All posts in Estate Planning Strategies

08 Apr

The Benefits of Gifting Stock With Built-in Gains

Estate Planner May-Jun 2000

The IRS recognizes that a company with built-in capital gains (tax on the appreciation of a corporation’s capital assets) may be worth less than a similar company without such gains. This means that for transfer-tax purposes, a company’s value may be reduced by some or all of its inherent capital gains tax liability. Accordingly, giving away stock of closely held companies that have built-in capital gains could enable you to reduce the size of your taxable estate.

Know Your Discounts

You may take a discount for gifts of shares of corporations with built-in capital gains tax liability — but determining the discount is not simple. The capital gains tax discount will be reflected in the discount allowed for lack of marketability of the closely held company’s stock. That discount is based on the idea that a willing buyer will pay less for an asset that cannot later be easily sold.

As noted, selling a business that has a built-in capital gains tax problem may be more difficult than for the owner of a business without such problems. This greater difficulty justifies a lower value — and a lower value allows you to pass on more assets at a lower transfer-tax cost.

Should You Liquidate?

You may also be able to deduct the full amount of the tax liability if a liquidation of the corporation stock is imminent at the time of the gift. But the IRS will usually value the discount amount at less than a dollar-for-dollar reduction in value because of the uncertainty that the capital gains tax would ever be paid. Even when liquidation is planned, current law prevents you from totally avoiding paying capital gains tax on the asset liquidation of a regular C corporation.

Because you may possibly postpone capital gains tax for a long time, a full discount is not allowed in valuing corporate stock. Even if the tax payment can be deferred indefinitely, you have incurred a loss, such as the loss of cash flow and income from assets that are not sold because of the capital gains tax that would be incurred.

Understanding the speculative nature of the tax payment is important because it will be reflected in the final determination of the company’s value in the real world and for transfer-tax purposes.
The law is continuing to evolve in the complicated realm of valuation. For instance, it is not yet clear whether a discount will be allowed when the built-in capital gain tax liability is a result of the conversion to an S corporation from a C corporation.

Develop Your Plan Now

If you would like help in developing a plan to cost-effectively transfer assets out of your taxable estate, please call us. We are available to help you select a plan that fits your needs.

Consider the Impact of Taxes

Suppose you are to receive a gift of 100 shares of stock worth $100 each for a total of $10,000. You would prefer shares having a basis of $100 per share rather than $10 per share. Why? Because even though the shares are worth the same for gift-tax purposes, if you sell the stock you must pay capital gains tax on the difference between the sales price and the basis, $100 vs. $10. Similarly, the potential purchaser of a business would consider the net after-tax proceeds of a future sale of the business assets.

08 Apr

Exploring the Previously Taxed Property Credit

Estate Planner Mar-Apr 2000

Paying estate tax can reduce the amount of property that passes to the intended recipient. Paying estate tax again on that property if the recipient dies soon after the first death could greatly reduce the amount of property received by the subsequent beneficiary. Fortunately a credit reduces this otherwise draconian result. The previously taxed property credit does just what its name implies — it provides a credit for estate tax previously paid on property subject again to estate tax within 10 years of the death that triggered the previous tax. The idea behind the credit may sound simple, but understanding when and how to use the credit can be much more complicated.

Determining the Credit

Consider, for example, a 70-year-old man in frail health who just lost his mother, his only living parent. If he dies within 10 years of his mother’s death, his estate will receive a credit for the estate tax paid on the property previously taxed in his mother’s estate that he leaves to his children.

His credit is subject to two limitations:

1. The amount of pro-rata tax paid on the property included in his mother’s estate. For example, if the property that passed to the son represented 25% of the value of the mother’s estate and incurred estate taxes of $300,000, the first limitation would be $75,000 (25% of $300,000).

2. The amount by which the son’s estate tax was increased by assets received from his mother being included in his estate. This amount is greater than a pro rata amount would be because the progressive tax rate increases from 37% to 55% and the second limitation counts the increase in tax at the higher rates when property is added to the estate.

The credit is further limited by how close the two deaths occur. The credit is reduced by 20% for every two years that the survivor lives. For example, if the son dies within two years of his mother, then 100% of the credit is available. If the son survives his mother for more than two years but less than four years, his estate is entitled to 80% of the credit.

