All posts in Estate Planning Strategies

08 Apr

Looking a Gift Horse in the Mouth: Qualified Disclaimer can be a Powerful Estate Planning Tool

In Estate Planning Strategies by admin / April 8, 2013 / 0 Comments

Estate Planner May-June 2007

At first glance, turning down an inheritance may seem like a foolish move. But in many cases, doing just that may be the best strategy. You (or your heirs) can use a qualified disclaimer to redirect property to another person while reducing the tax burden on your family.

What’s a disclaimer?

A disclaimer is an irrevocable and unqualified refusal to accept an interest in property. When you make a disclaimer, the disclaimed property is treated as if it had never been transferred to you. The property then passes – according to the terms of the transferor’s will or trust – as if you had died before him or her.

If your disclaimer is “qualified” (see “What qualifies a disclaimer?” below), you can redirect the property to a family member or other recipient without negative gift or estate tax consequences.

A qualified disclaimer is a flexible estate planning tool with a variety of uses. Here are a few examples:

” Marie’s will leaves all of her property to her three daughters or, in the event a daughter predeceases her, to that daughter’s children. When Marie dies, one of her daughters, Julie, is terminally ill. If Julie disclaims her inheritance, the property automatically passes to her children without being included in her taxable estate. Depending on how much is being disclaimed by Julie, Marie’s estate may be subject to generation-skipping transfer (GST) tax.

” Same facts as the first example, except that when Marie dies all of her daughters are healthy. One of the daughters, Jill, however, is quite successful and has already built up a substantial estate. Rather than expose her inheritance to unnecessary estate taxes, Jill makes a qualified disclaimer and allows the property to pass directly to her children. Similarly, there may be GST tax consequences to Marie’s estate by virtue of Jill’s disclaimer.

” Jim dies in 2007, leaving a $4 million estate. Jim’s will leaves everything to his wife, Lori, or, if Lori doesn’t survive him, to their children. The problem with Jim’s estate plan is that it wastes his $2 million federal estate tax exemption. The assets he leaves to Lori are sheltered from federal estate tax by the unlimited marital deduction. Lori dies in 2008, when the estate tax exemption remains at $2 million and the top marginal estate tax rate is 45%. Assuming the assets she inherited from Jim represent her entire estate and they are still worth $4 million, her estate will owe $900,000 in estate tax on those assets – or more if subject to state estate taxes.

If, instead, on Jim’s death Lori makes a qualified disclaimer with respect to half of Jim’s assets, or $2 million, that amount will pass directly to their children federal-estate-tax free, making full use of Jim’s $2 million exemption. When Lori dies, the remaining $2 million is sheltered from estate tax by her exemption, and no federal estate tax will be due at her death. Her estate tax liability will be reduced by at least $900,000.

Plan your estate with disclaimers in mind

Be sure to consult your estate planning advisor before making any disclaimers. You shouldn’t make a disclaimer unless you’re confident that it will achieve your objectives and that you understand the tax consequences. Remember that you can’t control the disposition of disclaimed assets. If you make a disclaimer, the assets will pass automatically according to the terms of the transferor’s estate plan.

Likewise, in planning your own estate, you can provide your family with the flexibility to make the most of your legacy by carefully spelling out who will receive disclaimed property.

Sidebar: What qualifies a disclaimer?

Under Internal Revenue Code Section 2518, a disclaimer of an interest in property is qualified if it meets these requirements:

1. The disclaimer is in writing.

2. The disclaimer is delivered to the transferor, or his or her representative, within nine months after the transfer is made (or, if later, within nine months after the disclaimant turns 21).

3. The disclaimant hasn’t accepted the disclaimed property interest or any of its benefits.

4. As a result of the disclaimer, the property interest passes – without any direction from the disclaimant – to the transferor’s spouse or to someone other than the disclaimant.

08 Apr

Section 529: Financial aid for your estate plan

In Estate Planning Strategies by admin / April 8, 2013 / 0 Comments

Estate Planner May-June 2007

When it comes to estate planning and college savings vehicles, Section 529 plans are at the head of the class. These plans receive high grades for their tax advantages, generous contribution limits and flexibility.

529 plans – which can be sponsored by a state, a state agency or an eligible educational institution – come in two forms: prepaid tuition plans and college savings plans. College savings plans are more popular because they usually offer greater flexibility and tax benefits.

529 plan lesson

A 529 college savings plan allows you to make cash contributions to a tax-advantaged investment account. Contributions aren’t tax deductible, but the account grows tax-free, and earnings may be withdrawn free of federal income tax provided they’re used to pay qualified higher education expenses. Qualified expenses include tuition, fees, books, supplies, equipment and some room and board costs. Earnings used for other purposes are subject to income tax and a 10% penalty.

Keep in mind that there are fees, charges and tax ramifications associated with 529 plans, and the underlying investment options are subject to market risk and will fluctuate in value.

