All posts in Gift & Estate Planning

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.

08 Apr

Avoid Income Tax Consequences of Funding FLPs

Estate Planner Nov-Dec 2000

Many people use family limited partnerships (FLPs) to transfer wealth from one generation to the next. Why? FLPs enable the older generation to maintain control, and the family benefits from lower estate taxes. Although many people focus on the estate planning benefits of FLPs, they often overlook the income tax consequences, which can be significant.

The “Investment Company” Issue

A family usually forms an FLP by contributing cash, securities and other assets to the partnership in exchange for interests in the partnership. The FLP then owns the contributed assets. In general, the partners recognize no gain or loss on property contributions to the FLP.

The Internal Revenue Code defines an investment company as a partnership in which more than 80% of the value of the assets (excluding cash and nonconvertible debt obligation) are investments such as marketable stocks or securities. If a transfer to an investment company results in the diversification of the transferor’s interest, then the transferor may recognize a current capital gain.

When Does Diversification Occur?

Diversification generally takes place when two or more people transfer nonidentical assets to the FLP. For example, if Paul and Linda create an FLP, and Paul contributes 100 shares of A Corporation and Linda contributes 100 shares of B Corporation – both publicly traded companies – Paul and Linda will recognize gain. What is the diversification? Paul and Linda each individually now hold 50 shares of A Corporation and 50 shares of B Corporation. In this case, the FLP is an investment company because it holds 100% of the partnership assets for investment and the assets consist of marketable stocks.

In reality, however, a family often creates a partnership with the transfer of already diversified portfolios. Realizing that the tax rules regarding recognition of gain generally were not aimed at those situations where partners did not realize any advantage by further diversification, Congress changed the law to broaden the nonrecognition rules.

What Makes a Portfolio Diversified?

A portfolio is considered diversified if not more than 25% of the total value is invested in the stock and securities of any one issuer, and not more than 50% of the total value is invested in stock and securities of five or fewer issuers. While for the 25% and 50% tests government securities (such as Treasury bills) are included in total assets for purposes of the denominator, they are not treated as securities of an issuer for purposes of the numerator.

For example, assume Dad contributes his portfolio of publicly traded stocks to an FLP, and no single stock accounts for more than 20% of his portfolio’s value. His children contribute Treasury bills. Before the change in the law, Dad would’ve recognized gain on the contribution. With the new provision, however, Dad will be considered diversified before the exchange. The transfer avoids investment company rules because no more than 25% of the noncash assets are invested in any one issuer, and no more than 50% of the assets are invested in five or fewer issuers.

Avoiding Recognition Rules

Although the rules regarding the income tax consequence of FLP creation can be confusing, they cannot be overlooked. Fortunately, you can avoid the recognition rules before forming an FLP.

For example, if Paul and Linda were married, they could have avoided recognition in the original example by each giving the other 50 shares of their respective stocks. Because of the marital deduction, this transfer would have had no gift tax consequences. Paul and Linda then could have each transferred their 50 shares of A Corporation and 50 shares of B Corporation to the FLP and avoided the recognition. In nonspousal situations, however, you must carefully review the assets before contributing them to the FLP.

We would be pleased to assist you in creating an FLP that meets your objectives and avoiding tax when funding it.

08 Apr

10 Steps to Creating a Proper FLP

Estate Planner Nov-Dec 2000

Family limited partnerships (FLPs) are an increasingly popular vehicle for managing and controlling family assets and for transferring wealth to younger generations. Unfortunately, the IRS is attempting to curtail this estate planning technique by challenging the technical structure of such partnerships as well as the valuation issues that arise when an FLP interest is gifted to children or grandchildren.

A typical FLP consists of at least one general partner and one limited partner. You transfer assets to the FLP, and generally, you (or an entity controlled by you) act as the general partner and, through your partnership interest, retain indirect ownership of a small portion of the assets. Placing your assets into an FLP transfers ownership — but not control — of the assets to the partnership. As general partner, you manage the partnership and have control over its operation, assets and cash flow distributions.