More Tax-Saving Opportunities

An estate doesn’t have to incur estate taxes on the previously taxed property to take the credit. For example, if the mother at death gave her son the right to live in her house for his lifetime, the son’s estate would not have to pay any estate tax on the right because it expired on his death. Nevertheless, the son’s estate is entitled to the credit based on the estate tax paid on his mother’s estate.

Similarly, if the mother left property in trust for her son and he had the right to receive all trust income for his life, that right would not trigger tax in his estate but could instead reduce estate tax in his estate owing to the credit because he is not deemed to own the underlying property.

Often the credit can be used in planning for a husband and wife situation. Generally, because of the use of the marital deduction and applicable exclusion amount, no estate tax is due on the death of the first spouse. Yet, pre-death or post-death planning strategies can force an estate tax on the death of the first spouse that will permit the use of the credit on the surviving spouse’s estate.

The end result is that the total of the estate tax in both estates minus the credit is smaller than the estate tax payable under the more traditional approach when all tax is deferred until the surviving spouse dies. The starting point for planning is when the deaths of a husband and wife will likely be within a few years, at most, of each other.

Don’t Go It Alone

If you have questions about the previously taxed property credit, please let us know. Our professionals would welcome the opportunity to help you determine if this tax tool is right for your particular circumstances.



08 Apr

How To Make Effective Deathbed Transfers

Estate Planner Jan-Feb 2000

Many people want to leave assets or a remembrance at their deaths to grandchildren, other relatives and friends. But giving assets during life instead may result in more of the donor’s wealth passing to beneficiaries and less going to the government as tax. Unfortunately, many people don’t realize this until they are on their deathbeds, and transfers at this time require special planning.

Why Make Gifts?

Donors may have many reasons for not making gifts until after death. They may not want to lose control or possession of assets until they’re certain they won’t need them. Or perhaps they simply have never considered lifetime gifts as alternatives.

But when a donor is not expected to live long, he or she may, for the first time, take seriously the prospect that estate tax will erode assets. Lifetime gifts can cut down on this erosion by removing assets from the donor’s taxable estate. A donor can give up to $10,000 per recipient per year free of gift taxes. It may be too late for donors on their deathbeds to implement other estate reduction strategies, but they can still take advantage of these annual exclusion gifts.

Selection and Timing of Gifts 

Tax considerations can favor gifting certain assets rather than others. The donor should generally select assets with a high income tax basis (close to current market value), such as stock that has not greatly appreciated since its purchase or cash with a 100% basis. The advantage of keeping assets with a low basis is that assets the donor owns at death will generally receive an increased (“stepped-up”) basis to the fair market value as of the date of the donor’s death, thereby eliminating any gain that was built into the asset.

Keep in mind that if the donor’s estate is less than the applicable exclusion amount ($675,000 in 2000, increasing to $1 million by 2006), deathbed gifts will offer no estate tax advantage to outweigh a loss of basis step-up.

Timing is critical with deathbed gifts. Gifts that are not completed will result in the assets not being removed from the donor’s taxable estate. For example, donors giving cash may use checks, but the recipients must deposit the checks before the donor dies. Otherwise, the gift will be includable in the donor’s gross estate for estate tax purposes.

Another way to make sure that beneficiaries actually receive gifts is for the donor to have ready access to the assets to be given. For example, the donor can:

  • Hold cash in a safe.
  • Give jewelry to recipients.
  • Sign deeds to gift real estate or portions of real estate.
  • Assign stock to recipients.
  • Give a brokerage firm written directions.

The donor should also execute a power of attorney for property that specifically authorizes the agent to make annual exclusion gifts.

We’re Here to Help

Please let us know if you would like us to help you develop an effective plan to make tax saving gifts to your loved ones both before and after you’re gone. Planning can help you sort through the many available options in time to find the best alternative. We can help you create an effective strategy and answer any questions you may have about deathbed transfers.



The Use of Checks

Donors using checks to make gifts should make certain that recipients quickly deposit them. If time is short, the donees should sign over their checks to a third party in exchange for either cash or property. The IRS has successfully argued that gifts are not complete unless checks are cashed before the donor’s death. The gifts remain incomplete until the bank pays the checks because donors can revoke gifts by stopping payment or withdrawing the funds before their bank pays the checks. Consult with your advisor to determine if this sign-over option is viable in your situation.



