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Estates & Trusts

The Importance of Updating Your Estate Plan

By Estates & TrustsNo Comments

Has it been several years since you last reviewed your estate plan? Estate planning can be expensive and, for many, involves difficult conversations with family members and loved ones. As a result, estate plans are often set up and then left unrevised for long periods of time. However, there is a cost to “set and forget” estate planning. Major life changes may not be appropriately captured and considered which can lead to squandered fortunes, diminished financial legacies, and bitter disputes between heirs.

Your estate plan should reflect your intent to transfer family wealth and your final wishes. Accordingly, most estate plans have, at a minimum, a will, a financial power of attorney, and a health care power of attorney. The content of these documents should run parallel to your life circumstances and change from time to time. At the most basic level, these documents will ensure that your final wishes are followed and your valuables are allocated between your designated beneficiaries in your intended way.

As a result, your plans should be reviewed frequently and revised as necessary. For some, this may mean an annual or semi-annual review, while for others, this may mean a review every three years. The appropriate frequency of review is dependent on your personal situation but, should be done at frequent enough intervals to capture and plan for major life events and tax changes. Your tax or legal professionals can help you determine when a review of your plans are necessary.

Consideration is always warranted and revision may be necessary to your estate plans whenever the following occur:

  • Change in the number of dependents
  • Birth of a grandchild
  • Change in your or your spouse’s financial goals
  • Illness or disability of you or your spouse
  • Purchase of a new home or other large asset
  • Death of a family member
  • Change in career
  • Change in wealth or status
  • Change in your wishes
  • Change in marital status
  • Receipt of a large inheritance
  • Major change in tax law

Besides major life events, changing tax law can dramatically alter the way you plan your estate.  Of particular relevance is President Trump’s proposed tax reform and its potential impact on the estate and gift tax.  The realization of any such changes to the tax code would warrant a review of current estate plans and a conversation with your tax and legal professionals.

Proper estate planning will ensure that your surviving wealth and family members are properly taken care of at the lowest external cost. Please contact your L&B professional at 858-558-9200 with any questions regarding estate planning.

Inherited IRA: When Can I take Distributions?

By Estates & TrustsNo Comments

Inheriting an IRA can provide a person with much needed additional income. However, receiving distributions from these accounts can be quite costly to the recipient if the rules are not understood. When and how you take distributions from an inherited IRA is affected by who and how old the person you inherited the account from was. In general, inherited IRAs are split into two groups – IRAs inherited from a spouse and IRAs inherited from a non-spouse. The category you fall into will affect the timing of distributions and can dramatically increase taxable income. However, careful planning can mitigate tax penalties while providing a new stream of income.

IRAs Inherited from Spouses

When you inherit your spouse’s IRA, you can choose from several courses of action:

1. Transfer the assets into your own IRA accountThis choice allows you to keep the assets in the IRA account where the assets can grow tax free. The account is also protected from creditors. Access to the assets is subject to traditional IRA rules. For all intents and purposes, this path treats the inherited IRA as if you were the original owner of the account.
2. Take a lump-sum distributionThis choice will not subject you to the 10% early withdrawal, but it may bump you into a higher tax bracket. While this will give you immediate access to the entirety of the account, it may be punitive tax-wise if you have been in a lower tax bracket before you received the distributions.
3. Transfer assets into an Inherited IRA (beneficiary approach)This approach allows you to avoid the 10% early withdrawal penalty and can allow you to keep the assets growing tax-deferred. Distribution rules, however, are dependent on the date of death of the original owner. These rules are complex and we recommend you discuss the potential tax impacts with your tax professional. In general, however, if the owner died before reaching the age of 70.5, distributions do not need to begin until the year in which the owner would have reached 70.5.

IRAs Inherited from Non-Spouses and the Five-Year Rule

IRAs inherited from non-spouses are subject to different distribution rules because you cannot roll non-spousal inherited IRAs into your own IRA. An additional element is also introduced into the equation – the designated beneficiary. A designated beneficiary is an individual who is named by the IRA owner to be entitled to some portion of the IRA upon the original owner’s death. A designated beneficiary must have a quantifiable life span because that life span is used to calculate required minimum distributions. These distributions must begin no later than December 31st of the year after the original owner’s death. A designated beneficiary cannot be an entity.