FLP Checklist

Creating an FLP can be complex. If improperly set up, it can stumble into many tax pitfalls. Here are 10 important steps to take when setting up an FLP:

1. Name the partnership. After you choose your partners, select a partnership name. To avoid calling attention to the fact that you are creating an FLP, consider naming it an “investment” or “management” partnership rather than a “family” partnership. Also, check the availability of the name with your local secretary of state or other governmental body that supervises the formation of business entities. Most states require that the designation “Limited” or “L.P.” be part of the entity’s name.

2. Consider the state of formation. Determining the jurisdiction where you create your partnership is critical. Why? Because the jurisdiction must have a limited partnership act that supports valuation discounts for FLP interests you may gift to family members. If state law relating to the transfer of partnership interests and the rights of a withdrawing partner are not restrictive, the tax code allows the IRS to disregard the relevant provisions of your partnership agreement for purposes of valuing partnership interests. This would reduce the marketability and lack of transferability discounts that would be otherwise available.

3. File a certificate of limited partnership. Once you choose a name, you must file a certificate of limited partnership. This is a critical step in the formation of your FLP. The requirements for a certificate vary from state to state but, generally, the certificate must list the partnership’s name, registered agent’s name and address, purpose of the partnership, and each general partner’s name and address. Until the state has accepted the partnership entity, the partnership is a general one — not a limited one — and different statutory rules apply relating to transfers of interests and partners’ rights.

4. Obtain a taxpayer identification number. An FLP is a legal entity even though it may not pay income tax. You need to obtain a taxpayer identification number from the IRS because the partnership is required to file income tax returns.

5. Sign a partnership agreement. Have your attorney draft a partnership agreement and have each partner sign it. The agreement should specify how the partnership:

  • Shares profits and losses,
  • Computes capital accounts,
  • Defines its policy on admitting new partners and — if new partners are permitted — conducts its admission process, and
  • Intends to manage and dissolve the partnership. The agreement should restrict transfers of partnership interests to support gifting discounts. Until you execute the agreement, the limited partnership statutes of the state will govern the partnership.

6. Funding the partnership. After you form the FLP and execute the agreement, transfer selected assets to the partnership. Generally, you recognize no gain or loss when you transfer property to an FLP in exchange for partnership interests. One exception to this rule is when the IRS views the partnership as an investment company. In this case, the IRS says you have a form of asset diversification and a deemed sale.

The IRS will classify your FLP as an investment company if more than 80% of the contributed assets’ fair market value consists of cash, securities and other types of investment property, and if the transfer results in diversification of the transferor’s interest. Diversification occurs when two or more persons transfer different assets — including cash — to the partnership in the exchange. You should be aware of these rules when you are considering creating an FLP.

7. Open a bank account. Open the account in the FLP’s name and maintain proper accounting records. Partnership assets, including bank accounts, must be owned in the FLP’s name — not in the name of individual partners. Only the partnership’s cash should be kept in these accounts.

8. File income tax returns. The FLP must file an income tax return. The return is primarily for informational purposes. The partnership is not subject to tax. Instead, the partners are taxed on their proportionate share of the partnership’s income.

9. Make distributions. The general partner controls the timing and amount of distributions of the FLP’s cash. Make distributions to partners in proportion to their ownership interests.

10. Respect the entity. The FLP is a distinct, separate entity — just as a corporation is an entity. You must respect the entity if it’s going to achieve your planning objectives. Steps you can take to help ensure success include conducting a formal, annual partner meeting and documenting actions taken or authorized. Don’t ignore the partnership and treat it as the general partners’ alter ego.

Seek Assistance When Setting Up an FLP

An FLP provides many estate planning advantages, but variables exist in setting one up. And because everyone’s situation is different, it’s best to work with a qualified advisor to develop a plan that’s right for you.

08 Apr

What To Expect When Named Executor of an Estate

Estate Planner Nov-Dec 2000

Few of us are prepared to oversee the financial affairs of a recently deceased relative or close friend’s estate. Nevertheless, it would not be unusual for such a person to name you as executor (or personal representative) of his or her will.