08 Apr

How Irrevocable Is Irrevocable? Build In Flexibility Now For More Control Later

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

Estate Planner Nov-Dec 1998

Your estate plan needs to meet your current goals and objectives yet provide flexibility to change if your goals change. For example, while irrevocable trusts may be advantageous for tax purposes, if you don’t build in flexibility, issues arising in the future may be difficult to deal with. For maximum flexibility you need to consider the extent of restrictions you want, your desire for certainty, and your tolerance for tax risks. An irrevocable trust cannot be changed, so what happens if a change in your circumstances makes the trust less desirable?

Use Disclaimers

A disclaimer is one tool you can use to build in flexibility, but only if you plan for it. If a beneficiary does not want to receive the trust assets, he or she can disclaim them. If done within nine months of the vesting of the beneficiary’s interest, the assets will pass to someone else as if the beneficiary had never received them. However, if the beneficiary directs where the assets will go, the disclaimer will be treated as a gift for tax purposes. Therefore, successfully using disclaimers means you need to plan ahead when you initially prepare the trust.

When might a disclaimer be useful? If the trust’s beneficiary already has substantial assets, he or she may want to use a disclaimer to keep the assets out of his or her estate.

To provide your beneficiaries with the flexibility to deal with situations such as these, when drafting your trust, consider who should receive the benefit if your beneficiary disclaims it. You can state in the trust document that if the trust beneficiary disclaims the payout, it should pass to the secondary beneficiary.

Exercise Powers of Appointment

One of the most effective ways to alter an estate plan after death is through the exercise of powers of appointment. A power of appointment allows a beneficiary to direct the trustee to distribute trust assets to certain individuals (objects of the power), either outright or in a new trust.

This can be useful if the beneficiary does not need the trust assets and would like to pass those assets on to someone else, such as a child or grandchild. With a power of appointment, he or she can direct or appoint those trust assets to any one or more objects of the power.

As the trust’s creator, you can grant the power of appointment to one of the trust’s beneficiaries. If you make the power too broad, however, it may be deemed a general power of appointment. This will cause adverse tax consequences for the beneficiary. To avoid this, you should restrict powers of appointment so that they cannot be exercised in favor of the beneficiary, the beneficiary’s estate or creditors of either.

Typically, a “limited” power to appoint will be exercisable in favor of your descendants, but sometimes it can be broader and allow for exercise in favor of people or charitable organizations other than the beneficiary, the beneficiary’s estate or creditors of either.

Exercise Discretionary Trust Provisions

Another means of providing flexibility in an irrevocable document is through discretionary trust provisions. For example, a trust can allow distributions to or for the benefit of the beneficiary according to a broad best interests standard, providing the trustee wide latitude to distribute funds that the beneficiary can use as he or she wishes. Essentially, you can add flexibility to a trust by drafting provisions that:

  • Allow greater discretion to an independent, yet carefully chosen, trustee;
  • Permit the primary beneficiary to have a certain amount of control over the selection of trustees;
  • Permit the beneficiary to exercise either broad or limited powers of appointment — either during life or on death; and
  • Permit the primary beneficiary to control trust investments. 

Reformation By Court Proceedings

One definitive way to change a trust after it has been signed is through a court reformation proceeding. While this alternative can be uncertain and expensive, it may achieve the desired result. You can initiate court reformation proceedings over an ambiguity in the document as well as under some other circumstances. If you seek a court reformation, make sure you avoid unwanted tax consequences. For example, if the trust is exempt from the generation-skipping transfer (GST) tax, a reformation that affects the quality, value or timing of any powers, beneficial interests, rights or expectancies of a beneficiary provided under the terms of the trust can be deemed a “modification,” which can cause the trust to lose its GST tax exempt status. But, many ways to reform will not cause loss of the exempt status.

Other Noncourt Trust Reformation Techniques

Certain situations allow a trust to be reformed without resorting to a court proceeding. You can grant a trustee certain powers to amend the trust agreement, to create a new trust for a trust beneficiary and to distribute trust property to that new trust. Also, certain state laws allow reformation of a trust pursuant to agreement of all trust beneficiaries without the involvement of a court. In all cases, you need to judiciously use these noncourt reformation techniques to avoid any adverse tax consequences to the parties involved.