Non-designated beneficiaries can receive proceeds from an inherited IRA but, they are subject to the 5-Year Rule. The 5-Year Rule requires that the entire balance of the inherited IRA be distributed by the end of the fifth year following the original owner’s death. Spreading distributions received over five years can help smooth income tax effects but very large IRAs can still push incomes into higher than expected tax brackets. It is important to note that if the original owner dies after reaching minimum distribution age, the 5-Year Rule cannot be applied.

If you have any questions regarding inherited IRAs, please contact your L&B professional at (858) 558-9200. Properly planning and timing income from these accounts can be complicated but financially rewarding if done properly.

The Potential Repeal of the Estate and Gift Tax and What That Might Look Like

By Estates & TrustsNo Comments

President-Elect Donald Trump has proposed the repeal of the federal estate and gift tax to be part of his tax reform policies upon assumption of office. This proposal is likely to come to fruition with a Republican controlled Congress. The elimination of the federal estate and gift tax unlocks significant tax planning and wealth transfer opportunities for families traditionally constrained by the $5 million lifetime transfer exclusion. There are, however, potential tax consequences for the receiving beneficiaries that warrant additional consideration.

At the moment, the lifetime transfer exclusion is set at $5.49 million ($10.98 million for married couples) for 2017. Under current tax rules, any transfer of assets valued over these thresholds could result in a 40% tax on the transferor or transferring estate. This high tax rate is partially offset by the step-up in basis to the beneficiaries of the estate. This removes the tax burden from the gift recipients who ultimately sell or dispose the gifted assets. Annual gifts of $14,000 per gift recipient are excluded from these calculations.

Under President-Elect Trump’s plan to repeal the federal estate and gift tax, families can transfer unlimited gifts and assets between direct descendants and skip-generation descendants with no immediate tax consequence. This potential change in tax rules presents unique opportunities for tax planning and the ability to fund future generations with little or no tax outlay. Consider the following example. A couple gifts $100 million in appreciated stock to their children and grandchildren who then sell off the stocks incrementally to fund their cost of living. Assuming that favorable capital gains rates persist, the children and grandchildren could potentially pay 0% federal tax on the sale of the stocks if they keep their income under certain thresholds. If they are in the highest tax brackets, the highest potential capital gains rate the children and grandchildren could face would be 20%.

The caveat to this situation is the loss of basis step-up. This means that the transferred assets retain the holding period from the original purchaser as well as the original cost basis. If large amounts of assets or a single large asset with this carryover basis is sold in one taxable period, significant taxable gains could be recognized by the gift recipient. This could present a challenge to the gift recipient if he/she is cash constrained.

It is important to remember that the elimination of the federal gift and estate tax has not yet occurred and could potentially not occur. Specific terms and rules, especially those that apply to individuals with estates under the current exclusion thresholds, are not set. State conformity will vary and additional considerations may be necessary, especially for those considering making irrevocable gifts in the near future.

Given the fluidity of the situation and the costs and benefits associated with the potential repeal of the estate and gift tax, a conversation with your tax professional may be warranted. Please feel free to contact us at 858-588-9200 with any questions or concerns.

Do you own an interest in a Limited Partnership? If so, proposed tax regulations could have a significant impact on your estate and gift taxes.

By Estates & TrustsNo Comments

These family controlled partnerships are often used in order to transfer assets to future generations during life or at death. Under current regulations, individuals transferring their interests are allowed to take valuation discounts if they meet certain criteria such as lack of control or lack of marketability. These discounts have provided an effective way for families to minimize the estate and gift taxes associated with these transfers. However, proposed regulations, if passed, will dramatically decrease or eliminate these valuation discounts. Click on the link below to learn more about these new regulations and how they will affect transfers involving family businesses.

