Garland Law Offices, P.A.

Take Advantage of Tax Laws Now

“If you like the way the laws are today, you need to take advantage of them now, before they are changed tomorrow. In other words, use it or lose it.”

The pundits are saying that the if Democrats win the White House and possibly Congress, expect changes to income, gift generation skipping transfer and estate taxes. This recent article from Forbes, “Use It Or Lose It: Locking In the $11.58 Million Unified Credit” says that the time to act is now.

Since 2000, the estate and gift tax exemption has taken a leap from $675,000 and a top marginal rate of 55% to an exemption of $11.58 million and a top marginal rate of 40%. However, it’s not permanent. If Congress does nothing, the tax laws go back in 2026 to a $5.6 million exemption and a top marginal rate of 55%. The expectation is that if Biden wins in November, and if Congress enacts the changes published in his tax plan, the exemption will fall to $3.5 million, and the top marginal rate will jump to 70%.

The current exemption and tax rate may be as good as it gets.

If you make a taxable gift today, you can effectively make the current tax laws permanent for you and your family. The gift will be reported in the year it is made, and the tax laws that are in effect when the gift is made will permanently applicable. Even if the tax laws change in the future, which is always a possibility, there have been proposed regulations published by the IRS that say the new tax laws will not be imposed on taxable gifts made in prior years.

Let’s say you make an outright taxable gift today of $11.58 million, or $23.16 million for a married couple. That gift amount, and any income and appreciation from the date of the gift to the date of death will not be taxed later in your estate. The higher $11.58 million exemption from the Generation Skipping Transfer Tax (GSTT) can also be applied to these gifts.

Of course, you’ll need to have enough assets to make a gift and still be financially secure. Don’t give a gift, if it means you won’t be able to support your spouse and family. To take advantage of the current exemption amount, you’ll need to make a gift that exceeds the reversionary exemption of $3.5 million. One way to do this is to have each spouse make a gift of the exemption amount to a Spousal Lifetime Access Trust (SLAT), a trust for the benefit of the other spouse for that spouse’s lifetime.

Be mindful that such a trust may draw attention from the IRS, because when two people make gifts to trusts for each other, which leaves each of them in the same economic position, the gifts are ignored and the assets in the trusts are included in their estate. The courts have ruled, however, that if the trusts are different from each other, based on the provisions in the trusts, state laws and even the timing of the creation and funding of the trusts may be acceptable.

These types of trusts need to be properly administered and aligned with the overall estate plan. Who will inherit the assets, and under what terms?

A word of caution: these are complex trusts and take time to create. Time may be running out. Speak with a skilled estate planning attorney with knowledge of tax law.

Reference: Forbes (July 17, 2020) “Use It Or Lose It: Locking In the $11.58 Million Unified Credit”

How Does an Intentionally Defective Grantor Trust Work?

“This type of trust can be established to benefit your spouse, children, grandchildren and other descendants. However, it may be more appropriate in some situations than others. Getting to know the details of what an IDGT is and how it works can help you decide if it makes sense for you.”

Using trusts as part of an estate plan creates many benefits, including minimizing estate taxes. One type of trust is known as an “intentionally defective grantor trust,” or IDGT. It’s a type of irrevocable trust used to limit tax liability when transferring wealth to heirs, as reported in the recent article “Intentionally Defective Grantor Trust (IDGT)” from Yahoo! Finance. It’s good to understand the details, so you can decide if an IDGT will help your family.

An irrevocable trust is one that can’t be changed once it’s created. Once assets are transferred into the trust, they can’t be transferred back out again, and the terms of the trust can’t be changed.  You will want to talk with your estate planning attorney in detail about the use of the IDGT, before it is created.

An IDGT allows you to permanently remove assets from your estate. The assets are then managed by a trustee, who is a fiduciary and is responsible for managing the trust for the beneficiaries. All of this is written down in the trust documents.

However, what makes an IDGT trust different, is how assets are treated for tax purposes. The IDGT lets you transfer assets outside of your estate, which lets you avoid paying estate and gift taxes on the assets.

The IDGT gets its “defective” name from its structure, which is an intentional flaw designed to provide tax benefits for the trust grantor—the person who creates the trust—and their beneficiaries. The trust is defective because the grantor still pays income taxes on the income generated by the trust, even though the assets are no longer part of the estate. It seems like that would be a mistake, hence the term “defective.”