Help Is Available

Creating an irrevocable trust may seem to limit your flexibility once the trust has been implemented. But, by carefully drafting the trust, or by using tools available to you after the trust is signed, you can have your cake and eat it too. We would be pleased to assist you in establishing a trust that will meet your needs.

08 Apr

Save Taxes Even After You’re Gone

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

Estate Planner Jan-Feb 1999

Roth IRAs Permit Tax-Free Growth for Beneficiaries Too

By creating the Roth Individual Retirement Account (IRA), the Taxpayer Relief Act of 1997 gives your money a way to grow tax free — not only while you’re alive but also after you’re long gone. While contributions to Roth IRAs are not tax deductible, qualified distributions from them are not included in gross income. This means the growth of the assets in a Roth IRA is not subject to income taxes.

As with traditional IRAs, if beneficiaries do not need the Roth IRA funds, you should defer distributions as long as possible. For traditional IRAs, deferral postpones the payment of built-in taxes. For Roth IRAs, deferral lets the assets continue to grow tax free even after your death.

Post-Death Distributions

Post-death distributions from Roth IRAs are subject to the rules governing distributions from traditional IRAs and to the terms of the agreement. Two options generally are available for a nonspouse beneficiary: Distributions must be made either over the beneficiary’s lifetime or by the end of the year after the fifth anniversary of the account holder’s death. Lifetime payments must begin by the end of the year after the holder’s death. Unless you need the assets sooner, you should choose the lifetime payment option to continue the tax-free growth of the assets as long as possible.

If the beneficiary is the Roth IRA holder’s spouse, special rules apply. The surviving spouse may treat the Roth IRA as his or her own, or may roll it over into his or her own Roth IRA. Whether the spouse treats the Roth IRA as his or her own or rolls it over, the tax-free growth will continue during his or her lifetime without any required distributions — even after age 70 1/2. The spouse can also name his or her own beneficiary, thus further continuing the tax-free growth of the assets.

Check the Roth IRA agreement carefully to determine if its distribution provisions are more restrictive than those stipulated by law. The agreement may not contain all available options. For example, a Roth IRA agreement may require that post-death distributions be made within five years of the Roth IRA holder’s death, not over the beneficiary’s lifetime. This would limit the income tax-free growth of the assets.

If the beneficiaries need additional funds, the Roth IRA can provide a source of income tax-free money. Distributions to beneficiaries made after the death of the individual Roth IRA holder are not included in gross income if the account has satisfied the five-year holding requirement.

Estate Planning Implications

Under traditional IRAs, the holder may take into account the effect of income taxes on the beneficiaries in determining how to divide assets among them. For example, the holder may provide additional assets to the beneficiary of a traditional IRA to offset the disadvantage of the built-in income taxes. Under a Roth IRA, the beneficiary has the advantage that any growth of the asset is income tax free.

Because Roth IRAs can grow tax free, you should ensure they won’t need to be liquidated to pay estate taxes. One way to make liquidity available to your estate is to purchase life insurance through an irrevocable trust.

Creating a trust to hold the Roth IRA proceeds after the holder’s death may also be advantageous. The trustee can defer distributions for as long as practical to increase assets for beneficiaries who would otherwise withdraw the proceeds too quickly. If there is significant age disparity among beneficiaries, you could use multiple trusts. Otherwise, payments will be based on the life expectancy of the oldest beneficiary.

Benefits Can Continue Long After Death

With careful planning, the tremendous income tax-saving benefits of Roth IRAs can continue long after the death of the holder. Please let us know if you have any questions about post-death distributions from a Roth IRA. We would be glad to help you take advantage of this opportunity to have your money grow tax free long after you’re gone.

08 Apr

IRS Allows More Trust Options

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

Estate Planner May-Jun 1998
Regulations on Trusts as IRA Beneficiaries Are Loosened

An individual retirement account (IRA) or other retirement plan is often an individual’s largest and most difficult-to-handle asset. Decisions regarding when and how to take distributions, distribution amounts, and choice of beneficiaries all affect both income and estate taxes. While changes in the Taxpayer Relief Act of 1997 have eased the tax bite on IRAs, the rules remain complicated. The Internal Revenue Service (IRS) has, however, simplified the requirements for treating trusts as designated beneficiaries for distribution rule purposes.