Key Changes

Individuals owning closely-held limited partnerships have been using valuation discounts for over 30 years. This means that the value of their ownership of the business for federal and estate gift tax purposes is reduced for issues such as lack of marketability or lack of control. These discounts have been aggressively used by estate tax attorneys to decrease the value of their client’s estate when gifting assets to their heirs, thus reducing the estate and gift taxes. The proposed regulations would significantly limit the use of valuation discounts for any type of family limited partnership or other family business transfer, where the family retains control before and after the gift or bequest occurs.

The proposed regulations would expand the family attribution rules to include siblings as part of the definition of family. If a family, as a whole, controls an entity, their interest must be treated as a controlling interest with the ability to liquidate the entity, regardless of the size of each individual interest. Therefore, any minority interest transfer of a family controlled entity would be seen as having control under the expanded definition and as such, would not qualify for any discounts for lack of control.

The proposed regulations would also disregard certain restrictions placed on the redemption or liquidation of family controlled interests. This means that certain restrictions would be ignored in valuing these interests for gift or estate tax purposes when they are transferred to a family member. This would reduce or eliminate any minority or marketability discounts that would have otherwise been applied.

The proposed regulations could become final any time after December 1, 2016 and would only apply to transfers after the effective date. If you are considering any transfers of interest in a family owned business or have any questions regarding these proposed regulations, please contact your L&B Professional.

Modifying or Terminating a Trust

By Estates & TrustsNo Comments

Trusts may not live in perpetuity, but they can sure last a long time. During that time, so much can change. Laws can change, your beneficiaries’ needs can change, the state of the economy can change. So many factors can affect whether or not your trust is maximizing its potential and serving its original purpose. The ability to modify or terminate a trust is dependent on the type of trust you have and the language in the trust agreement. Click on the link below to learn more about the flexibility you have in modifying each type of trust, and the steps for terminating a trust.

The language in a trust agreement is key in determining how a trust can be modified or terminated and by whom.  A trust is either revocable or irrevocable and this classification also controls the fate of the trust.

Revocable trusts may be modified at any time by the settlor, the creator of the trust. The trust agreement contains details on the distributions and termination of the trust, and also explicitly states if the trustee may decide to modify or terminate the trust.

Irrevocable Trusts cannot be modified or revoked without a court order and the consent of the settlor and beneficiares. If the settlor is no longer alive, the courts give extensive consideration to the settlor’s intent in setting up the trust, making it difficult for beneficiaries to make arbitrary modifications or terminations. If a modification allows the trust to fulfill the settlors objectives more effectively and efficiently, it will more likely be approved. The courts also have the ability to make a change retroactive to achieve a tax objective. Courts may also approve a termination if keeping the trust does not make economic sense (i.e. the cost to maintain the trust is depleting the value of the assets in a trust with minimal assets remaining).

If no action is taken by the settlor, beneficiaries, and/or trustee, a trust will generally terminate upon the occurrence of a specific event, whether it be when the beneficiary reaches a certain age, or when the settlor dies. However, a trust does not automatically terminate as soon as this event occurs. The trustee and beneficiaries are allowed a reasonable amount of time to perform the duties necessary to complete the administration of the trust. Below are the steps for closing the administration of a trust.

Steps for Closing Trust Administration

  1. Review the provisions for termination in your original trust agreement.
  2. Ensure that all expenses and taxes have been paid and accounted for.
  3. Obtain approval from all beneficiaries concerning the termination of the trust.
  4. Determine the proper owners of the assets within the trust and distribute accordingly.
  5. Request and sign a Revocation of Trust document.

Please feel free to contact your L&B professional with any questions or concerns you may have on this matter.

Enhance Your Estate Plan with a Life Insurance Trust

By Estates & TrustsNo Comments

Although not subject to federal income tax, life insurance death benefits can be subject to federal estate tax. Life insurance policies not only boost the value of your total estate, but the death benefit can also create an unexpected federal estate tax consequence. This, coupled with the uncertainty in the future of the federal estate tax, calls for careful planning. An irrevocable life insurance trust can be a very useful estate planning tool for this purpose.