However, there’s a reason for that. The creation of an IDGT trust freezes the assets in the trust. Since it is irrevocable, the assets stay in the trust until the owner dies. During the owner’s lifetime, the assets can continue to appreciate in value and are free from any transfer taxes. The owner pays taxes on the assets while they are living, and children or grandchildren don’t get stuck with paying the taxes after the owner dies. Typically, no estate tax applies on death with an IDGT.

Whether there is a gift tax upon the owner’s death will depend upon the value of the assets in the trust and whether the owner has used up his or her lifetime generation-skipping tax exemption limit.

Your estate planning attorney can help establish an IDGT, which should be created to work with the rest of your estate plan. Be aware of any exceptions that might alter the trust’s status or result in assets being lumped in with your estate. Funding the IDGT also takes careful planning. The trust may be funded with an irrevocable gift of assets, or assets can be sold to the trust. Your attorney will be able to make recommendations, based on your specific situation.

Reference: Yahoo! Finance (June 3, 2020) “Intentionally Defective Grantor Trust (IDGT)”

Why Should I Think About a Dynasty Trust?

“When transferring wealth to the next generation, many families prefer to make gifts to younger family members in trust, rather than gifting the assets outright. Gifting assets to a trust has many advantages, including asset protection, tax planning and maintaining family control until the beneficiary reaches adulthood.”

A dynasty trust is a trust that lasts longer than one generation below that of the grantor. This trust can be a worthwhile estate planning tool for multi-generational families. Forbes’ recent article, “2 Reasons To Consider A Dynasty Trust” explains that dynasty trusts have two unique benefits that make them attractive.

Generation-Skipping Transfer Tax (GST) Exemption. According to the American Bar Association, the GST tax is imposed on asset transfers to grandchildren and more remote descendants that exceed the exemption limits. As a result, the transferor can’t avoid transfer taxes by "skipping" a generation. The GST is imposed, in addition to gift and estate taxes.

A person can give up to $11.4 million in assets (the GST tax-exempt amount) to a trust in 2019. Trust assets are protected from transfer taxation for as long as the trust document and state law permit it. A dynasty trust uses the federal GST tax exemption by taking family wealth out of the transfer tax system for as long as the trust is in existence; income and principal is used to benefit each succeeding generation.

An additional benefit is that the GST tax exemption can often be extended, by transferring assets subject to valuation discounts.

Grantor Trusts Provide More Tax Benefits. In most cases, grantor trusts treat the trust creator as the owner of the trust assets for income tax purposes. This allows the trust principal to grow free of income tax. Creating the trust as a grantor trust adds another level of tax benefit to a dynasty trust.

The estate planning benefits of the asset transfer are increased by the grantor making the income tax payments instead of the trust. In other words, the assets in the trust aren’t reduced by income taxes. Any income taxes paid by the grantor reduce the size of the grantor’s overall taxable estate when calculating estate taxes.

There are a number of strategies a person can implement using dynasty trusts. You can discuss all your choices with an experienced estate planning attorney.

Reference: Forbes (July 23, 2019) “2 Reasons To Consider A Dynasty Trust”

Will the New Tax Law Affect My Estate Plan?

“Let’s consider what happens with a married couple, where the first spouse to die has a relatively small estate, which doesn’t use all the estate-tax credit. What happens when the second spouse dies, and their respective estate is more than their applicable estate-tax credit?”

The Tax Cuts and Jobs Act of 2018 temporarily doubles the allowable credit for the federal estate tax. It is $11.2 million for an individual and $22.4 million for those who are married, reports Newsmax’s recent article, “Trump Tax Law Necessitates Immediate Review of All Estate Plans.”

Note that a more recent change, called “portability”, allows the unused estate tax credit from the first spouse to die to be used in the second spouse’s estate. It’s an election and not automatic. Portability will let nearly all the estates of U.S. persons avoid estate taxes.  However, for some, estate tax planning is still the major factor in creating an effective estate-planning strategy.

Estate plans drafted and implemented before 2018 should be reviewed. Standard estate plans for married couples before the 2018 increase in tax exemptions and before portability involved the use of a credit-shelter trust and a marital trust to zero-out most estates on the first spouse to die. This is commonly called the A-B trust system.