Most college savings plans are open to both residents and nonresidents, but many states offer state income tax incentives to residents, such as deductible contributions or tax credits based on contribution amounts. Consult with your tax advisor about your particular situation.

Investment options and features vary from plan to plan, as do contribution limits. Most 529 plans have generous contribution limits – generally ranging from the low $200,000s to the low $300,000s per beneficiary. All assets, including earnings, under a 529 plan established for the benefit of a particular beneficiary must be aggregated when applying the limit. New contributions will not be allowed after this limit is reached, and earnings will continue to accrue.

Learning the estate planning benefits

The primary purpose of a 529 plan is to save for college, but don’t fail to overlook its unique estate planning benefits. Typically, to shield assets from estate taxes you must permanently give up control over them. But when you create a 529 plan for your child, your grandchild or another beneficiary other than yourself, the contributions and earnings are removed from your taxable estate even though you maintain control over the funds.

Unlike irrevocable trusts and other estate planning vehicles, a 529 plan allows you to retain control over the timing of distributions as well as the right to change beneficiaries. You also can roll the funds into another 529 plan as often as once a year without adverse tax consequences. In addition, you can revoke the plan and get your money back (subject to taxes and penalties).

529 plans also offer unique gift tax advantages. Although contributions are considered taxable gifts to your beneficiary, they’re eligible for your $12,000 annual gift tax exclusion ($24,000 for gifts you split with your spouse). (If you’re a grandparent, this also means you can avoid any generation-skipping transfer tax when funding a 529 plan to benefit your grandchild.) Ordinarily, you can’t take advantage of the annual exclusion if you retain the power to change beneficiaries or revoke an account.

Even better, you can accelerate five years of annual exclusion gifts and make a single tax-free contribution of up to $60,000 ($120,000 for married couples) per beneficiary. Bear in mind that, once you accelerate your annual exclusions, you can’t make additional annual exclusion gifts to the same beneficiary for five years. So before you take advantage of this benefit, be sure to consider how it will affect other gift, estate and succession planning strategies. Also, if you die within five years, a portion of your gift will be brought back into your estate.

Making the grade

529 plans have a few disadvantages. For instance, you can make only cash contributions, and your investment options are limited to those offered by the plan. But with a unique combination of tax and estate planning benefits, they should be at the top of your list of estate planning options.

Please contact your investment professional for more information on 529 plans and to obtain the appropriate disclosure statements and the applicable prospectuses for the underlying investments. Investors are asked to consider the investment objectives, risks, charges and expenses of a portfolio carefully before investing or sending money.

Sidebar: 3 recent laws bolster 529 plans

Thanks to three bills signed into law in 2006, Section 529 plans are even more attractive:

1. Pension Protection Act of 2006 (PPA). Despite a 529 plan’s advantages, until recently there was a shadow hanging over it: Many of its most significant benefits – including tax-free withdrawals for qualified college expenses and the ability to change plans without changing beneficiaries – were set to expire at the end of 2010. PPA makes these changes permanent. It also allows private institutions to continue sponsoring 529 plans after 2010 and makes cousins permanent “members of the family” for rollover purposes.

2. Deficit Reduction Act of 2005 (DRA). DRA clarifies that a 529 plan is considered an asset of the plan owner. This is significant for financial aid purposes because, in determining how much a family can afford to pay for college, the federal formula factors a student’s assets much more heavily than the parents’ assets.

3. Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). The “kiddie tax” provides that a child’s unearned income – including interest, dividends and capital gains – is taxed at the parents’ marginal rate once it reaches a specified threshold ($1,700 for the 2007 tax year). Previously, the kiddie tax applied only to children under age 14, but TIPRA expands the tax to apply to children under 18. As a result, tax strategies involving vehicles such as Uniform Transfers to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA) accounts have become less effective, making 529 plans even more attractive.

08 Apr

Sizing up a FIT: Tailor a family incentive trust to meet your needs

In Estate Planning Strategies by admin / April 8, 2013 / 0 Comments

Estate Planner September/October 2006

As baby boomers grow older in the coming decades, enormous amounts of wealth will pass from one generation to the next. In fact, a 1999 (and reexamined in 2003) report published by the Boston College Center on Wealth and Philanthropy estimates that between $41 trillion and $136 trillion will be transferred by 2052.

Despite the vast sums at stake, surveys show that affluent baby boomers are less concerned about sharing money with the younger generation than with sharing values, a sense of responsibility, a strong work ethic and a commitment to education. To achieve this goal, an increasing number of people are using family incentive trusts (FITs) to shape their legacies by shaping the character of their heirs.

Dangers of unrestricted wealth

There’s a popular misconception that many of the richest Americans inherited their wealth. In fact, the vast majority of today’s millionaires are self-made, and they recognize the importance of earning one’s keep. Many believe that inherited wealth can have a corrupting influence.

And you don’t have to be on the Forbes 400 list to share these concerns. A $2 million bequest that earns a modest 6% return will generate an annual income of $120,000 – more than enough for a child to live off his or her inheritance.