Tax savings. The purpose of an irrevocable life insurance trust (“ILIT”) is to remove your insurance policy from your estate, thereby reducing or eliminating federal estate tax on the death benefit if you survive three years after transferring the policy. In addition, cash contributions made to the ILIT to cover insurance premium payments can qualify for the annual gift exclusion ($14,000 in 2016).

Greater flexibility. A skillfully crafted ILIT not only removes the death benefit proceeds from your estate for estate tax purposes, but also enhances your ability to direct how the insurance proceeds will provide for your loved ones. Once the ILIT instrument is drafted, your new or existing life insurance policy or policies are transferred to the trust. Cash can also be transferred to the trust to cover future premium payments. The trust owns the policy and is also designated as the beneficiary of the policy insuring your life. The trustee (someone other than yourself) makes sure that the insurance premiums are paid, properly manages the trust, and follows the directions you built into the trust regarding distribution of the insurance proceeds after your death.

Your ILIT provisions can be customized to distribute the insurance proceeds in a way that an insurance policy contract alone cannot. Whereas an insurance contract form generally only allows for a beneficiary designation, ILIT provisions can be specifically tailored. For example, an ILIT can direct that your spouse have the benefit of the income and the principal for his or her support during his or her lifetime, after which any remaining assets would be distributed to your children, either in trust or outright once the children reach a certain age designated by you.

Some ILIT caveats. Irrevocable life insurance trusts are, by definition, irrevocable: the trust cannot be changed once it is signed. Moreover, you must give up all ownership rights in the policy, including the right to modify the trust, change the insurance policy beneficiary designation, or borrow against the policy. In addition, someone other than you must serve as trustee in order to satisfy the irrevocability requirement. This irrevocability is necessary, however, in order to remove the insurance policy from your estate for estate tax purposes.

Annual Premiums. The annual insurance premiums, which are paid by you, qualify for the annual gift tax exclusion as long as the guidelines for gifting are met. Thus, if the premiums are less than the annual exlusion per beneficiary of the trust, the gift will be tax-free and will not count against your lifetime estate tax exemption ($5,450,000 in 2016). For example, if you and your spouse have four children who are beneficiaries of the ILIT, you can effectively move $112,000 ($14,000 x 4 kids x 2 spouses) out of your estate tax-free in 2016 and not have dipped into your lifetime exlusion.

If you would like to discuss how an ILIT might enhance your estate plan, please contact your L&B professional for more information.

Gifting – An Important and Powerful Estate Planning Tool

By Estates & TrustsNo Comments

Do you want to make gifts to your loved ones and reduce the tax you pay when you pass away? Most people do not like to think about planning their estate, but, a well-planned gift-giving program will effectively reduce your estate tax and ensure the financial security of your loved ones. As of 2016, the maximum estate and gift tax rate is 40 percent, a rate that will significantly decrease the assets passed on to your heirs. There are several strategies that can be used to reduce these taxes which include maximizing your lifetime gifts, making annual tax-free gifts, and paying certain expenses on behalf of your loved ones.

Planning Tip #1: Make Lifetime Gifts

As of 2016, the lifetime estate and gift tax exclusion is $5.45 million per person. The exclusion amount allows $5.45 million of assets to be gifted during your lifetime or passed onto your heirs when you pass away without paying estate or gift taxes. If you are married, you and your spouse can make tax-free gifts up to $10.9 million. This exclusion is typically indexed for inflation each year, but can be significantly increased or decreased by tax legislation. You can take advantage of increasing lifetime exclusions by maximizing your gifts each year. The 2015 exclusion was $5.43 million and was increased to $5.45 million in 2016. For example, if you made $5.43 million gifts in 2015, you can gift an additional $20,000 to your beneficiaries in 2016 without paying any gift tax. This additional $20,000 does not include the annual gift tax exclusion which we will discuss next.