A credit shelter trust holds assets equal to the estate tax credit. The remainder of the estate funds the marital trust and avoids taxability in the first estate.  However, it’s taxable in the estate of the second spouse to die—if that estate exceeds its estate-tax exemption. With the increased tax exemption and portability, many tax experts now think that using the marital trust may not be best for many estates.

For example, the wholesale changes in 2018 Tax Cut and Jobs Act dictate considerations for tax planning. There’s the impact of the new lower tax rate (21%) on corporations, and the 20% deduction on the active business income of pass-thru entities, like LLCs, which hold investments.

Another important complication is the inherited tax basis on the property funding the credit shelter or marital trust, and its projected tax impact on sale.

If you have an existing estate plan, work with your attorney to review your estate strategies and documentation. If you don’t have an estate plan, now is the time to put one in place that will take advantage of the new tax law.

Reference: Newsmax (April 30, 2018) “Trump Tax Law Necessitates Immediate Review of All Estate Plans”

Are Contingent Beneficiaries Subject to Inheritance Tax on Life Insurance?

“The inheritance tax is determined by the relationship between the deceased and the beneficiary…”

Let’s say that you and your spouse both have life insurance policies of $500,000 on each other and have no children. Each spouse is named as the primary beneficiary on the other's policies, and the contingent beneficiaries are a brother and a niece. The issue that’s often raised, is whether the brother and the niece would be subject to the inheritance tax, if they received the proceeds.

nj.com asked and answered this very question in its recent article, “Do the beneficiaries of life insurance have to pay inheritance tax?” Although New Jersey’s state estate tax is gone, there’s still an inheritance tax.

Life insurance—when paid to a named beneficiary or a trust for the benefit of a named beneficiary—is a specific asset that’s exempt from New Jersey’s inheritance tax, despite the relationship of the beneficiary to the decedent.

If the life insurance was left to the owner’s estate, and the estate was passed to the brother and niece under the will, it wouldn’t be exempt from the inheritance tax. It wouldn’t matter that the brother and niece were named as contingent beneficiaries on the life insurance policies, so long as they were named as beneficiaries on the policy and wouldn’t be taking the proceeds as beneficiaries under the will.

The New Jersey inheritance tax is imposed on certain bequests based on the relationship between the deceased and the beneficiary, and the value and nature of the asset transferred. The tax is also levied on transfers within three years of death.

There is no inheritance tax imposed, if the beneficiary is a spouse, domestic partner, civil union partner, grandparent, parent, descendant, stepchild of the decedent, or a charity. If the beneficiary is in one of these categories, the value or nature of the bequest doesn’t matter. If the beneficiary does not fall within one of these categories, then the relationship to the beneficiary and the value or nature of the bequest will be considered to see if there is an inheritance tax.

Transfers to a sibling, son-in-law or daughter-in-law (“Class C” beneficiaries) aren’t taxable up to the first $25,000. Transfers in excess of that to $1.1 million are taxable at 11%. Transfers in excess of $1.1 million and up to $1.4 million are taxed at 13%, and transfers over $1.4 million up to $1.7 million are taxed at 14%. Any larger transfers are taxed at 16%.

All other beneficiaries are referred to as “Class D” beneficiaries. Transfers to these beneficiaries are taxed at 15% if the value is greater than $500 up to $700,000 and at 16 % for anything valued higher. In addition to life insurance paid directly to a named beneficiary, certain other assets, like public employee benefits are exempt from the tax.

Reference: nj.com (March 26, 2018) “Do the beneficiaries of life insurance have to pay inheritance tax?”

How the Changes to the Death Tax May Affect You

“The good news and the bad news about the death tax.”

The changes to the federal estate tax law or “death taxes” went into effect on January 1. MarketWatch’s recent article, “Watch out for the gift tax trap in the new tax law,” reports the new law significantly  increases the amount allowed to calculate taxes on estates, where no federal tax would be applied.

A single person could now die owning up to $11.2 million without paying an estate tax, and married couples now have double that amount (if a timely portability election was made after the first spouse’s death).

Failing to pay attention to the new details in the law can lead to misapplication of the changes.  This could result in significant tax consequences for the beneficiaries of the estate, as it relates to gifting.