Of course you could decline the offer. Circumstances may have changed since your relative or friend asked you to be executor — or he or she may never have consulted you. And, perhaps, a successor such as a bank or trust company could better serve the family. But if you decide to accept the responsibility of executor, you could have a long and complicated task ahead. Let’s review some of the duties you’ll perform as executor and then examine the steps necessary to administer the estate.

Duties of the Executor

Running an estate is similar to running a business. You’ll have to make decisions regarding each asset and claim. The first month or so of the estate’s administration will be busy. Your duties as executor may include:

  • Collecting and managing estate assets,
    Investing estate assets to preserve value,
  • Directing the payment of taxes, debts and administration expenses from estate assets, and
  • Distributing the remaining estate assets to the named beneficiaries or heirs in accordance with the terms of the will.

You’ll need professional advice and assistance throughout the administration of the estate. Assemble a team consisting of an accountant (particularly one who is familiar with the decedent’s financial and tax records), an attorney qualified in estate and trust administration, a life insurance broker with expertise in filing insurance claims, and, in large estates, a financial manager or advisor. You may be able to combine various functions in one firm or individual or choose to spread the duties among several. You may also need to establish banking and brokerage relationships for the estate.

Administering the Estate

Once you assemble your team of professional estate advisors, begin preparing to administer the estate or trust. Your team members may assume many of the specific tasks, but you need to understand the steps involved in the administration. Here’s a brief explanation of those steps:

1. Confirm that appropriate funeral arrangements have been made.

2. Safeguard the decedent’s household and assets until you’ve taken control of them. This may involve changing locks or notifying asset holders and power of attorney users of the decedent’s death.

3. Locate the original will and file it with the appropriate supervisory court — usually a probate court.

4. Determine whether a formal reading of the will is required and whether to send a copy, summary or outline to interested parties.

5. Have the will formally accepted in a probate court and have yourself appointed as the personal representative of the estate.

6. Direct the post office to forward the decedent’s mail to you.

7. File Form 56 with the IRS, advising that you are the estate’s personal representative and entitled to receive all IRS notices.

8. Determine the nature and extent of the decedent’s assets and family benefit plans. These may include the contents of safe deposit boxes; Veteran’s Administration and fraternal organization benefits; existing qualified benefit plans; and individual retirement accounts, securities, and brokerage and banking accounts.

9. Determine whether the estate should pay the surviving spouse and minor children awards or allowances and whether Social Security benefits are available.

10. File medical insurance claims for payment or reimbursement of expenses for the decedent’s last medical care.

11. Identify life insurance policies, file claims for proceeds and obtain Form 712 from the insurance companies for use with the federal estate tax return.

12. Determine what formal notices you need to give to interested parties and the type of notice court rules require be published in a local newspaper.

13. Ascertain the estate’s liabilities, such as the decedent’s debts, bank loans, mortgages and auto loans, and arrange for payments or settlement.

14. Formally object to all questionable claims against the estate.

15. Arrange for valuation of all assets except cash items and marketable securities. This includes real estate (residence, investment and business), closely held business interests, investment interests in partnerships and limited liability companies, and tangible personal property — including personal effects, jewelry, antiques and art collections.

16. Prepare an estate asset inventory and determine whether you need to file a copy with the court and whether beneficiaries should receive copies now or later.

17. File the decedent’s income tax return for the prior year (if unfiled) and for the year of death.

18. File income tax returns for the estate.

19. File federal estate tax returns and state estate or inheritance tax returns for the estate and related trusts.

20. Determine whether you need to file gift tax and generation-skipping tax returns for the year of death and for prior years.

Look Out for Trouble

If you assemble a competent team and delegate many of the executor duties to professionals, you may ultimately have a rewarding experience. But if there is a disgruntled heir, a confusing or ambiguous will, or a conflict among family members, your experience may be frustrating and difficult. If you decide to serve as executor, make certain you understand what may lie ahead.



