Is Estate Tax Exemption Going to Change? – Annapolis and Towson Estate Planning

In 2022, the estate and gift tax exemption increases from $11.7 million in 2021 to $12.06 million per individual, according to new inflation-adjusted numbers from the IRS. The gift tax annual exclusion also increases, from $15,000 to $16,000. The IRS announced these numbers, as well as tax brackets, standard deductions and more, as reported in the article “New Higher Estate And Gift Tax Limits for 2022: Couples Can Pass On $720,000 More Tax Free” from Forbes.

The estate tax is 40% on the biggest estates, but wealthy individuals use legal strategies, like transferring wealth to heirs while they are living, making big gifts and also making multiple $16,000 annual exclusion gifts that do not count against the $12 million lifetime limit.

In 2022, a wealthy person may leave $12.06 to heirs with no federal estate or gift tax. A married couple may leave $24.12 million. If by some chance a couple has maxed out their lifetime gifts, this latest increase means they have the option to give away another $720,000 in 2022.

A series of annual exclusion gifts of $16,000 can add up, especially when they are done in a planned method over an extended period of time. Since these gifts do not count toward the $12 million amount, they are especially valuable for managing estate tax liability.

Estate sizes may also be reduced by making direct payments for medical and tuition expenses, for as many people as desired, with no gift or tax consequences. There is no limit on the amount to be paid, as long as these payments are made directly to the institution.

There are any number of ways to take money out of an estate. These include outright gifts, loans to family members and special trusts. A variety of trusts are created to preserve family wealth, from simple to complex trusts used to extend wealth across many generations.

In addition to planning for the increased numbers for 2022, this is also the time to check on basic estate planning documents and be certain they are up to date. These include a will, any kind of revocable living trust, a durable power of attorney, a healthcare directive and a living will. If the family includes a special needs member or a disabled individual, there are other planning methods to be discussed with an experienced estate planning attorney.

Despite the good news of these increases, the $12 million estate tax exemption will be halved at the start of 2026. The historical high exemption was created under President Donald J. Trump by the 2017 Tax Cuts and Jobs Act, which temporarily doubled the estate tax exemption from 2018 to 2025. While there was a lot of discussion about the Infrastructure Bill and funding through estate taxes, any provisions impacting estate planning were dropped before the bill was passed.

One more reason to gift now: state estate taxes and inheritance taxes are still alive and well in many states. If you live in a state with these taxes, the state tax bite could be just as bad, if not worse, than the federal tax.

Reference: Forbes (Nov. 11, 2021) “New Higher Estate And Gift Tax Limits for 2022: Couples Can Pass On $720,000 More Tax Free”

 

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Do Gifts Count Toward Estate Taxes? – Annapolis and Towson Estate Planning

With all of the talk about changes to estate taxes, estate planning attorneys have been watching and waiting as changes were added, then removed, then changed again, in pending legislation. The passage of the infrastructure bill in early November may mark the start of a calmer period, but there are still estate planning moves to consider, says a recent article “Gift money now, before estate tax laws sunset in 2025” from The Press-Enterprise.

Gifts are used to decrease the taxes due on an estate but require thoughtful planning with an eye to avoiding any unintended consequences.

The first gift tax exemption is the annual exemption. Basically, anyone can give anyone else a gift of up to $15,000 every year. If giving together, spouses may gift $30,000 a year. After these amounts, the gift is subject to gift tax. However, there is another exemption: the lifetime exemption.

For now, the estate and gift tax exemption is $11.7 million per person. Anyone can gift up to that amount during life or at death, or some combination, tax-free. The exemption amount is adjusted every year. If no changes to the law are made, this will increase to roughly $12,060,000 in 2022.

However, the current estate and gift tax exemption law sunsets in 2025. This will bring the exemption down from historically high levels to the prior level of $5 million. Even with an adjustment for inflation, this would make the exemption about $6.2 million. This will dramatically increase the number of estates required to pay federal estate taxes.