The new law leaves in place the rule that says when a person dies, the cost basis of the assets (not including IRAs and retirement plans) would be increased to the value of the asset at the date of the owner’s death. That’s a step up in basis. As a result, the capital gain or profit created in the assets over time is wiped out at the owner’s death.

Remember, the asset only qualifies for gain forgiveness—and the new cost basis—if the owner still owns the asset at his or her death.

It can’t be gifted during the life of the owner or there’s no benefit of step up in basis at the death of the person who previously made the gift.

If you’re considering making lifetime gifts, you should be educated on the consequences of gifting and apply the correct estate planning strategies using current estate tax law. Talk with an experienced estate planning attorney before proceeding with any proposed gifting action.

Reference: MarketWatch (February 1, 2018) “Watch out for the gift tax trap in the new tax law.”

What’s Really in The Tax Cuts and Jobs Act of 2017?

“Expanded estate tax exemption leaves many reasons to engage in estate planning…”

With the new Tax Cuts and Jobs Act, most of us won’t have to pay a federal estate tax. However, with the expanded exemption, there are still several reasons to engage in estate planning, according to an article published in Think Advisor, “9 Ways New Tax Law Could Affect Clients’ Estate Plans.”

The new tax legislation increases the federal estate, gift and generation-skipping transfer (GST) tax exemptions to $10 million (indexed for inflation) per person beginning on January 1, 2018. The exemptions are scheduled to sunset (expire) on January 1, 2026. Things then revert to the current federal law. Of course, there’s always a chance of a repeal of the tax law in a subsequent Congress, so it’s critical to stay informed. However, right now, high-net-worth individuals should pay close attention to these areas:

• Estate planning. A trust can provide protection from creditors and divorcing spouses, along with control over how beneficiaries inherit wealth. A trust can also help preserve wealth for generations.
• Portability election. This allows a surviving spouse to use the deceased spouse’s unused federal estate and gift tax exemption. It’s unchanged and means a married couple can use the full $20 million exemption (indexed for inflation).
• Estate tax liability. For those with a high net-worth who will still have federal estate tax exposure and those who live or own property in states that have their own estate tax, the traditional wealth transfer strategies will still be sound. Talk to your estate planning attorney about your federal estate tax exposure under the new rules.
• Basis step-up at death. This lets a decedent’s assets get a step-up in tax cost to their fair market value at the date of death. It’s unchanged. Therefore, with a much higher federal estate tax exemption, income tax planning is a crucial component of estate planning and estate administration.
• Annual exclusion gifts. Making gifts during your lifetime may be a wise tax planning strategy. The gift tax annual exclusion amount is $15,000 and the gift tax annual exclusion amount is still subject to an adjustment for inflation.
• Basis carryover for gifts. Gifts made during the donor's lifetime will continue to pass to the donee with the donor’s tax cost. Perhaps a donor might wait in making gifts of assets that have significant unrealized gain until his or her death, to give the beneficiary the asset and the step-up in tax cost. There are other considerations in gift tax planning, so talk to your estate planning attorney.
• GRATs. Short-term grantor-retained annuity trusts (GRATs) or qualified personal residence trusts (QPRTs) whose terms end before the Act’s sunset provisions in 2026, will still be a good planning tool for very high net-worth clients.
• Irrevocable trusts. Existing irrevocable trusts that hold low-basis assets should be examined to see if there’s an upside to (and the possibility of) rendering them subject to estate tax in the estate of a beneficiary who might die before the increased exemptions sunset. This could result in a step-up in tax cost (thus reducing capital gains tax for the next set of beneficiaries) without payment of estate tax.
• Closely held businesses. With the exemption amounts scheduled to revert to $5 million (indexed for inflation) in 2026, planning is still vital for families with large closely held businesses and a net worth significantly greater than the exemption amounts. If it looks like reversion to the current law is possible as we get closer to 2026, individuals should determine if an aggressive gifting plan makes sense.

Reference: Think Advisor (January 10, 2018) “9 Ways New Tax Law Could Affect Clients’ Estate Plans”

Questions to Ask Your Attorney About the New Tax Law

“An estate plan is like a car or a house: It needs regular maintenance to function as intended. Yet unlike your car or home, external events can create the need for adjustments.”