08 Apr

Save Taxes Even After You’re Gone Roth IRAs Permit Tax-Free Growth for Beneficiaries Too

Estate Planner Sept-Oct 2000 Fulfillment

By creating the Roth individual retirement account (IRA), the Taxpayer Relief Act of 1997 allows your money to grow tax free – not only while you’re alive but also long after you’re gone. While you can’t deduct contributions to Roth IRAs, your qualified distributions are not included in gross income. This means the growth of the assets in a Roth IRA is not subject to income tax.

As with traditional IRAs, if you don’t need Roth funds, defer distributions as long as possible. For traditional IRAs, deferral postpones payment of income tax. 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 taken either over your beneficiary’s lifetime or by the end of the year after the fifth anniversary of your death. Lifetime payments must begin by the end of the year after you die. Unless the assets are needed sooner, choose the lifetime payment option to continue the tax-free growth of the assets as long as possible.

If your Roth beneficiary is your spouse, special rules apply. He or she may treat the Roth IRA as his or her own, or may roll it over into his or her own Roth IRA. Regardless, the tax-free growth will continue during his or her lifetime without any required distributions – even after age 70 1/2. Your 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. Are its distribution provisions more restrictive than those required by law? The agreement may not contain all available options. For example, your Roth agreement may require that post-death distributions be made within five years of your death, not over the beneficiary’s lifetime. This would limit the income tax-free growth of the assets.

If your beneficiaries need additional funds, the Roth can provide a source of tax-free income. Distributions to beneficiaries made after you die are not included in
gross income if the account has been open for five years.

Estate Planning Implications

With traditional IRAs, you may take into account the effect of income tax on your beneficiaries in determining how to divide assets among them. For example, you may provide your beneficiary with additional assets of a traditional IRA to offset the income tax they’ll owe. Under a Roth IRA, your beneficiaries have the advantage that any growth of the asset is income tax free.

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

Creating a trust to hold the Roth IRA proceeds after you die 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. Use multiple trusts if significant age disparity exists among beneficiaries. Otherwise, payments will
be based on the oldest beneficiary’s life expectancy.

Benefits Can Continue Long After Death

With careful planning, the tremendous income tax-saving benefits of Roth IRAs
can continue long after your death.

08 Apr

Long-Term Tough Love: Incentive Trusts Provide Assets to Successive Generations

Estate Planner Sept-Oct 2000

Striking the right balance between encouraging your children to accomplish their goals and providing for their needs can be difficult to achieve during your lifetime. Reaching the desired results when you are no longer around is even harder. With the resurgence of long-term dynasty trusts — through which assets are retained in trust generation after generation — comes a renewed interest in providing distribution incentives designed to encourage the trust’s beneficiaries to lead productive lives. This approach is referred to as an incentive trust. These incentives are often coupled with disincentives to discourage inappropriate behavior.

If you are considering leaving assets to successive generations in trust, you’ll want to consider the variety of incentives and disincentives available. Let’s take a closer look at how incentive trusts work.

Communicate Your Objectives 

The first step in establishing an incentive trust is to communicate your objectives for the trust. A statement concerning your intentions can set the tone for trust distributions for years to come. These intentions may include:

  • Allowing beneficiaries to live off the trust assets, and
  • Allowing the trust to provide security but not necessarily a sole means of support.

In addition to a general statement regarding the proper uses of trust assets, you can set forth more specific directions for the trustee to follow. But be careful to provide for contingencies that might arise. For instance, you could include provisions that prevent trust assets from impairing a beneficiary’s motivation to be a productive citizen.

Encourage Education

If you value education and wish your beneficiaries to attain a certain level, then you may want to provide extra incentives to encourage scholastic achievement. Begin by providing the trustee with broad authority to distribute funds to beneficiaries pursuing their educations. Make certain to permit the trustee to pay not only for tuition and room and board, but also for a broad range of educational activities including travel, lessons in the arts or religious education. Identify the types of schooling you wish to encourage, whether private school, vocational school, graduate programs or schooling abroad.

You also may wish to consider additional monetary incentives to encourage beneficiaries to pursue these objectives. One way is to direct the trustee to provide beneficiaries with a stipend while they are pursuing their educations. In addition, consider providing a reward to beneficiaries who obtain desired levels of academic achievement, such as grades or degrees. These rewards and stipends can help offset forgone opportunities to earn outside income while pursuing educational objectives.