One way to protect your heirs from the temptations of easy money is to limit their inheritance or even to disinherit them altogether. A less harsh approach, however, is to use a FIT to share your wealth with some strings attached.

A FIT can serve many important estate planning goals, such as providing a safety net so your heirs will never end up homeless, providing financial incentives to lead responsible, productive lives, and creating opportunities by lending to or investing in a family business.

Structuring a FIT

You can designate most estate planning trusts – including living trusts, asset protection trusts, insurance trusts and certain charitable trusts – as FITs. Typically, FITs are structured as spendthrift trusts, meaning beneficiaries can’t assign their interests (such as collateral for a loan), and the assets enjoy some protection against creditors’ claims and divorcing spouses. FITs often are set up as dynasty trusts, which allow you to have an impact not only on your children, but also on your grandchildren and later generations. (See the sidebar “Creating a FIT dynasty.”)

You may base distributions from a FIT on virtually any criteria, from obtaining a college or graduate degree to maintaining gainful employment to reaching a certain age. Whatever the criteria, however, you likely want to design the FIT so your heirs can’t live off the trust funds while doing nothing.

You can limit distributions to the trust’s income or provide for distributions of both income and principal. If your children are responsible adults, you can give them unrestricted access to trust funds and provide for the trust to convert into a FIT for your grandchildren.

Typically, a FIT’s income or principal is applied first toward providing a safety net so heirs never will be destitute and next toward incentives to encourage desired behavior. You may use leftover funds to establish a “family investment bank” to invest in family businesses or other worthwhile endeavors.

FIT flexibility

Designing a FIT requires intense planning to ensure that it accomplishes your goals while being flexible enough to avoid unintended consequences and adapt to changing circumstances.

You might provide an incentive to work, for example, by linking trust payouts to a beneficiary’s earnings. But what if success in a beneficiary’s chosen career requires that he or she start with a low-paying or unpaid internship? What if a beneficiary becomes disabled and can’t work? A well-designed FIT should accommodate these circumstances.

You also should consider the fact that living responsibly can mean different things for different people. A FIT that requires beneficiaries to work, for example, may penalize a stay-at-home parent committed to raising his or her children.

A good way to ensure a FIT is sufficiently flexible is to establish general principles for distributing trust funds but to give the trustees broad discretion to apply these principles depending on the facts and circumstances. For a multigenerational FIT, another effective approach is to give beneficiaries a special power of appointment they can use to adapt the FIT to meet the needs and circumstances of their children.

Accentuating the positive

Most experts agree that negative reinforcements are counterproductive. Financial incentives that require a beneficiary to refrain from drug use, gambling or other behavior you deem undesirable can send the message that you’re “ruling from the grave” and can lead to resentment and conflict. Such incentives also may encourage beneficiaries to conceal their conduct and avoid seeking help.

By stressing positive behavior, such as gainful employment or higher education, the negative behavior tends to take care of itself. After all, it’s tough for a substance abuser to hold down a job or stay in school.

It’s also important to avoid “buying” desired conduct. If your daughter wants to work but your FIT offers an enormous bonus if she stays home with the kids, she may feel that she has no choice. It’s better to offer beneficiaries a variety of positive options that make them feel that they can do anything, so long as they do something productive.

Fitting rewards

A FIT is a flexible estate planning tool that allows you to shape your legacy by encouraging your heirs to lead responsible, productive lives. It also helps preserve your wealth for future generations by preventing your children from getting a free ride.

Sidebar: Creating a FIT dynasty

If you want your family incentive trust (FIT) to influence many generations to come, consider setting it up as a dynasty trust. A number of states have relaxed or eliminated restrictions on the longevity of trusts, allowing you to create a trust that, in theory, can last forever.

If you establish a dynasty trust, plan carefully to avoid the generation-skipping transfer (GST) tax. The GST tax was intended to prevent families from avoiding estate taxes in one generation by transferring assets directly to the following generation. It’s a flat tax – on top of any other gift and estate taxes – imposed at the highest marginal estate tax rate (currently 46%) on gifts, bequests or trust distributions made directly to a “skip person.” A skip person is a grandchild or other person more than one generation below you, or a nonfamily member who’s at least 37 1/2 years younger than you.

To avoid GST tax, allocate some or all of your GST exemption (currently $2 million) to trusts you intend or expect to benefit your grandchildren or other skip persons. One of the most powerful tools for leveraging the GST exemption is an irrevocable life insurance trust (ILIT). You can create millions of dollars in tax-free benefits for future generations, but you use only the GST exemption amounts needed to cover contributions for insurance premiums.

Dynasty trusts are complex and require careful planning. Be sure to consult an expert to design a trust that achieves your goals in the most tax-efficient manner.

08 Apr

Estate planning red flag: Most of your wealth will pass through beneficiary designations

In Estate Planning Strategies by admin / April 8, 2013 / 0 Comments

Estate Planner September/October 2006

No matter how long you agonize over who gets what in your will or living trust, your wishes may not be carried out if the bulk of your estate will be transferred through beneficiary designations.