The Regulations

In 1987, the IRS issued proposed regulations to explain the then recent amendments to the Internal Revenue Code (IRC) relating to required distributions from qualified plans and IRAs. The regulations stated that:

Distributions to a plan participant (or IRA owner) cannot generally begin without penalty before the participant reaches age 591/2.

  • Distributions must begin by April 1st of the year following the participant reaching age 701/2, the date known as the required beginning date.
  • Distributions must be made at least annually and/or based on the life expectancy of the participant and, if applicable, the designated beneficiary named by the participant.
  • Post-death distributions must be completed at least as rapidly as lifetime distributions. If no designated beneficiary has been named as of the required beginning date, then the participant is treated as having no designated beneficiary when determining the minimum required distributions. In that situation, distributions are based on the participant’s life expectancy.
  • If the participant dies before the required beginning date, distributions must begin within one year of the participant’s death and must be made over the life or life expectancy of the designated beneficiary. If there is no designated beneficiary, distributions must be completed within five years of the participant’s death.

A Question of Trusts

The IRC defines”designated beneficiary” as an individual designated as a beneficiary by the participant. The term “individual” generally rules out the possibility of naming a trust, the participant’s estate or a charity as a designated beneficiary. Under the 1987 regulations, however, a trust can be a designated beneficiary for minimum distribution purposes if it meets the following requirements:

1. The trust is valid under state law.
2. The trust is irrevocable.
3. The individual beneficiaries are identifiable from the trust instrument.
4. A copy of the trust instrument is provided to the plan administrator.

As a result of these requirements, naming a revocable trust did not appear to be an option. While naming the revocable trust was arguably a viable option if a plan participant died prior to the required beginning date (since, on the death of the participant, the trust would become irrevocable), this would not be possible for a participant who is approaching or has reached age 701/2.

Revocable Trusts Allowed

After more than 10 years, the IRS has determined that allowing a revocable trust to be a designated beneficiary makes sense and adopted revised requirements in December, 1997. Under the modified proposed regulations, a trust can either be irrevocable or become irrevocable, by its terms, on the death of the participant. In addition, the rule saying a copy of the trust instrument must be provided to the plan administrator has also been revised to allow alternate methods for satisfying the documentation requirement.

The preamble to the proposed regulations indicates that taxpayers may rely on the revised proposed regulations pending the issuance of final regulations. Also, note that the IRS did not indicate that the revised regulations should apply prospectively only. It would, therefore, appear that these proposed changes apply retroactively to the effective date of the existing proposed regulations.

Careful Planning Is Key

We have only touched on the issues regarding distributions from IRAs and other qualified plans. The importance of proper IRA distribution planning cannot be over emphasized. We would be pleased to discuss these issues with you in greater detail.

Rules For Spousal Beneficiaries

The rules relating to a spouse as a designated beneficiary are somewhat different than the general rules. Specifically, if a participant’s spouse is named as a beneficiary of the IRA, the spouse has several options. One is to transfer and rollover the IRA benefits into his or her own IRA, allowing the spouse to defer taking distributions until he or she reaches age 701/2, if desired. This also allows the spouse to designate a new IRA beneficiary, potentially allowing further deferral until after that beneficiary’s death. If the spouse is older, he or she can also elect to retain the participant’s IRA and defer taxable distributions until the participant would have reached age 701/2.

Another benefit: Naming a spouse as beneficiary not only means possible tax advantages, but also allows you to use the marital deduction for estate tax purposes. However, if you do not want your spouse to have full control over your IRA benefits on death, you should consider other alternatives.

Penalties Loosened

Under the prior rules, not only are issues regarding the timing of distributions and the designated beneficiary complex, but severe penalties were imposed when a participant took out too much from the plan in any given year (excess distributions) or died with too much in the plan (excess accumulations). Changes made by Taxpayer Relief Act of 1997 repealed the excise tax on both excess retirement distributions and excess retirement accumulations for distributions after 1996 and for taxpayers dying after 1996. Other penalties and excise taxes still apply however:

1. With limited exception, a 10% additional income tax is imposed on distributions made prior to the time when the participant reaches age 591/2.
2. A 50% penalty tax continues to be imposed on the amount of a required distribution that is not actually distributed.