For households with net worth below $6 million for an individual and $12 million for a married couple, federal estate taxes may be less of a worry. However, there are state estate taxes, and some are tied to federal estate tax rates. Planning is necessary, especially as some in Congress would like to see those levels set even lower.

Let us look at a fictional couple with a combined net worth of $30 million. Without any estate planning or gifting, if they live past 2025, they may have a taxable estate of $18 million: $30 million minus $12 million. At a taxable rate of 40%, their tax bill will be $7.2 million.

If the couple had gifted the maximum $23.4 million now under the current exemption, their taxable estate would be reduced to $6.6 million, with a tax bill of $2,520,000. Even if they were to die in a year when the exemption is lower than it was at the time of their gift, they would save nearly $5 million in taxes.

There are a number of estate planning gifting techniques used to leverage giving, including some which provide income streams to the donor, while allowing the donor to maintain control of assets. These include:

Discounted Giving. When assets are transferred into an entity (commonly a limited partnership or limited liability company), a gift of a minority interest in the entity is generally given a discounted value, due to the lack of control and marketability.

Grantor Retained Annuity Trusts. The donor transfers assets to the trust and retains right to a payment over a period of time. At the end of that period, beneficiaries receive the assets and all of the appreciation. The donor pays income tax on the earnings of the assets in the trust, permitting another tax-free transfer of assets.

Intentionally Defective Grantor Trusts. A donor sets up a trust, makes a gift of assets and then sells other assets to the trust in exchange for a promissory note. If this is done correctly, there is a minimal gift, no gain on the sale for tax purposes, the donor pays the income tax and appreciation is moved to the next generation.

These strategies may continue to be scrutinized as Congress searches for funding sources, but in the meantime, they are still available and may be appropriate for your estate. Speak with an experienced estate planning attorney to see if these or other strategies should be put into place.

Reference: The Press-Enterprise (Nov. 7, 2021) “Gift money now, before estate tax laws sunset in 2025”

 

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How Can I Pass Wealth to My Children and Grandchildren? – Annapolis and Towson Estate Planning

AARP’s recent article “6 Ways to Pass Wealth to Your Heirs” says that providing financial security to your heirs after you are gone is a goal you can reach in a number of ways.

Let us look at a few common options, along with their pluses and minuses:

  1. 401(k)s and IRAs. These grow tax-free while you are alive and will continue tax-free growth after your beneficiaries inherit them. Certain heirs, such as spouses and people with disabilities, can hold these accounts over their lifetime. Withdrawals from Roth IRAs and Roth 401(k)s are nearly always tax-free. However, other heirs not in those categories have to empty these accounts within 10 years.
  2. Taxable accounts. Heirs now get a nice tax break on investments that have grown in value over time. Say that years ago you bought stock for $300 that now trades for $3,000. If you sold it now, you would owe taxes on $2,700 in capital gains. However, if your son inherited the stock when it was trading at $3,000 and sold it at that price, he would owe no taxes on the sale. However, note that the Biden administration has proposed limiting the amount of investment capital gains free from taxes in this situation, which could impact wealthier families.
  3. Your home. If you own a home, it will typically be the most valuable non-financial asset in your estate. Heirs might not have to pay capital gains tax on it, if they sell it. However, use caution: whoever inherits the home will have to cover large expenses, such as upkeep and taxes.
  4. Term life insurance. This can be a great tool for loved ones who depend on your income or rely on your unpaid caregiving. You can get a lot of coverage for very little money. However, if you purchase plain-vanilla term insurance and do not die while the policy is in force, you do not get the money back.
  5. Whole life insurance. These policies provide a guaranteed death benefit for heirs and a cash-value component you can access for emergencies, long-term care, or other needs. However, these policies are more expensive than term insurance.
  6. Annuities. A joint-and-survivor annuity guarantees the survivor (your spouse, perhaps) a steady stream of income for life. Annuities with a death benefit can provide a lump sum for a beneficiary. However, while you are alive, annual fees for variable annuities can be high, limiting potential returns. Moreover, cashing in your annuity for a lump sum may be expensive or impossible.

