, 2019) “Revocable Trusts: The Swiss Army Knife Of Financial Planning”

Judge Rules against Oil Tycoon, Three Companies Remain in Family Trust

Three companies that manage the vast holdings of Grynberg were put into the family’s name and not his own in an effort to protect his vast wealth from creditors, estate taxes and even kidnapping or extortion attempts. The tycoon took a minimal salary throughout the years by choice, says The Denver Post’s article “Denver oil tycoon Jack Grynberg not entitled to $400 million in back pay in family feud, judge rules.”

Grynberg didn’t anticipate that his now ex-wife and children would take over the companies that he created, built and ran. His attorney said that his children had made no contributions to these companies and have now received about $1 billion that he had earned, while Grynberg has kept less than $5 million for his 25 years of hard work.

Meanwhile, the attorney representing his three adult children and ex-wife reportedly said the judge’s decision confirms that they were within their rights when they acted to assert control over the oil and gas companies. They say that they did so to protect the companies and their father’s legacy.

The case centers on the argument that Grynberg, 87, wasn’t the same as he was when he battled major oil conglomerates and foreign governments with accusations of cheating and wrongdoing. It was through the extensive use of the courts that Grynberg built his fortune. A Holocaust survivor and graduate of the Colorado School of Mines, Grynberg said he put his family’s name on the companies, with the understanding that he would maintain control of the business during his lifetime.

In February, an Arapahoe County jury disagreed with that and said the family-owned the companies and could fire Grynberg whenever they wanted. That is what the family did. Grynberg asked for back pay of about $400 million.

The family didn’t know that they had the legal right to fire him until 2016. Prior to that time, he had complete control of the companies. When a family member had an opinion or disagreed with him, he’d refuse the request. When all was well, the family was fine with this arrangement. However, as he aged and his decisions became more questionable, the family decided it was time to take control.

The judge maintained that Grynberg was a brilliant businessman, describing him as “very astute and calculating in all of his business decisions.” In other words, when he gave control over to the family, he knew exactly what he was doing.

Sadly, the battle has resulted in Grynberg being estranged from his children and divorced from his wife, Celeste, now 83. But all is not lost. He still owns half of his ex-wife’s 25% ownership in one of the companies.

Reference: The Denver Post (June 21, 2019) “Denver oil tycoon Jack Grynberg not entitled to $400 million in back pay in family feud, judge rules”

Are Inheritances Taxable?

Inheritances come in all sizes and shapes. People inherit financial accounts, real estate, jewelry, and personal items. Whatever kind of inheritance you have, you’ll want to understand exactly what, if any, taxes might be due, advises the article “Will I Pay Taxes on My Inheritance” from Orange Town News. An inheritance might have an impact on Medicare premiums or financial aid eligibility for a college-age child. This post looks at some different assets and how they may impact a family’s tax liability.

Bank Savings Accounts or CDs. As long as the cash inherited is not from a retirement account, there are no federal taxes due. The IRS does not impose a federal inheritance tax. However, there are some states, including Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania, that do have an inheritance tax. Speak with an estate planning attorney about this tax.

Primary Residence or Other Real Estate. Inheriting a home is not a taxable event. However, once you take ownership and sell the home or other property, there will be taxes due on any gains. The value of the home or property is established on the day of death. If you inherit a home valued at death at $250,000 and you sell it a year later for $275,000, you’ll have to declare a long-term capital gain and pay taxes on the $25,000 gain. The cost-basis is determined when you take ownership.

Life Insurance Proceeds. Life insurance proceeds are not taxable, nor are they reported as income by the beneficiaries. There are exceptions: if interest is earned, which can happen when receipt of the proceeds is delayed, that must be reported as income. The beneficiary will receive a Form 1099-INT and that interest is taxable by the state and federal tax agencies. If the proceeds from the life insurance policy are transferred to an individual as part of an arrangement before the insured’s death, they are also fully taxable.

Retirement Accounts: 401(k) and IRA. Distributions from an inherited traditional IRA are taxable, just as they are for non-inherited IRAs. Distributions from an inherited Roth IRA are not taxable unless the Roth was established within the five years prior to inheritance.

There are some changes coming to retirement accounts because of pending legislation, so it will be important to check on this with your estate planning attorney. Inherited 401(k) plans are or eventually will be taxable, but the tax rate depends upon the rules of the 401(k) plan. Many 401(k) plans require a lump-sum distribution upon the death of the owner. The surviving spouse is permitted to roll the 401(k) into an IRA, but if the beneficiary is not a spouse, they may have to take the lump-sum payment and pay the resulting taxes.

Stocks. Generally, when stocks or funds are sold, capital gains taxes are paid on any gains that occurred during the period of ownership. When stock is inherited, the cost basis is based on the fair market value of the stock or fund at the date of death.

Artwork and Jewelry. Collectibles, artwork, or jewelry that is inherited and then sold will incur a tax on the net gain of the sale. There is a 28% capital gains tax rate, compared to a 15% to 20% capital gains tax rate that applies to most capital assets. The value is based on the value at the date of death or the alternate valuation date. This asset class includes anything that is considered an item worth collecting: rare stamps, books, fine art, antiques and coin collections fall into this category.

Speak with an estate planning attorney before signing and accepting an inheritance, so you’ll know what kind of tax liability comes with the inheritance. Take your time. Most people are advised to wait about a year before making any big financial decisions after a loss.

Reference: Orange Town News (May 29, 2019) “Will I Pay Taxes on My Inheritance”