An Example

Dan Jones, who will reach age 701/2 in 1998, named as his IRA beneficiary a revocable trust for the benefit of his sister, Melissa. The terms of the trust provide that it becomes irrevocable at Dan’s death. Dan has provided a copy of the trust agreement to the plan administrator. Under the proposed regulations as modified in December, 1997, Melissa will be treated as Dan’s designated beneficiary, so distributions can be made over their joint lives or life expectancies. Under the prior proposed regulations, Melissa would not have been treated as Dan’s designated beneficiary unless Dan amended the trust to make it irrevocable by his required beginning date.

08 Apr

Reduce Taxes Through Deathbed Planning

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

Estate Planner May-Jun 1998

Ben Franklin said only two things in life are certain: death and taxes. When a family member is elderly or seriously ill, both death and taxes are all too certain. Although you can’t reduce the emotional impact of a family member’s death, you can reduce the tax impact with proper planning.

The term “deathbed planning” is often used to describe implementing or fine tuning the estate plan of an elderly or seriously ill person. Time is limited, yet a number of planning techniques can reduce or minimize taxes and enhance the estate that is left for the family.

Of course, initial attention should be focused on the welfare and comfort of the dying person, as well as providing for the orderly transition of the estate. These concerns include healthcare powers and living wills, durable powers of attorney, funded living trusts, and listing advisors, inventory of assets and essential documents.

But there may be time to try to reduce the tax burden for heirs. There are several places to look for possible tax savings and the techniques that are available.

Make Lifetime Gifts

Gift tax advantages. Taxable transfers made during life (gifts) are less expensive than those made at death (bequests). Why? For a gift, tax is paid on only the amount of the gift itself, while for bequests, tax is paid on the amount of the bequest plus the amount used to pay the tax on the bequest. In other words, gifts are tax exclusive and bequests are tax inclusive. But, there is often little advantage to making gifts shortly before death because the tax paid on taxable gifts made within three years of death are added back to the estate when making the federal estate tax computations.

Annual exclusion gifts. One exception is the annual exclusion gift, which allows someone to give $10,000 per year ($20,000 if the gifts are split with a spouse) to an unlimited number of recipients tax free. Each annual exclusion gift will save $3,700 to $5,000 in estate taxes, depending on the person’s estate tax bracket. Accordingly, someone with three children, two daughters-in-law and five grandchildren can make deathbed gifts of $200,000 ($20,000 x 10 recipients). The assets will still be in the family, and the estate would save between $74,000 and $110,000 in estate taxes. As a bonus, the gifts to grandchildren are not subject to the 55% generation-skipping transfer (GST) tax and do not use any of the $1 million GST tax exemption.

Gifts of controlling interests. Some gifts can make taxable value disappear. If a controlling interest, for example 52%, is held in a family business or venture, a gift of a 3% interest to family members can allow the remaining 49% to be valued for estate tax purposes without a control premium, thus lowering estate taxes.

Gifts between spouses. Gifts between spouses also can be advantageous in equalizing estates to fully use the $625,000 unified credit equivalent or in equalizing estate tax brackets. All gifts between U.S. citizen spouses are gift and estate tax free. A lifetime qualified terminable interest property (QTIP) trust might help as the vehicle for the gift.

Consider Income Taxes

Capital losses. Assets in the estate get a new basis for income tax purposes. Generally, this is a step-up in basis. But, there also can be a step-down in basis if stocks or other capital assets have a current value less than what was paid for them. These should be sold before death to recognize the losses. The losses can still be used on the income tax return and any extra losses may carry forward on a spouse’s return. Otherwise, the losses are gone and will not be available to the estate.

Deductible contributions. If deductible contributions can be made to an individual retirement account (IRA), profit sharing or other relevant account, they should be made at this time.

Deductible charitable bequests. Bequests to charity should be advanced and paid now. The estate tax consequence remains the same, but as an additional benefit, the individual will receive a current income tax deduction. If the dying family member cannot change his or her will, the charity should be willing to acknowledge that the gift is an advancement. Also, consider whether a bequest to charity can be satisfied through an IRA or qualified plan beneficiary designation; either can result in significant income tax savings. An alternative is to increase the bequest to a spouse and put language in the estate plan expressing a strong desire that the spouse make a lifetime charitable gift. The estate will still use deductions (marital instead of charitable), and the spouse then can take advantage of income tax benefits by making gifts to charity at suitable times.