Bonus Tip. Discuss your plans with your children sooner rather than later, especially if you are leaving them different amounts or giving a large sum to a favorite cause, so you have time to explain your rationale.

Reference: AARP (Sep. 9, 2021) “6 Ways to Pass Wealth to Your Heirs”

 

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Why Do People Give to Charities at End of Year? – Annapolis and Towson Estate Planning

The landscape for charitable giving has undergone a lot of change in recent years. More changes are likely around the corner. This year, a more intentional approach to year-end giving may be needed, according to the article “How to Make the most of Year-End Charitable Giving” from Wealth Management.

From the continuing pandemic to natural and humanitarian disasters, the need for relief is pressing on many sides. Donors with experience in philanthropy understand charitable giving as part of a tax strategy, part of providing the essential support needed by non-profits to keep operating and respond to emergencies and, at the same time, ensure their charitable dollars are aligned with their family values and missions.

For the tax perspective, changes resulting from the Tax Cuts and Jobs Act of 2017 left many nonprofits harshly impacted by the doubling of the standard deduction, which gave fewer people a financial incentive to donate. The question now is, could the latest round of proposed changes spur greater giving?

Amid all of these changes, sound and stable giving strategies remain the wisest option.

The CARES Act encouraged individual giving during times of hardship, and tax breaks were extended in 2021. However, certain incentives are now closing, such as the ability to deduct up to 100% of adjusted gross income for cash gifts made directly to public charities.

The Build Back Better Agenda proposes increasing the long-term capital gains tax rate for individuals with more than $400,000 of taxable income, and married couples filing jointly with more than $450,000 of taxable income, to 25%, plus a 3% surcharge to income of more than $5 million. This would make charitable giving more attractive from an income tax perspective. However, this bill has yet to be passed.

Consider the following strategies:

Qualified charitable distributions. RMDs must be taken in 2021. For donors taking a standard deduction, a qualified charitable distribution is a possible option. If you are 70½ and over, you can donate up to $100,000 from an IRA. This satisfies the RMD, as long as the gift goes directly to a charity, not to a Donor Advised Fund.

Contributions of appreciated stock. To make charitable gifts in the most tax-efficient way possible, a donation of appreciated stock is a smart move. Donors receive a charitable income tax deduction (subject to AGI limitations) and avoid capital gains tax.

Charitable bequests. The uncertainty around income tax reform includes estate taxes, and pro-active individuals are now reviewing their estate plans with their estate planning attorneys.

Funding a Donor Advised Fund (DAF). A DAF allows donors to contribute assets to a tax-free investment account, from which they can direct gifts to the charities of their choice. The contribution to the fund provides the donor with a charitable income tax deduction in the year it is made.

Reference: Wealth Management (Oct. 11, 2021) “How to Make the most of Year-End Charitable Giving”

 

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What Is “Income in Respect of Decedent?” – Annapolis and Towson Estate Planning

One of the tasks required after a person’s death is to pay taxes on their entire estate and often for the last year of their life. Most people know this, but not everyone knows taxes are also due on any income received after a person has died. Known as “Income In Respect Of A Decedent” or “IRD,” this kind of income has its own tax rules and they may be complex, says Yahoo! Finance in a recent article simply titled “Income in Respect of a Decedent (IRD).”

Income in respect of a decedent is any income received after a person has died but not included in their final tax return. When the executor begins working on a decedent’s personal finances, things could become challenging, especially if the person owned a business, had many bank and investment accounts, or if they were unorganized.

What kinds of funds are considered IRDs?

  • Uncollected salary, wages, bonuses, commissions and vacation or sick pay.
  • Stock options exercised
  • Taxable distributions from retirement accounts
  • Distributions from deferred compensation
  • Bank account interest
  • Dividends and capital gains from investments
  • Accounts receivable paid to a small business owned by the decedent (cash basis only)

As a side note, this should serve as a reminder of how important it is to create and update a detailed list of financial accounts, investments and income streams for executors to work with to prevent possible losses.