Discourage Negative Behavior

In addition to rewarding positive behavior, an important part of incentive trusts is to discourage negative behavior. Unfortunately, some beneficiaries may need encouragement to be productive members of society. Ensure that trust assets will not be used to subsidize nonproductive behavior. If a beneficiary is unable to handle money because of self-destructive behavior such as drug abuse, indolence or being under the control of others that would take advantage of the beneficiary’s generosity, the trustee should be empowered to address such concerns.

You may want to authorize the trustee to retain in trust any distributions that would otherwise have gone to the troubled beneficiary. You may even want to authorize the trustee to take more drastic measures. For example, you could empower the trustee to distribute funds as if the troubled beneficiary were deceased. It may be possible in such cases to provide support to the family of such a beneficiary.

Provide for Future Generations 

Incentive trusts can encourage a beneficiary’s development and protect the trust by preventing misuse of funds so that succeeding generations can also benefit from your legacy. Consult a professional advisor to learn how to include incentive trusts in your estate plan.



08 Apr

The Responsibilities Of Being a Trustee with Discretion

Estate Planner Sept-Oct 2001

As a result of a family, personal or professional relationship, you may be asked to serve as trustee for an estate planning trust established for the benefit of someone’s spouse or descendants, or a combination of the two. Before deciding to accept this responsibility, you should understand the distribution authorities and requirements contained in the trust agreement.

As trustee, you may be granted broad or limited authority to make discretionary trust asset distributions. Such distributions generally consist of either income or principal to meet trust objectives (and the trustor’s intent). To properly function as a trustee, you must be aware of the primary distribution requirements you may be called upon to make.

Decisions and Provisions

Usually, no one will interfere with your decisions in the exercise of your discretionary distribution power as long as you don’t act in bad faith or abuse your discretion. But you must understand the trustor’s intent to determine whether the trust agreement clearly satisfies the intent.

The following provisions are often found in estate planning trusts and dictate your ability to exercise discretion in making distributions:

Medical care. What’s involved in a distribution to provide for the healthcare of a beneficiary? Based on the document, what would you do as trustee with respect to: psychiatric care, dental needs, substance abuse clinics, elective medical procedures, medical insurance premiums and nursing home care? Every situation doesn’t need to be spelled out, but the document should generally tell what is expected of you.

Education. Discretion to distribute trust assets for a beneficiary’s education, unless specifically restricted, generally includes college, post-graduate, professional, vocational, language and artistic studies. But a question you may need to consider is: Does the trust cover religious education, private schools, boarding schools or tutorial expenses?

Support. Discretionary distributions normally consider support as day-to-day living expenses including housing, food and healthcare based on the beneficiary’s reasonable standard of living. Support generally includes more than the bare necessities and contemplates distributions for at least basic educational purposes and maintenance in reasonable comfort. But how does the trust account for the support of a person dependent on the beneficiary, such as a spouse, minor child or adult-dependent child?

Best interests. Trusts that authorize discretionary distributions for the beneficiary’s best interest or that provide no standard at all and gives the trustee unrestricted discretion give the trustee comfort because such discretion is so broad and indefinite that it cannot be abused. Accordingly, discretionary distributions may be made for travel (perhaps via first class) or the purchase of a $50,000 automobile (rather than a $20,000 vehicle). If the beneficiary desires to make gifts to friends or family, would distributions for this purpose be in his or her best interests? What would the trustor have wanted you to do?

Standard of living. Using your discretion to make distributions may be limited to distributions in accordance with the beneficiary’s standard of living. But when is that determined — when the trust was created or when the distribution is being considered? You may need guidance to determine what state law provides. What if the beneficiary is living substantially above or below the standard of living he or she can afford? In case of multiple beneficiaries, do you favor the one with the higher standard of living?