Many types of assets pass to your heirs on the basis of beneficiary designations, including life insurance, brokerage accounts, IRAs and 401(k) accounts. It’s not unusual for these assets to make up most of a person’s wealth. And the beneficiary designation controls their disposition, regardless of the terms of your will or trust.

Suppose, for example, your living trust provides for all of your assets to benefit your children. If the bulk of your estate is in an IRA, and your spouse is the designated beneficiary, your estate plan may not be what you think it is.

To avoid this result, you might consider designating the living trust as the beneficiary of your IRA. However, if you do so, it’s critical that the trust be designed as a qualified beneficiary so as not to accelerate the income tax on the IRA assets.

To ensure that your wishes are carried out, review all of your beneficiary designations periodically and confirm that they’re consistent with the terms of your estate plan.

08 Apr

What to do with the collectibles? Addressing personal property in an estate plan

In Estate Planning Strategies by admin / April 8, 2013 / 0 Comments

Estate Planner September/October 2006

When planning their estates, many people focus on stocks, bonds and real estate, and pay little attention to personal property. But it’s not unusual for collectibles – such as art, jewelry, antiques, automobiles, coins and stamps – to make up a significant portion of one’s wealth.

If your estate includes valuable collectibles, there are a number of estate tax planning challenges to be aware of and opportunities to consider.

Determining worth

Whether you give collectibles to family members or donate them to charity, it’s critical to obtain a qualified appraisal. The value of property for federal gift, estate and income tax purposes is its fair market value; thus, it’s vital to establish this value.

Given the subjective nature of art valuation, and the potential for abuse, IRS auditors are required to refer gifts of art valued at $20,000 or more to the IRS Art Advisory Panel. The findings of the panel – which includes top curators, dealers and other experts – become the IRS’s official position on the art’s value. To obtain the best possible outcome, include a comprehensive appraisal by a qualified expert with your return.

An appraisal also can give you some peace of mind with regard to federal gift taxes. The statute of limitations for gift tax purposes doesn’t begin to run until you file a gift tax return that satisfies the IRS’s adequate disclosure rules. A qualified appraisal fulfills many of the rules’ requirements.

For additional comfort, ask the IRS for an advance ruling on the value of personal property for tax purposes. To obtain such a ruling, you must:

· Make the request after you transfer the property,
· Obtain a qualified appraisal,
· Transfer at least one item whose value is $50,000 or more, and
· Attach copies of Form 8283 and the appraisal to the ruling request.

Bear in mind that there is a fee of $2,500 for the first three items and $250 for each additional item.

Making testamentary gifts

If you plan to leave collectibles to your heirs in your living trust or will, it’s usually best to make specific bequests. If you transfer collectibles through residual gifts – that is, as part of the property that’s left after other beneficiaries receive their bequests – the recipient also may inherit some unwelcome tax liabilities in the form of being responsible to the estate for the share of tax related to the item.

Some people’s wills allow their beneficiaries to choose the personal property they’d like to keep and provide for the remainder to be sold. If the beneficiary is a surviving spouse, however, there’s a risk the gift won’t qualify for the marital deduction. (Ordinarily, the marital deduction defers estate taxes on an unlimited amount of property you transfer to your spouse, as long as he or she is a U.S. citizen.)

There’s some authority for the proposition that the marital deduction applies as long as the spouse is required to choose the collectibles he or she wants to keep within the time period for making a qualified disclaimer. (Qualified disclaimers are used to refuse a bequest and allow the property to pass to someone else without adverse tax consequences.) But a safer approach is to bequeath all collectibles to the spouse and allow him or her to disclaim any unwanted items.

You also can make testamentary gifts to charity, but, as discussed below, lifetime charitable gifts are preferable because they generate significant income tax benefits.

Donating to charity

Art and other collectibles are ideal assets for charitable giving, particularly if they’ve appreciated significantly in value. When you donate appreciated property to charity, you avoid capital gains taxes – a big advantage for collectibles, which are taxed at a hefty 28% rate. (Long-term gains on most capital assets are currently taxed at 15%.)

If the charity’s use of the donated property is related to its tax-exempt purpose, you’re also entitled to a charitable income tax deduction equal to the property’s fair market value – up to 30% of your adjusted gross income (AGI). Otherwise, your deduction is limited to your cost basis (up to 50% of AGI). If you donate a painting to a museum for display, for example, or to a university for use in art classes, the use is related to the charity’s exempt purpose. If the charity sells the painting and uses the proceeds, however, it’s not used for a related purpose.

Keep in mind that, if you donate art or other copyrighted property and you own the copyright, you’re entitled to a charitable deduction only if you transfer the copyright along with the work. This rule creates a tax trap for unwary donors. For works created before 1978, purchased art includes the copyright unless the seller specifically reserves it. But under the Copyright Act of 1976, the copyright is presumed to stay with the seller unless it’s specifically transferred to the buyer.