How is IRD taxed? IRD is income that would have been included in the decedent’s tax returns, if they were still living but was not included in the final tax return. Where the IRD is reported depends upon who receives the income. If it is paid to the estate, it needs to be included on the fiduciary return. However, if IRD is paid directly to a beneficiary, then the beneficiary needs to include it in their own tax return.

If estate taxes are paid on the IRD, tax law does allow for an income tax deduction for estate taxes paid on the income. If the executor or beneficiaries missed the IRD, an estate planning attorney will be able to help amend tax returns to claim it.

Retirement accounts are also impacted by IRD. Required Minimum Distributions (RMDs) must be taken from IRA, 401(k) and similar accounts as owners age. The RMDs for the year a person passes are also included in their estate. The combination of estate taxes and income taxes on taxable retirement accounts can reduce the size of the estate, and therefore, inheritances. Tax law allows for the deduction of estate taxes related to amounts reported as IRD to reduce the impact of this “double taxation.”

Reference: Yahoo! Finance (Oct. 6, 2021) “Income in Respect of a Decedent (IRD)”

 

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What Should Small Business Owners Know about Estate Planning? – Annapolis and Towson Estate Planning

Not having an estate plan can place business owners and entrepreneurs in jeopardy because they may face difficulties in keeping the business running, if they have to withdraw from the business at any point in time.

Legal Reader’s recent article entitled “What Small Business Owners Should Know about Doing Estate Planning” explains that estate planning is necessary to ensure business continuity. Think about who can take control when you are no longer around to have the business continue according to your wishes contained in your estate plan. An experienced estate planning attorney can help business owners create a comprehensive estate plan, so things do not become chaotic for their family in the event of premature death or any permanent disability. Consider these steps when it comes to good estate planning for business owners.

Create an estate plan if you have not got one. A will is designed to detail your wishes about how you want the business to run and the manner of sharing your property at your death. A power of attorney allows an entrusted individual to undertake your business transactions and manage your finances, if you are incapacitated by injury or illness. A healthcare directive permits a trusted agent to make medical decisions on your behalf when you cannot do so yourself.

Plan for taxes. Tax planning is a major component of estate planning. Our tax laws keep changing frequently, so you have to stay in constant touch with your attorney to develop strategies for decreasing your tax liability, as well as creating a strategy for minimizing inheritance/estate taxes.

Buy life and disability insurance. Small business owners should think about purchasing life insurance, so their families can have a source of income after their death.

Create a succession plan. In addition to estate planning, a business owner should have a succession plan that specifies exactly how your company, and your family will prepare for a transition of ownership. The purpose of a well thought out succession plan is to keep the business operating or to take steps to sell it. This plan also includes the organizational structure of the business in case of maintaining business continuity.

Finally, you should keep everyone impacted by your decisions apprised of your estate plan and your business succession plan.

Reference: Legal Reader (Aug. 26, 2021) “What Small Business Owners Should Know about Doing Estate Planning”

 

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Should I Try Do-It-Yourself Estate Planning? – Annapolis and Towson Estate Planning

US News & World Report’s recent article entitled “6 Common Myths About Estate Planning explains that the coronavirus pandemic has made many people face decisions about estate planning. Many will use a do-it-yourself solution. Internet DIY websites make it easy to download forms. However, there are mistakes people make when they try do-it-yourself estate planning.

Here are some issues with do-it-yourself that estate planning attorneys regularly see:

You need to know what to ask. If you are trying to complete a specific form, you may be able to do it on your own. However, the challenge is sometimes not knowing what to ask. If you want a more comprehensive end-of-life plan and are not sure about what you need in addition to a will, work with an experienced estate planning attorney. If you want to cover everything, and are not sure what everything is, that is why you see them.

More complex issues require professional help. Take a more holistic look at your estate plan and look at estate planning, tax planning and financial planning together, since they are all interrelated. If you only look at one of these areas at a time, you may create complications in another. This could unintentionally increase your expenses or taxes. Your situation might also include special issues or circumstances. A do-it-yourself website might not be able to tell you how to account for your specific situation in the best possible way. It will just give you a blanket list, and it will all be cookie cutter. You will not have the individual attention to your goals and priorities you get by sitting down and talking to an experienced estate planning attorney.