Favoring beneficiaries. Generally, a trust will have more than one beneficiary. Two or more beneficiaries could receive current discretionary distributions, or a beneficiary may not acquire an interest until the current beneficiary dies or some other specified event occurs. As trustee, you may have to make disproportionate distributions or allocate all trust assets to current beneficiaries, excluding remainder beneficiaries. The trust agreement should direct you in this area, perhaps authorizing disproportionate or unequal distributions or authorizing trust termination in favor of one beneficiary.

Other resources. You may be required to consider other resources available to a beneficiary in exercising your discretion to distribute assets. If a beneficiary wants a distribution, he or she should give you financial statements and tax returns.

Carrying Out the Trustor’s Wishes

If you serve as a trustee, you will find that your power of distribution discretion will serve to accomplish the trustor’s objective under unknown and changing circumstances. You will be able to implement what you have determined to be the wishes of the trustor. Yet, your duty to act in good faith and not abuse your discretion may at times conflict with other duties imposed on you as a trustee, such as the duty to treat beneficiaries impartially. If you have questions concerning your existing or proposed trusteeship, contact a professional estate planning advisor.

08 Apr

Paying for Long-Term Care: Are You Eligible To Receive Medicaid?

Estate Planner July-Aug 2000

You’ve worked a lifetime to build up your assets and create a legacy for your family and you probably don’t want to lose everything to pay for long-term care costs. Giving away assets may make sense if you or a loved one is facing the prospect of nursing home placement, but be aware of the availability and consequences of receiving public benefits to cover the cost of care. Long-term nursing home care is expensive and not covered by Medicare, which forces many elderly individuals to apply for Medicaid benefits.

Medicaid eligibility for long-term care depends on your financial position. To prevent you from intentionally impoverishing yourself, an ineligibility period is applied for asset transfers made before applying for Medicaid. The rules are complex because some assets are exempt from the determination of an applicant’s financial status, and the transfer of certain assets to certain individuals also does not affect eligibility. Let’s take a closer look at the implications of transferring assets to qualify for Medicaid.

The Rules of the Game

Each state has different requirements, but generally, transfers you make within a certain period of application for Medicaid are subject to penalties that make the transferred property includable in your financial position for the relevant period. The period varies depending on whether an asset was transferred to a trust (60 months) or outright to an individual (36 months). Whether the trust was revocable and the value of the property transferred may also affect the ineligibility period.

What Is Exempt?

The Medicaid system exempts certain assets from the determination of eligibility. For example, your principal residence is exempt if your spouse or a disabled child lives there. In addition, you may transfer the residence without impact on Medicaid benefits to a child who:

  • Is under age 21,
  • Is disabled, or
  • Has provided care to you and has been residing in your residence with you for two years before the date you enter the nursing home.

An automobile is also exempt up to $4,500 if you are unmarried, or up to an unlimited value if you are married. Burial and cemetery plots of any value are exempt. Household goods of up to $2,000 in value are exempt. Finally, up to an additional $2,000 in any form is exempt from the determination.

To prevent impoverishment of your spouse who remains in the home, he or she is permitted to retain a certain amount of assets and is entitled to a monthly income allowance fixed by statute. These amounts are adjusted annually for changes in the cost of living.

Recovering Medicaid Expenses

Federal law requires all states to have a program that provides for the recovery of nursing home and long-term care Medicaid expenses from the estates of deceased applicants and from their transferees. A state may have a claim against a person’s estate for the amount paid to a nursing home spent on behalf of that person.

The term “estate” is generally defined as all real and personal property included within your estate. It also includes any other real and personal property and other assets in which you had a legal title, or interest, at the time of death. It may include assets conveyed to a survivor or heir through joint tenancy, tenancy in common, life estate or a revocable trust. In most states, the claim may not be enforced until after the surviving spouse’s death and only if there is no surviving child who is under age 21 or is disabled. The claim may be waived in some circumstances where a hardship exists.

Plan Now For Long-term Care Costs

Long-term care insurance that covers both nursing home and stay-at-home care may be the solution to protecting your estate for yourself and your loved ones. The availability and consequences of receiving public benefits such as Medicaid to pay for long-term care can greatly affect your estate planning strategy.

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.