Deferred income. In some situations, deferred income can be accelerated and recognized currently. The income tax paid should be less than that paid (after credits) by the estate. Here it becomes necessary to make projections and income forecasts.

Examine Business Structures

Preservation of status. The estate or living trust can be a shareholder of an S corporation for only two years. After that time, the shares need to be redeemed or passed to a qualified shareholder, otherwise the special S corporation status is lost. If the person owns S corporation stock, his or her estate plan should direct proper disposition of the S corporation shares. Special trusts eligible to own S corporation stock, known as qualified subchapter S trusts and electing small business trusts, can be created for minor children or other beneficiaries.

Pass-through taxation. The owners of certain types of business entities are taxed directly on business net earnings, whether or not they receive a distribution from the business. These entities are S corporations, partnerships, limited liability partnerships and limited liability companies. Is this an issue that needs to be reviewed in light of the designated beneficiaries of the interests under the estate plan? If there are capital losses in these entities, can these losses be extended to be used by a spouse? Partnership investments also create a special situation. When a partner dies during the year, partnership books for the deceased partner are deemed to close on the date of death. The income or loss is either allocated pro rata or an exact allocation is made. Accordingly, this can result in an overall tax mismatch of income and losses. Consider transferring this partnership interest now into joint tenancy or making provisions for a successor in interest under the partnership agreement.

Deferrals and redemptions. Special tax benefits are available when a large part of the estate consists of interests in closely held businesses. If the estate meets certain percentage qualifications and other Internal Revenue Service (IRS) tests, it can pay part of the estate taxes in installments over 15 years (with interest, of course, and for a limited partner, the interest is at the bargain rate of 2%). Also, the estate or beneficiary may be able to redeem part of any corporate stock to pay taxes and administration costs and receive favorable capital gain tax treatment. It is time to analyze the estate to see if it meets these tests.

Review Life Insurance Policies

At this point, any life insurance owned by the ill person probably will be included in the estate even if it is transferred. Yet, there may be some planning opportunities available and they need to be discussed with the insurance agent.

Repayment of loans. If any policy loans are outstanding, investigate the advantages of paying off the loans, which may increase policy dividends. If the dividends are being used to buy term or paid-up additions, in effect, the ill person will be buying more life insurance, even though he or she is not insurable. Also, some state inheritance tax laws give special tax benefits to life insurance proceeds compared with other types of assets. Further, if the estate may have creditor problems, life insurance proceeds again may receive favored treatment, so don’t let policy death benefits be reduced by an outstanding loan balance.

Waiver of premium clause. A premium waiver provision that would come into play during disability will keep the policy in force until death and may also entitle the ill person to a refund of all or part of a recent premium payment.


Change of domicile. Let’s say you have a terminally ill parent who has a substantial estate and is living in a state that has a high inheritance or estate tax. Or, perhaps probate in your parent’s state is a particularly expensive procedure. Comfort, care, treatment and all else being equal, a change of your parent’s domicile to a “friendlier” state that may have only an estate pick-up tax may be possible and practicable. Domicile may be changed upon meeting some simple criteria. The resulting savings can be significant.

Transfer by spouse. Generally, if someone receives a gift of appreciated property and dies within one year thereafter, that property will not receive a step-up in basis in the estate if the property passes back to the donor. The step-up in basis can be important because it can eliminate the 20% capital gains tax on the amount of appreciation. Therefore, gifts to an ill spouse should not be overlooked. First, there is always the possibility that the spouse will survive more than a year. Second, perhaps the transferred property can be allocated to satisfy other bequests with the transferring spouse being equalized through the marital formula.

Raising the Subject

Perhaps the most difficult part of planning in anticipation of death is raising the subject. It is impossible to be distant and detached. Yet, the benefits and tax savings that are available require a discussion to be started. Each person’s estate situation is different, and other planning opportunities may become evident only if the subject is addressed.

08 Apr

Using Retirement Funds for Credit Shelter Trusts

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

Estate Planner Mar-Apr 1999

If you are like many people, individual retirement accounts (IRAs) and other retirement plans may constitute a significant portion of your estate. In the past, fully using the gift and estate tax applicable exclusion amount (currently $650,000) in such a situation was difficult because participants could not name revocable trusts, such as credit shelter trusts, as beneficiaries. The only trust option — irrevocable trusts — often limited flexibility and increased the fees involved in creating an effective estate plan. But under proposed U.S. Treasury regulations, you can now name a revocable trust or a trust established under your Will as beneficiary of your retirement accounts, as long as the trust becomes irrevocable on your death.