Forbes’ recent article, “5 Questions To Ask Your Estate Planner After The New Tax Law,” gives you some ammunition for your next meeting with your estate planning attorney.

First, be sure your estate plan is up-to-date. Even if it won’t be affected by the new tax law, you should talk with your attorney to be certain your current wishes are reflected in your estate planning documents.

When you meet with your attorney, you might ask some questions to be sure that your plan still fully supports your interests and those of your heirs. Here are a few:

Will the new federal law affect my estate tax picture? The federal government exempts a certain amount of an estate’s value from this tax. Congress just doubled this exemption to more than $11 million per person.

Will the new law impact my state estate tax? There are 15 states that still have some form of estate tax: Minnesota, Iowa, Nebraska, Washington, Oregon, Kentucky, Tennessee, Pennsylvania, New Jersey, Massachusetts, Rhode Island, Connecticut, Delaware, Maryland, and DC. Some of these states’ exemption limits mirror the federal limits, so the federal increase will automatically trigger the same increase in those states. However, others don’t, and their exemption limits will remain the same.

Are my estate documents tailored to fulfill my wishes and avoid unintended consequences? Results that conflict with your intentions can occur when documents aren’t specific enough. This isn’t uncommon with financial powers of attorney (POA), which instructs your agent(s) on how your finances are to be managed, if you’re incapacitated and unable to make decisions. Without specific provisions to assure your wishes are executed, vague or overly general POAs could permit the agent managing these finances (often, a spouse) to do as they wish, rather than abiding by your instructions.

To prevent negative outcomes, ask your estate planning attorney to be certain that your POA is sufficiently specific.

Reference: Forbes (January 9, 2018) “5 Questions To Ask Your Estate Planner After The New Tax Law”

Which States Will Tax Your Estate the Most in 2018?

“Thanks to the federal tax bill on President Donald Trump’s desk, the amount you can leave tax free to heirs will be a whopping $11.2 million in Hawaii, Maine and Washington, D.C. in 2018—and in Maryland in 2019, and in Connecticut in 2020.”

The big numbers are because many states have linked their state estate taxes to the federal amount. Since the GOP tax bill doubles the base federal estate tax exemption amount to a little over $11 million, indexed for inflation for tax years 2018 through 2025, those states will also increase their thresholds.

Forbes notes in its recent article, “Where Not To Die In 2018,” that along with this news, there are two states that are eliminating estate taxes in 2018: New Jersey and Delaware. New York is set to match the current federal exemption amount—a base of just over $5 million indexed for inflation—in 2019. Massachusetts and Oregon now tie for the lowest estate tax exemptions at $1 million per person.

The federal estate tax is 40% on assets above $11.2 million. This tax affects just 1,800 estates in the US next year. However, many more taxpayers pay state estate taxes. The number of state taxable estate tax returns in the state of Oregon alone was 1,563 in 2015. That state’s exemption is just $1 million.

The amount of money you can leave to your heirs without any state death tax depends on where you live and own property, to whom you’re leaving the money and whether your estate planning is current. The highest rates are about 16%, and for inheritance tax states, the tax can apply to the first dollar of assets, meaning there’s no credit like there is on federal estate taxes.

Seventeen states and Washington, D.C. will impose an estate tax or inheritance tax (Maryland has both) in 2018. Eight of these states and DC are making changes for 2018.

New Jersey has repealed its estate tax, but there’s a separate state inheritance tax that hits non-lineal heirs like siblings, nieces, and nephews. The Garden State now is in the group of other inheritance-tax only states: Nebraska, Iowa, Kentucky, and Pennsylvania.

Minnesota and Maryland have scheduled increases to their exemption amounts, and Connecticut just made scheduled changes to its exemption in its 2018 state budget. Washington and Rhode Island made minor upward adjustments in their exemption amounts, due to inflation indexing.

You should not believe that you don’t need to do estate planning because of these larger exemptions. There are plenty of non-tax reasons to plan, including designating a guardian for your minor children and naming someone to act on your behalf with a financial power of attorney, if you become incapacitated.

Speak with a qualified estate planning attorney to be sure your estate plan is up-to-date and addresses any tax law changes in your state.

Reference: Forbes (December 21, 2017) “Where Not To Die In 2018”