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As we are wrapping up the 2019 year, we want to think about things we can do to minimize tax liability on trusts and estates. This article outlines the changes in trust and estate taxation for 2020 as well as some tax planning strategies to consider.

Federal Estate Tax.

Estates of decedents who die during 2019 have a lifetime exclusion amount of $11,400,000. The exclusion increases to $11,580,000 in 2020. The value of a person’s estate and/or lifetime gifts exceeding the exclusion amount is subject to a 40% estate and gift tax rate. Further, through a so-called “portability” provision, if a spouse dies after 2010 without exhausting his or her estate and gift tax exclusion amount, the surviving spouse may be able to use the deceased spouse’s remaining exclusion amount against his or her transfers during lifetime or at death.

Federal Gift Tax.

The annual exclusion for gifts remains at $15,000 per person for 2019. Direct payments for tuition and medical expenses are exempt from gift tax. The annual exclusion will stay the same in 2020. Making annual exclusion gifts is one of the easiest ways to maximize wealth transfers to future generations.

A person is not limited as to the number of donees to whom he or she may make such gifts. Further, because the annual exclusion is applied on a per-donee basis, a person can leverage the exclusion by making gifts to multiple donors (family and non-family). Thus, if an individual makes $15,000 gifts to 10 donees, he or she may exclude $150,000 from tax. In addition, because spouses may elect to apply their exemptions to a single gift from either spouse (”gift-splitting”), married givers may effectively double the amount of the exclusion to $30,000 per donee. A person may not carry over his or her annual gift tax exclusion amount to the next calendar year.

The annual gift tax exclusion applies to gifts of any kind of property, as long as the gift is of a present, rather than a future, interest. Gifts of appreciated property also could result in income tax savings to the giver, because the recipient would pay the capital gains tax on any sale. Therefore, before giving away appreciated property that is likely to be sold, consider the income tax cost to the recipient.

A special rule allows a contributor to utilize up to five annual gift tax exclusions simultaneously when funding a 529 plan. Thus, for 2020, he or she may fund the plan with up to $75,000 (5 × $15,000), then elect on his or her gift tax return to spread this gift over five years (2020 through 2024) for gift tax purposes. By using five annual exclusions, the entire gift becomes gift-tax-free. However, the contributor must wait until 2025 to make another tax-free contribution to this plan, or any annual exclusion gifts to that child or grandchild.

Trust Tax Rates.

See below for the current tax rates versus the tax rates for 2020.

2019 Trust Tax Table

If taxable income is: Then income tax equals:

Not over $2,600                                  10% of the taxable income

Over $2,600 but not over $9,300        $260 plus 24% of the excess over $2,600

Over $9,300 but not over $12,750      $1,868 plus 35% of the excess over $9,300

Over $12,750                                      $3,075.50 plus 37% of the excess over $12,750

2020 Trust Tax Table

If taxable income is: Then income tax equals:

Not over $2,600                                  10% of the taxable income

Over $2,600 but not over $9,450        $260 plus 24% of the excess over $2,600

Over $9,450 but not over $12,950      $1,904 plus 35% of the excess over $9,450

Over $12,950                                      $3,129 plus 37% of the excess over $12,950

Capital Gains.

The adjusted net capital gain of an estate or trust is taxed at the same rates that apply to individual taxpayers.

  • A 0% rate applies to adjusted net capital gain that, if it were ordinary income, would be subject to the 10% income tax rate;
  • A 15% rate applies to adjusted net capital gain that, if it were ordinary income, would be subject to the 24% or 35% income tax rate;
  • A 20% rate applies to adjusted net capital gain that, if it were ordinary income, would be subject to the 37% income tax rate;

Investment Income Surtax.

For tax years beginning after 2012, a 3.8% surtax applies to the lesser of (1) undistributed net investment income (NII) or (2) any excess of adjusted gross income over $12,500. Any given item of NII is included in the NII of either the trust/estate or its beneficiary. Distributed NII is NII to the beneficiary as indicated on Schedules K-1, and undistributed NII is NII to the estate or trust.

Methods to Reduce Surtax Liability.

The 3.8% surtax applies to income from a passive investment activity. To help reduce the amount of income subject to the surtax the following should be considered:

  • For complex trusts, compare the tax with and without distributions to beneficiaries to determine whether the trust or individual is in the lower tax bracket
  • Use Installment Method to spread out gain on sale over multiple years
  • Use like-kind exchanges to defer gains
  • Recognizes losses to offset gains

Income/Deductions.

Some strategies that can be used to accelerate or defer income and/or deductions are looking at the:

  • Timing surrounding payment of state income taxes and property taxes, keeping in mind the new law limits the aggregate deduction for state and local taxes, including income taxes and property taxes, to $10,000 per year. Property taxes related to the production of income and investment holdings do not fall under this limitation and can be deducted in full.
  • Timing surrounding payment of other trust expenses (i.e. fiduciary, accounting, legal)
  • Revisiting the trust’s distribution strategy to see if more income can be passed out to beneficiaries taxed at a lower rate than the trust

Certain Payments of Estimated Tax Treated as Paid by Beneficiary.

The fiduciary (or executor, for the final year of the estate) may elect to have any portion of its estimated tax payments treated as made by a beneficiary (and not as payments made by the estate or trust). Such an amount is treated as a payment by the beneficiary on their Form 1040 on the January 15th following the end of the tax year. The fiduciary must make the election on the Form 1041-T, Allocation of Estimated Tax Payments to Beneficiaries. The election must be filed on or before the 65th day after the close of the estate’s or trust’s tax year.

65-Day Rule.

 Complex trust and estate distributions made within the first 65 days of 2020 may electively be treated as paid and deductible in 2019. The election is to be made on the 2019 tax return.

Trust Agreements

It is important to read the trust agreement when doing planning for trusts to see what the agreement says about income/principal distributions as well as life events. Some trusts specify that distributions should start when the beneficiary attains a certain age or a certain event occurs. If this is the case, it could have an effect on planning for the trust.

Tax planning for trusts and estates can be very complex. Please feel free to contact us with any questions you have at 858-558-9200.

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