Offering fractional gifts

Fractional giving is a great way to generate income tax savings while continuing to enjoy your art – at least for part of the year. Say you donate a 25% interest in your art collection to a local museum. The museum gains the right to display the collection for three months each year. You deduct 25% of the collection’s fair market value immediately, while continuing to display the art in your home for the remaining nine months. Most museums will accept fractional gifts only if you agree that the work eventually will become the museum’s exclusive property.

If the art continues to appreciate, your deductions will grow with each donation. Giving art away gradually also can help you avoid losing deductions that exceed the 30%-of-AGI limit. Although excess deductions can be carried forward for up to five years, the deductions may be lost permanently if a work or collection is extremely valuable.

Collecting your thoughts

These are just a few of the many strategies you can use to transfer art and other collectibles in a tax-efficient manner. Other options for charitable giving include charitable trusts, artwork loans and bargain sales. Techniques for sharing collectibles with your family include trusts, family limited partnerships and family limited liability companies.

Whichever strategies you choose, if you own valuable collectibles it’s important to include them in your estate plan.


08 Apr

An Air of Uncertainty: The Roth 401(k) may be good for your Estate Plan, but will it last?

In Estate Planning Strategies,Retirements by admin / April 8, 2013 / 0 Comments

Estate Planner September-October 2006

Beginning this year, businesses can establish a Roth 401(k) plan or add a Roth contribution option to an existing 401(k) plan. Yes, these plans offer attractive retirement benefits, but the estate planning benefits may be their biggest draw. You must, however, bear in mind that the Roth 401(k) plan provisions expire at the end of 2010 unless Congress acts to extend them.

Tax-free retirement income benefits

Like a Roth IRA, contributions to a Roth 401(k) aren’t tax deductible, but earnings accumulate tax-free and can be withdrawn tax-free in retirement. This can be a big advantage, particularly if you expect your income tax bracket to increase after you retire.

High income taxpayers, however, haven’t been able to take advantage of the Roth IRA. (Under the Tax Increase Prevention and Reconciliation Act of 2005, beginning in 2010 there will no longer be any income limitation on converting a traditional IRA to a Roth IRA.) Eligibility for contributing to a Roth IRA is phased out beginning at $95,000 of modified adjusted gross income (AGI) – $150,000 AGI for joint filers. The Roth 401(k) provides you an opportunity to enjoy the Roth benefits, because there are no AGI limits for contributing.

Contribution limits for Roth 401(k) plans are the same as for traditional 401(k) plans: In 2006, the maximum contribution to all 401(k) accounts is $15,000, plus a $5,000 “catch-up” contribution if you’re 50 or older by the end of the year. If no AGI phaseout applies, Roth IRA contributions are limited to $4,000 plus a $1,000 catch-up contribution.

Stretch out estate planning benefits

It’s often said that traditional IRA and 401(k) accounts are the worst assets to leave to your heirs. Why? Because the combination of income and estate taxes can shrink these accounts to a fraction of their original value. But Roth accounts don’t have this drawback because qualified distributions aren’t subject to income taxes.

With careful planning, assets in a Roth 401(k) account can continue growing tax-free throughout your lifetime and beyond – provided you have other sources of retirement income. Although a Roth 401(k), like a traditional 401(k), is required to begin mandatory distributions when you reach age 70 1/2, IRS rules allow you to roll the funds over into a Roth IRA, which isn’t subject to mandatory distribution requirements until the death of the Roth owner.

This technique allows you to stretch out the account’s tax-free benefits, providing a valuable nest egg for your children and even your grandchildren. Heirs are required to take distributions, but the distributions can be spread out over their lifetimes. Depending on the size and growth rate of the account, this means there may even be more left in the account for the grandchildren’s benefit.

Too good to last?

If Congress doesn’t act to extend the Roth 401(k) provisions, you’ll have to stop contributing to the account after 2010. But you should be able to leave your previous contributions in the account or roll them over into a Roth IRA.

If you feel a Roth 401(k) is right for you, and your employer offers it, at the very least you’ll have a little over four years to take advantage of its retirement and estate planning benefits.

08 Apr

Prepaid tuition strategy gets passing grade from IRS

In Estate Planning Strategies by admin / April 8, 2013 / 0 Comments

Estate Planner July-August 2006

For many people, the $2 million estate tax exemption (up this year from $1.5 million) and the $1 million lifetime gift tax exemption are more than enough to shield their assets from estate tax. But if the value of your estate exceeds the exemption amounts, you’ll need some creative strategies to preserve your wealth for future generations.

In a recent private letter ruling (PLR) No. 200602002, the IRS gave its blessing to a planning technique that allows you to remove significant amounts of wealth from your estate tax-free, without using up your exemptions.