Planning Tip #2: Take Advantage of the Annual Exclusion

As of 2016, you can make tax-free gifts up to $14,000 to any person on an annual basis. For example, if you make $14,000 of gifts to three different individuals this year, you end up transferring a total of $42,000 out of your estate without using any of your $5.45 million life-time exclusion and without paying any gift tax. Your spouse can give the same recipients $14,000 each without using their own $5.45 million lifetime exclusion or paying any gift tax. It is essential to consider this annual gift giving strategy for estate and gift tax planning purposes.

Planning Tip #3: Pay for Medical and Educational Expenses

In addition to the annual $14,000 annual gift tax exclusion, you can pay an unlimited amount of medical and educational expenses for any individual without triggering gift tax or using your lifetime exclusion. In order to be treated as a tax-free gift, payments for medical expenses must be paid directly to the health provider. Similarly, tuition payments must also be made directly to the educational institution.

If carefully planned, a gift-giving program can benefit both you and your heirs. If you have any questions regarding estate planning and gifting strategies, please contact your L&B professional for more information.

Can an Alimony Trust Make Your Divorce Less Painful?

By Estates & TrustsNo Comments

Divorce and separation can be a very stressful time on many levels, including from a taxation standpoint. One of the issues that generally arises is whether alimony will be required, meaning one spouse providing financial support for the other spouse following the divorce or separation. Trust and estate law provides an avenue to fund a specific type of trust known as an Alimony Trust with the purpose of providing such financial support. This article will take a closer look at alimony trusts, including its general structure as well as its tax implications.

Generally, an alimony trust is setup with its own trust agreement, similar to that of standard trusts, as part of the final settlement involving two spouses. The payor spouse transfers investments such as stocks or rental property that generate income into a trust. The other spouse is known as the recipient spouse and is also the beneficiary for the trust. A third-party professional trustee can act as an intermediary between the two spouses to keep the asset management structured in an agreed upon way. When active, the recipient spouse will receive distributions of all of the income from the trust as alimony for the agreed upon time period. When the term expires or the recipient spouse passes away, the remaining assets or principal can be used in a wide variety of ways depending on the terms of the trust agreement: New trusts can be formed for the benefit of children or grandchildren, the assets can be donated to a charitable organization, or the assets can even be returned to the payor spouse.

Alimony trusts can be of benefit to both spouses. For example, if the recipient spouse is concerned about the risk of not being paid due to the payor spouse becoming bankrupt or insolvent, an alimony trust sets aside the assets before such an event occurs. Another example would be when the payor spouse is a business owner who would need to sell an interest in the business to fund regular alimony payments. In this scenario, a portion of equity in the business would be used to fund the trust with the recipient spouse receiving the applicable portion of income from the business on a yearly basis for the term prescribed in the final agreement. When the term ends, the share of the business reverts back to the payor spouse.

The recipient spouse will report and pay tax on the trust income received under Section 682 of the Internal Revenue Code (IRC) as the income beneficiary of the trust instead of reporting the income as alimony. For this reason, the payor spouse is not allowed to claim an alimony deduction for the income generated in the trust. In addition, there is also the risk of overfunding or underfunding the trust relative to the terms of the settlement. In the case of underfunding an alimony trust, the payor spouse may elect to personally guarantee any shortfall of alimony payments and regain the ability to deduct such amounts on the tax return, but leaves the potential to be taxed on the income from the trust if any part of the guaranteed payments are derived from the trust assets. Should an alimony trust be overfunded and the payments decrease over time, the payor spouse would not be subject to the potential penalty of recapturing alimony payments made during the first three years following the divorce or separation.

Alimony trusts, while a useful option in the right circumstances, can add another complex layer in the already difficult process of divorce and separation. Should you have any questions or need assistance in setting up an alimony trust, please contact your L&B professional.

A Closer Look: ESBTs and QSSTs

By Estates & TrustsNo Comments

Do you currently own or will potentially own stock in an S Corporation? Trust and estate law provides two different avenues to fund a trust with S Corporation Stock: An Electing Small Business Trust (ESBT) and a Qualified Subchapter S Trust (QSST). A trust can elect to be either, but not both. This article will take a closer look at each trust’s requirements and tax implications.