Estate laws vary from state to state. Every state may have different rules for estate planning, such as for powers of attorney or a health care proxy. There are also 17 states and the District of Columbia that tax your estate, inheritance, or both. These tax laws can impact your estate planning. Eleven states and DC only have an estate tax (CT, HI, IL, ME, MA, MN, NY, OR, RI, VT and WA). Iowa, Kentucky, Nebraska, New Jersey and Pennsylvania have only an inheritance tax. Maryland has both an inheritance tax and an estate tax.

Setting up health care directives and making end-of-life decisions can be very involved. It is too important to try to do it yourself. If you make a mistake, it could impact the ability of your family to take care of financial expenses or manage health care issues. Do not do it yourself.

Reference: US News & World Report (July 5, 2021) “6 Common Myths About Estate Planning”

 

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What Exactly Is a Trust? – Annapolis and Towson Estate Planning

MSN Money’s recent article entitled “What is a trust?” explains that many people create trusts to minimize issues and costs for their families or to create a legacy of charitable giving. Trusts can be used in conjunction with a last will to instruct where your assets should go after you die. However, trusts offer several great estate planning benefits that you do not get in a last will, like letting your heirs to see a relatively speedy conclusion to settling your estate.

Working with an experienced estate planning attorney, you can create a trust to minimize taxes, protect assets and spare your family from going through the lengthy probate process to divide up your assets after you pass away. A trust can also let you control to whom your assets will be disbursed, as well as how the money will be paid out. That is a major point if the beneficiary is a child or a family member who does not have the ability to handle money wisely. You can name a trustee to execute your wishes stated in the trust document. When you draft a trust, you can:

  • Say where your assets go and when your beneficiaries have access to them
  • Save your beneficiaries from paying estate taxes and court fees
  • Shield your assets from your beneficiaries’ creditors or from loss through divorce settlements
  • Instruct where your remaining assets should go if a beneficiary dies, which can be helpful in a family that includes second marriages and stepchildren; and
  • Avoid a long probate court process.

One of the most common trusts is called a living or revocable trust, which lets you put assets in a trust while you are alive. The control of the trust is transferred after you die to beneficiaries that you named. You might want to ask an experienced estate planning attorney about creating a living trust for several reasons, such as:

  • If you would like someone else to take on the management responsibilities for some or all of your property
  • If you have a business and want to be certain that it operates smoothly with no interruption of income flow, if you die or become disabled
  • If you want to shield assets from the incompetency or incapacity of yourself or your beneficiaries; or
  • If you want to decrease the chances that your will may be contested.

A living trust can be a smart move for those with even relatively modest estates. The downside is that while a revocable trust will usually keep your assets out of probate if you were to die, there still will be estate taxes if you hit the threshold.

By contrast, an irrevocable trust cannot be changed once it has been created. You also relinquish control of the assets you put into the trust. However, an irrevocable trust has a key advantage in that it can protect beneficiaries from probate and estate taxes.

In addition, there are many types of specialty trusts you can create. Each is structured to accomplish different goals. Ask an experienced estate planning attorney about these.

Reference: MSN Money (July 9, 2021) “What is a trust?”

 

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Do You have to Go through Probate when Someone Dies? – Annapolis and Towson Estate Planning

Probate involves assets, debts and distribution. The administration of a probate estate involves gathering all assets owned by the decedent, all claims owed to the decedent and the payments of all liabilities owed by the decedent or the estate of the decedent and the distribution of remaining assets to beneficiaries. If this sounds complicated, that is because it is, according to the article “The probate talk: Administrators, creditors and beneficiaries need to know” from The Dallas Morning News.

The admission of a decedent’s will to probate may be challenged for up to two years from the date it was admitted to probate. Many people dismiss this concern, because they believe they have done everything they could to avoid probate, from assigning beneficiary designations to creating trusts. Those are necessary steps in estate planning, but there are some possibilities that executors and beneficiaries need to know.