The ruling permits a taxpayer to prepay tuition for his six grandchildren through 12th grade, without triggering estate, gift or generation-skipping transfer (GST) taxes. Bear in mind that a PLR applies only to the taxpayer who requested it and sets no legal precedent. But it does provide valuable guidance on how the IRS may rule in similar cases.

The basics

An important estate planning goal is to find ways to share your wealth with your heirs without incurring transfer taxes or depleting your exemptions. One way to accomplish this is to take advantage of the annual gift tax exclusion, which allows you to transfer up to $12,000 per recipient tax-free (up this year from $11,000). If you elect to split gifts with your spouse, you can give up to $24,000 per recipient.

The problem with this approach is that it can take years to transfer a meaningful amount of wealth. You can give more, however, by paying tuition or medical expenses on behalf of your children or other heirs. As long as you make the payments directly to the school or health care provider, they’re exempt from gift tax without consuming any of your exemptions or annual exclusions.

For example, each year, Tom and Mary give $24,000 to their granddaughter, Alice, to help pay for her $20,000 tuition and other education expenses. They would like to help out even more, but if they make additional gifts they’ll have to pay gift taxes at rates as high as 46% or use their gift tax exemptions. But if Tom and Mary pay Alice’s tuition directly to her school, they can still use their annual exclusion to give Alice up to $24,000, for a total tax-free gift of $44,000.

An accelerated program

The strategy approved in the PLR allows you to accelerate the process by paying tuition in advance. The taxpayer who requested the ruling planned to enter into separate written agreements with the school for each of his six grandchildren. Under the agreements, he would prepay the total annual tuition for each grandchild through 12th grade. The amounts would be based on the school’s current tuition rates, and the grandfather or the children’s parents would agree to pay any tuition increases in subsequent years.

The prepaid tuition would not guarantee enrollment or afford the grandchildren any additional rights or privileges over other students. Also, the prepayments would be nonrefundable – that is, they would be forfeited to the school in the event a grandchild drops out or transfers to another school.

The IRS ruled that, under the facts presented, prepaid tuition was exempt from gift and GST taxes. The ruling has significant implications for people who want to remove large amounts of assets from their estates tax-free but don’t have the time they need to accomplish this through annual exclusion gifts.

The PLR doesn’t mention the ages of the six grandchildren or the school’s tuition rates. But it’s likely that the dollar amounts involved are substantial. Suppose the grandchildren are in grades 2, 3, 4, 5, 6 and 7 and that the average tuition is $15,000 per year. The grandfather could transfer $765,000 without paying gift, estate or GST taxes or using any of his exemption amounts. Plus, he would still be able to use the annual exclusion to make additional gifts to his grandchildren.

Study before choosing a strategy

The main disadvantage of the technique approved in the PLR is that you have to make nonrefundable payments to a specific school on behalf of a designated student. Unlike other educational savings vehicles, such as Section 529 college savings plans, you can’t transfer the funds to another school or another person if the student transfers or drops out.

The most tax-efficient way to finance educational expenses is to start contributing early to a Section 529 plan, a Coverdell Education Savings Account, a tax-advantaged educational trust or some combination of these vehicles. These tools offer greater flexibility and less risk than the technique described in the PLR, but they also require more lead time because of contribution limits and the need to use your annual exclusion to avoid gift tax. But if you don’t have the luxury of time, and you’re looking for ways to shield large amounts of wealth from gift and estate taxes, the prepaid tuition strategy is worth further study.

08 Apr

The Future of Estate Planning – As Laws Change, Focus Shifts to Income Tax, State Taxes

In Estate Planning Strategies by admin / April 8, 2013 / 0 Comments

Estate Planner Jan-Feb 2006

The future of the estate tax may be uncertain, but one thing is clear: Rumors
of the death of estate planning are greatly exaggerated. Permanent repeal of the
federal estate tax seems unlikely, but many experts expect legislators to push for even higher estate tax exemptions, reducing the number of Americans subject to the tax.

Whether Congress kills the estate tax or increases the exemption, the need for estate planning will live on. But its focus will shift from federal estate taxes to other issues, such as federal income taxes and state death taxes.

Income tax planning

For many years, when estate tax rates were high and exemptions relatively low, estate planning revolved around avoiding the federal estate tax. But that’s beginning to change. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) lowered estate tax rates and boosted the estate tax exemption from $1 million to $1.5 million for 2004 and 2005, to $2 million in 2006, and to $3.5 million in 2009.

As the estate tax becomes less of a factor, income tax issues take on added importance, turning traditional estate planning techniques on their head. Traditionally, taxpayers strive to minimize the value of their taxable estates to reduce or eliminate estate taxes. But taxpayers who are well within the estate tax exemption may benefit by increasing the value of their estates. Why? Because assets transferred at death receive a stepped-up basis in the hands of their heirs, minimizing the effects of income taxes. Here’s an example:

Jean owns a 35% interest in a business worth $4.7 million. Her daughter and sole heir, Julie, owns the other 65%. Jean’s remaining assets consist of $115,000 in cash and marketable securities. Assuming a 25% minority interest valuation discount, Jean’s interest in the business is worth $1,233,750. If Jean dies in 2006, when the federal estate tax exemption is $2 million, there’s no estate tax liability. Julie inherits Jean’s interest in the business with a stepped-up basis equal to its fair market value, or $1,233,750.

Suppose, instead, that Jean purchases a 20% minority interest in the business from Julie in exchange for a $705,000 promissory note, increasing her stake to a 55% controlling interest worth $2,585,000. When this amount is combined with Jean’s remaining assets and the $705,000 liability is subtracted, her estate is valued at $1,995,000, still within the federal estate tax exemption.

But under this scenario, Julie’s basis is stepped up to $2,585,000. If Julie were to sell the business for $4.7 million, the increased basis would save her more than $270,000 in capital gains taxes, assuming a 20% capital gains tax. Bear in mind that this strategy might cause an increase in state death taxes if Jean lived in a state that has decoupled its estate tax from the federal estate tax.

State estate tax planning

In addition to lowering rates and increasing exemptions, EGTRRA also eliminated the state estate tax credit and replaced it with a federal estate tax deduction for state taxes paid. Before EGTRRA, estates received a dollar-for-dollar credit for estate or inheritance taxes they paid to a state.

Rather than create separate tax systems, most states simply imposed death taxes in an amount equal to the federal credit. These were called “pick-up” taxes because the state would pick up the amount allocated as a credit under federal law. Of the states without a pick-up tax, most had death taxes that were coupled in some way with the federal estate tax and exemption scheme.

But by increasing the estate tax exemption and repealing the state death tax credit, EGTRRA reduced or eliminated the tax revenues collected by a state with the pick-up tax. To make up for these lost revenues, many states have decoupled from the federal tax and established their own estate or inheritance taxes.

This phenomenon affects estate planning in two ways: First, depending on your state’s laws, you may be subject to state death taxes even if you’re exempt from the federal estate tax. And second, the lack of uniformity among state death taxes complicates your estate plan, especially if you own property in more than one state or relocate to another state.

Weighing potential tax consequences

Income tax and state death tax issues aren’t new, but until recently these taxes were generally eclipsed by the federal estate tax. If the estate tax is repealed, estate planning will shift its focus to minimizing income taxes and state death taxes. Or, if Congress retains the estate tax but increases the exemption, estate planning will get more complicated as taxpayers attempt to strike a balance between estate tax and income tax concerns.

To evaluate estate planning strategies, weigh the potential estate, income and state tax consequences, and choose the option that provides the greatest benefits to you and your family.


08 Apr

Keeping Private Matters Private – 5 Ways to Structure Your Assets to Avoid Probate

In Estate Planning Strategies by admin / April 8, 2013 / 0 Comments

Estate Planner, Oct-Nov 2005

Suppose someone told you that after your death much of your personal financial information, as well as a detailed description of who received your assets, would become a part of the public record. Oh, and for the privilege of making all of that information available, you’d incur significant court fees and legal expenses.

Perhaps you’d prefer to save those costs and keep your estate plan private. The good news is that avoiding probate is not terribly difficult.

Probate avoidance strategies

In a nutshell, probate is a court-supervised process to protect the rights of creditors and beneficiaries and to ensure the orderly transfer of assets. But because probate can be time-consuming, expensive and public, you may want to include avoiding probate as part of your estate plan. If so, consider these strategies:

1. Set up a revocable trust. A revocable, or living, trust is a simple way of titling assets so you can avoid the probate process at your death or similar court proceedings if you become legally incompetent. But just creating the trust isn’t enough. Until you transfer assets to the trust, it’s useless with respect to probate avoidance. Once your assets are re-titled into the trust, though, it becomes an extremely powerful estate planning tool that lies in wait until needed.

Technically, you no longer own the assets, the trust does; but during your life the trust is virtually disregarded. You have complete control over the assets, for example, how they’re invested, when they’re sold and when you spend the funds. All tax-related activity of the funds is still reported on your personal income tax return. In a sense, all you’ve done is transfer the assets from one pocket to another.

On your death, the trust’s assets are included in your taxable estate but they aren’t included as a part of your probate estate. Thus, the revocable trust is not designed to avoid, or even reduce, estate tax. It’s designed solely to reduce the expenses of administration. That is, it will reduce your probate costs.

2. Hold assets in joint tenancy with right of survivorship. A revocable trust may pack the biggest punch, but perhaps the most popular way for married couples to hold assets to avoid probate is in joint tenancy with the right of survivorship. Here, title in the joint property vests only in the survivor immediately on the death of the other joint tenant.

Although joint tenancy with right of survivorship may be easy to set up, what you gain in simplicity you can lose in your ability to reduce or even avoid estate tax. For instance, unless your and your spouse’s combined estate is less than the estate tax exemption available to one spouse, if in fact all of your assets are owned jointly, then you may have to pay some estate tax on the survivor’s death that you could easily have avoided.

Joint tenancy with right of survivorship also is sometimes used when a parent (especially a widow or widower) wants to leave assets to his or her child. But keep in mind that the joint tenant has immediate access to funds in the account. Therefore, if your child withdraws funds from the account prior to your death, you may be treated as having made a taxable gift. Thus, it’s vital that you understand the ramifications of creating a joint tenancy, lest you be negatively impacted by an unintended consequence. (For the impact on home ownership, see the Estate Planning Red Flag in this issue.)

3. Establish a life estate. A life estate allows you to continue enjoying all the benefits of owning your property during your life without having the potential issues involved with joint tenancy. Using a life estate accomplishes essentially the same thing as a revocable trust. But it’s geared for use with a specific piece of property rather than a variety of assets that would be held in the trust.

At your death, title automatically vests in your remainderperson, such as your child or grandchild, without having to go through a lengthy probate process. Real property is a great candidate for retaining a life estate and transferring the remainder. There are, as with anything, technical aspects of a life estate that will vary depending on where the property is located.

4. Designate retirement plan beneficiaries. Retirement plans with properly designated beneficiaries aren’t subject to probate. When you initiated your IRA, 401(k) or other retirement plan accounts, you likely filled out a beneficiary designation form. Even if you know that you provided the custodian with the right information, be sure the form is readily accessible. That way, on your death, there will be no delay in your beneficiaries gaining access to the funds. Plus, retirement accounts have specific rules with respect to distributions in the hands of beneficiaries. A lot of flexibility can be lost if the estate is deemed to be the beneficiary.

5. Designate life insurance and annuity beneficiaries. As with your retirement plan accounts, insurance policies and annuities with properly designated beneficiaries aren’t subject to probate. When you purchased a life insurance policy or an annuity you likely designated a beneficiary. Over time, though, situations can change. Be sure to verify that the beneficiary you designated is still the one you want. You should also confirm that you and your heirs know where the documentation is located. If you are unable to find it, or if your beneficiary designation is outdated, be sure to take the time to locate or change it.

Privacy protected, time and money saved

Avoiding probate is easy and can be extremely worthwhile. Whatever steps you decide to take, be sure that everything is properly documented. After all, taking action today to ensure that you’re able to avoid probate will allow your family to protect your privacy and will enable your heirs to save time, money and aggravation.

08 Apr

A Net Gift Can Save You Big Money in Gift Tax

Estate Planner Jan-Feb 2001

What can you do if you want to transfer appreciated property — such as stock or real estate — to your child but lack cash to pay the gift tax? You can make a “net gift.” When you make a net gift, your child (or other recipient) agrees to pay the gift tax and the gift’s value is reduced by the amount of tax your child pays.

Tax Advantages of a Net Gift

A net gift can be useful when you have a large estate, little “free” cash and an illiquid asset. If your child has enough cash to pay the gift tax or can liquidate other assets to do so, you can transfer the illiquid property intact. This technique also makes sense if you (or your parent) are averse to personally paying gift tax or perhaps would incur a taxable gain by liquidating assets to pay the tax. And you may save a capital gains tax if part of your gift must be sold to raise cash to pay the gift tax, because the tax basis of the gift to the recipient is increased by the amount of the gift tax.

A net gift is similar to a sale of an asset for less than fair market value because your child gives you cash in the amount of the gift tax. Thus, the IRS will treat only a portion of the property you transfer to your child as a gift. The amount of the actual gift is determined by an interrelated calculation too complicated to go into here.

You can use the net gift technique even if you haven’t used your entire gift and estate tax applicable exclusion amount — currently $675,000. (The amount of the applicable exclusion is scheduled to increase until 2006, when it will reach $1 million per person.) If all or a portion of your exclusion amount is available, you must first apply it to any taxable transfers you make. Doing so shelters part of the gift from gift tax, and the net gift will apply to the overage.

Your net gift agreement with your child may be implied or expressed. But a written agreement is better in case the IRS, an heir or an executor has questions later.

Of course, with a net gift, your child will receive less property after paying the gift tax than if you pay it. But a net gift will lower the gift tax. For example, assume Jenna has used her applicable exclusion amount and wants to give stock worth $125,000 to her daughter, Katrina. The gift tax will be $31,000 if Jenna pays it. Thus, the cost of giving $125,000 to Katrina is $156,000. But the gift tax is only $24,000 if Katrina pays it, a saving of $7,000. And the gift costs Jenna only the original amount she wished to part with: $125,000, not $156,000, for a total saving of $38,000. Katrina will only receive $101,000 net after she pays the gift tax.

A Net Gift Is Better Than No Gift

A net gift is a win-win estate planning tool: Your child receives your gift of appreciated stock or real estate and pays the gift tax on the transfer that you lacked the cash to pay, thus making the gift possible. If you would like to learn more about this gift tax savings technique, please give us a call.

A net gift can be useful when you have a large estate, little “free” cash and an illiquid asset.