Electing Small Business Trust (ESBT) – With an ESBT, typically a portion of the trust’s assets are invested in S-Corporation stock. To be treated as this type of trust for tax purposes, a specific election must be made by the trustee under Section 1361 of the Internal Revenue Code (IRC) within 2 1/2 months of the trust receiving the stock. As such, all of the trust’s beneficiaries must be individuals or estates eligible to be S-Corp shareholders. However, each beneficiary counts as a separate shareholder for the purposes of meeting the 100 or fewer shareholder requirement for S-Corporations. The trust is then treated as two separate trusts: 1) The portion of the trust related to the investment in S-Corp stock is taxed at the individual rate based on all activity related to the S-Corp, such as income, deductions, taxes paid by the S-Corp, etc. 2) The remaining portion of the trust not related to an S-Corp investment is taxed in the same manner as a normal trust.

Qualified Subchapter S Trust (QSST) – A Qualified Subchapter S Trust (QSST) is similar to an ESBT, but with three main differences. First, the beneficiary makes the QSST election rather than the trustee. Second, while an ESBT allows for multiple beneficiaries so long as the S-Corp meets its other requirements, only one (1) beneficiary, who is a U.S. citizen or resident, is allowed in a QSST.  Third, the entirety of the income portion of the trust related to S-Corp investments is passed directly to the beneficiary and is thus taxed at the individual level. However, like ESBTs, the portion of the trust not related to an S-Corp investment is taxed in the same manner as a normal trust. There are several requirements to be met under Sec. 1361 (d) (3) of the Internal Revenue Code (IRC), including that the the trust only have one (1) income beneficiary.

It is possible to convert an ESBT to a QSST and vice versa. To do so, the trust must meet the requirements of the trust it wishes to convert to (i.e. an EBST may convert to a QSST provided the requirements of the QSST are met), and a election to convert must not have been made in the last 36 months.

With both types of trusts, making one mistake can be costly. For example, failing to make the proper elections can jeopardize the S-Corporation’s existence as an S Corporation and creates the potential to be subject to double taxation on both the corporation and its shareholders. If you would like to know more about these trusts or need assistance in setting up an ESBT or QSST, please contact us at 858-558-9200.

What You Need to Know: Distributions

By Estates & TrustsNo Comments

If you are the trustee of a particular trust, you have a fiduciary duty to follow the trust agreement impartially in the interests of the grantor and the beneficiaries. Simple trusts will include a clause in its trust agreement that requires all distributable net income from the current year to be distributed to the beneficiaries in the current year. For more complex trusts without such a clause, the trust agreement may state that a certain amount of income must be distributed to a beneficiary once he or she reaches a certain age (i.e. 18, 21, or 25), or when he or she reaches college to pay for educational expenses. It is critical to make the distributions when required, as there are legal ramifications when distributions are not made when required including but not limited to: appointment of a receiver or temporary trustee to administer the trust, removal of the trustee, reduction of trustee compensation, and/or legal action.

From a tax standpoint, the distributions made or not made can affect the distribution deduction allowed on the trust’s Form 1041 tax return, thus affecting the tax liability at the trust level. Sections 651 and 661 of the Internal Revenue Code (IRC) discusses the deduction allowed for simple and complex trusts, respectively, to the extent of net income in the current year. Whereas simple trusts can deduct only the income required to be distributed currently, complex trusts may be able to deduct any income required to be distributed along with any principal distributed during the current year, if total distributions are below the distributable net income limitation. Additionally, under Section 643(b) of the IRC, trustors of complex trusts may grant the power to trustees to treat capital gains as income instead of principal, allowing further deductions from distributions.

In situations where principal assets are to be distributed, such as a rental property or marketable securities, the trustee is allowed to discuss the timing of the distribution of these assets with the beneficiary to determine the most appropriate time to transfer these assets. However, the trustee’s discretion must follow the terms of the trust agreement and could be subject to similar legal ramifications as mentioned earlier.

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