How Credit Shelter Trusts Work

Currently, married couples may protect $1.3 million in assets (twice the applicable exclusion amount) from estate tax if both spouses fully use their own applicable exclusion amounts. To take full advantage of the available tax savings, however, each spouse must own assets worth the full amount of the exclusion at death. Married couples may transfer assets from one spouse to the other without gift tax to ensure that none of the applicable exclusion amount is wasted on the death of either.

As a general estate planning technique, on your death assets equal in value to the applicable exclusion amount can be placed in a credit shelter trust to be held for the benefit of your surviving spouse and descendants. The trust then provides income to your spouse during his or her lifetime and can provide principal payments if needed to maintain his or her lifestyle. If set up properly, this trust is not taxable in the surviving spouse’s estate.

The proposed Treasury regulations make it easier to use retirement accounts to fund credit shelter trusts. For example, let’s say you own an IRA with a value of $1 million, and the value of all your other assets, including the residence and liquid assets of you and your spouse, are worth $650,000. Under the proposed regulations, you may use a portion of the IRA to fund the credit shelter trust, so that both you and your spouse can fully use the applicable exclusion amount.

After your death, retirement account distributions may be made to the credit shelter trust as a named beneficiary. Your spouse, and in some cases your descendants, can receive an income interest in the credit shelter trust. In some instances, it is possible to have the payments from the retirement account made to the credit shelter trust over your spouse’s life expectancy. Care should be used in structuring the credit shelter trust so that, if desired, payments and taxes can be deferred as long as possible.

The estate tax savings from naming the credit shelter trust as the beneficiary of a retirement account do have a cost, however. Your spouse loses the ability to further defer income taxes by rolling over the retirement account into his or her own IRA. And the portion of the retirement distribution that remains in the trust as principal is taxed at the highest marginal income tax rate of 39.6%, unless the trust also complies with the “defective” grantor trust rules (which is a topic of another article).

Qualified Disclaimers Add Flexibility

Determining what portion of the retirement account should pass to the credit shelter trust can be difficult due to such uncertainties as the health and life span of you and your spouse and future cost of living. Rather than predetermining the portion of the retirement account that will pass to the credit shelter trust, your spouse may prefer to make that determination after your death. With planning, this option is available through the use of a qualified disclaimer.

A disclaimer is the refusal to accept all or a portion of a benefit. If your spouse is named as the primary beneficiary of the retirement account and the credit shelter trust is named as the secondary beneficiary, then any portion of the retirement account that is not accepted by your spouse will pass to the credit shelter trust. Your spouse may wish to disclaim that portion of the retirement account that results in the use of your entire applicable exclusion amount after taking into account other assets available for that purpose.

You should ensure that a proper disclaimer can be made. A disclaimer is not allowed more than nine months after the date that a surviving spouse is irrevocably named as the beneficiary of the retirement account.
Therefore, an irrevocable beneficiary designation should not be made if a disclaimer is intended to be used, so that your spouse may disclaim after your death within the applicable time period.

When To Use Retirement Funds

Generally, only use retirement accounts to fund credit shelter trusts if other assets are not available. Retirement accounts, which are subject to income tax, are less desirable for funding a credit shelter trust because the amount sheltered from estate tax is reduced by the income tax paid. The effect is that the amount that will eventually pass to your children or other beneficiaries is reduced. Consider other assets before the use of a retirement account, including cash, Roth IRAs and assets that receive a stepped-up basis on your death, such as securities or real estate.

If the retirement account is payable directly to your spouse, then income tax paid on the retirement account reduces the amount that will later be taxable in your spouse’s estate. If other assets are not available, then using retirement accounts to fund credit shelter trusts may be a better option than wasting the applicable exclusion amount.

Planning Considerations

As retirement accounts become a disproportionately high percentage of your wealth, and as the estate tax applicable exclusion amount grows to $1 million, greater consideration will need to be given to using such accounts for credit shelter trust planning. If you would like to see if using retirement accounts to fund a credit shelter trust is right for you, please call us to discuss this estate planning tool in greater detail.