Any creditor can open a probate estate and sue to pull assets back into the estate. A disappointed heir can sue the executor/administrator and claim that designations and transfers were made when the decedent was incapacitated, unduly influenced or the victim of fraud.

It is very important that the administrator handles estate matters with meticulous attention to detail, documenting every transaction, maintaining scrupulous records and steering clear of anything that might even appear to be self-dealing. The administrator has a fiduciary duty to keep the beneficiaries of the estate reasonably informed of the process, act promptly and diligently administer and settle the estate.

The administrator must also be in a position to account for all revenue received, money spent and assets sold. The estate’s property must not be mixed in any way with the administrator’s own property or funds or business interests.

The administrator may not engage in any self-dealing. No matter how easily it may be to justify making a transaction, buying any of the estate’s assets for their own benefit or using their own accounts to temporarily hold money, is not permitted.

The administrator must obtain a separate tax identification number from the IRS, known as an EIN, for the probate estate. This is the identification number used to open an estate bank account to hold the estate’s cash and any investment grade assets. The account has to be properly named, on behalf of the probate estate. Anything that is cash must pass through the estate account, and every single receipt and disbursement should be documented. There is no room for fuzzy accounting in an estate administration, as any estate planning lawyer will advise.

Distributions do not get made, until all creditors are paid. This may not win the administrator any popularity contests, but it is required. No creditors are paid until the taxes are paid—the last year’s taxes for the last year the decedent was alive, and the estate taxes. The administrator may be held personally liable, if money is paid out to creditors or beneficiaries and there is not enough money in the estate to pay taxes.

If the estate contains multiple properties in different states, probate must be done in all of those different states. If it is a large complex estate, an estate planning attorney will be a valuable resource in helping to avoid pitfalls, minor or major.

Reference: The Dallas Morning News (May 16, 2021) “The probate talk: Administrators, creditors and beneficiaries need to know”

 

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Does Your State Have an Estate or Inheritance Tax? – Annapolis and Towson Estate Planning

Did you know that Hawaii and the State of Washington have the highest estate tax rates in the nation at 20%? There are 8 states and DC that are next with a top rate of 16%. Massachusetts and Oregon have the lowest exemption levels at $1 million, and Connecticut has the highest exemption level at $7.1 million.

The Tax Foundation’s recent article entitled “Does Your State Have an Estate or Inheritance Tax?” says that of the six states with inheritance taxes, Nebraska has the highest top rate at 18%, and Maryland has the lowest top rate at 10%. All six of these states exempt spouses, and some fully or partially exempt immediate relatives.

Estate taxes are paid by the decedent’s estate, prior to asset distribution to the heirs. The tax is imposed on the overall value of the estate. Inheritance taxes are due from the recipient of a bequest and are based on the amount distributed to each beneficiary.

Most states have been steering away from estate or inheritance taxes or have upped their exemption levels because estate taxes without the federal exemption hurt a state’s competitiveness. Delaware repealed its estate tax at the start of 2018, and New Jersey finished its phase out of its estate tax at the same time. The Garden State now only imposes an inheritance tax.

Connecticut still is phasing in an increase to its estate exemption. They plan to mirror the federal exemption by 2023. However, as the exemption increases, the minimum tax rate also increases. In 2020, rates started at 10%, while the lowest rate in 2021 is 10.8%. Connecticut’s estate tax will have a flat rate of 12% by 2023.

In Vermont, they’re still phasing in an estate exemption increase. They are upping the exemption to $5 million on January 1, compared to $4.5 million in 2020.

DC has gone in the opposite direction. The District has dropped its estate tax exemption from $5.8 million to $4 million in 2021, but at the same time decreased its bottom rate from 12% to 11.2%.

Remember that the Tax Cuts and Jobs Act of 2017 raised the estate tax exclusion from $5.49 million to $11.2 million per person. This expires December 31, 2025, unless reduced sooner!

Talk to an experienced estate planning attorney about estate and inheritance taxes, and see if you need to know about either, in your state.

Reference: The Tax Foundation (Feb. 24, 2021) “Does Your State Have an Estate or Inheritance Tax?”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys