How to Plan in a Time of Uncertainty – Annapolis and Towson Estate Planning

There’s a saying in estate planning circles that the only people who pay estate taxes are those who don’t plan not to pay estate taxes. While this does not cover every situation, there is a lot of truth to it. A recent article from Financial Advisor entitled “Estate Planning In This Particular Time of Uncertainty” offers strategies and estate planning techniques to be considered during these volatile times.

Gifting Assets into Irrevocable Trusts to Benefit Family Members. If done correctly, this serves to remove the current value and all future appreciation of these assets from your estate. With the federal estate tax exemption ending at the end of 2025, the exemption will drop from $12.06 million per person to nearly half that amount.

Combine this with a time of volatile asset prices and it becomes fairly obvious: this would be a good time to take investments with a lowered value out of the individual owner’s hands and gift them into an irrevocable trust. The lower the value of the asset at the time of the gift, the less the amount of the lifetime exemption that needs to be used. If assets are expected to recover and appreciate, this strategy makes even more sense.

Spousal Limited Access Trust (SLAT). This may be a good time for a related technique, the SLAT, an irrevocable trust created by one spouse to benefit the other and often, the couple’s children. Access to income and principal is created during the spouse’s lifetime. It can even be drafted as a dynasty trust. Assets can be gifted out of the estate to the trust and while the grantor (the person creating the trust) cannot be a beneficiary, their family can. Couples may also create reciprocating SLATs, where each is the beneficiary of the other’s trust, as long as they are careful not to create duplicate trusts, which have been found invalid by courts. Talk with an experienced estate planning attorney about how a SLAT may work for you and your spouse.

What about interest rates? A Grantor Retained Annuity Trust (GRAT), where the grantor contributes assets and enjoys a fixed annuity stream for the life of the trust, may be advantageous now. At the end of the trust term, remaining assets are distributed to family members or a trust for their benefit. To avoid a gift tax on the calculated remainder, due when the trust is created, most GRATs are “zeroed out,” that is, the present value of the annuity stream to the grantor is equal to the amount of the initial funding of the trust. Since you get back what’s been put in, no taxable gift occurs. The lower the interest rate, the higher the value of the income stream. The grantor can take a lower annuity amount and with decent appreciation of assets in the trust, there will be a larger amount as a remainder for heirs. Interest rates need to be considered when looking into GRATs.

Qualified Personal Residence Trust (QPRT) is a trust used to transfer a primary residence to beneficiaries with minimal gift tax consequences. The grantor retains the right to live in the house at no charge for a certain period of time. After the time period ends, the property and any appreciation in value passes to beneficiaries. The valuation for the value of the initial transfer into the trust for gift tax purposes is determined by a calculation relying heavily on interest rates. In this case, a higher interest rate results in a lower present value of the remainder and a lower gift value when the trust is created.

Reference: Financial Advisor (July 8, 2022) “Estate Planning In This Particular Time of Uncertainty”

 

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When Should I Hire an Estate Planning Attorney? – Annapolis and Towson Estate Planning

Kiplinger’s recent article entitled “Should I Hire an Estate Planning Attorney Now That I Am a Widow?” describes some situations where an experienced estate planning attorney is really required:

Estates with many types of complicated assets. Hiring an experienced estate planning attorney is a must for more complicated estates. These are estates with multiple investments, numerous assets, cryptocurrency, hedge funds, private equity, or a business. Some estates also include significant real estate, including vacation homes, commercial properties and timeshares. Managing, appraising and selling a business, real estate and complex investments are all jobs that require some expertise and experience. In addition, valuing private equity investments and certain hedge funds is also not straightforward and can require the services of an expert.

The estate might owe federal or state estate tax. In some estates, there are time-sensitive decisions that require somewhat immediate attention. Even if all assets were held jointly and court involvement is unnecessary, hiring a knowledgeable trust and estate lawyer may have real tax benefits. There are many planning strategies from which testators and their heirs can benefit. For example, the will or an estate tax return may need to be filed to transfer the deceased spouse’s unused Federal Estate Unified Tax Credit to the surviving spouse. The decision whether to transfer to an unused unified tax credit to the surviving spouse is not obvious and requires guidance from an experienced estate planning attorney.

Many states also impose their own estate taxes, and many of these states impose taxes on an estate valued at $1 million or more. Therefore, when you add the value of a home, investments and life insurance proceeds, many Americans will find themselves on the wrong side of the state exemption and owe estate taxes.

The family is fighting. Family disputes often emerge after the death of a parent. It is stressful, and emotions run high. No one is really operating at their best. If unhappy family members want to contest the will or are threatening a lawsuit, you will also need guidance from an experienced estate planning attorney. These fights can result in time-intensive and costly lawsuits. The sooner you get legal advice from a probate attorney, the better chance you have of avoiding this.

Complicated beneficiary plans. Some wills have tricky beneficiary designations that leave assets to one child but nothing to another. Others could include charitable bequests or leave assets to many beneficiaries.

Talk to an experienced attorney, whose primary focus is estate and trust law.

Reference: Kiplinger (July 5, 2022) “Should I Hire an Estate Planning Attorney Now That I Am a Widow?”

 

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What’s Involved with Being a Trustee? – Annapolis and Towson Estate Planning

There is an old saying that the two best days in a boat owner’s life are the day they buy their boat and the day they sell it.

Forbes’ recent article entitled “How To Be An Effective Trustee” says that a similar notion applies to being a trustee – it is an honor to be named and then a huge relief when it is over. That is because being a trustee is difficult.

Remember that a trust is a fiduciary relationship in which one party (the trustor) gives another party (the trustee) the right to hold title to property or assets for the benefit of a third party (the beneficiary). Trusts are created to provide legal protection for the trustor’s assets, to make certain those assets are distributed according to the wishes of the trustor, and to save time, reduce paperwork and, in some cases, avoid or reduce inheritance or estate taxes.

Being a trustee requires knowledge about a wide range of topics, including:

  • The trustee’s fiduciary duties, which include loyalty, impartiality, duty of care, protection of trust property, enforcement of claims and the duty to inform and account to beneficiaries, among others (violation of these duties exposes the trustee to liability).
  • Understanding the details of the trust, like the specifics of the distribution instructions.
  • Investments and the ability to engage and monitor investment managers.
  • Administrative matters, such as record keeping and principal and income accounting.
  • Estate planning, trusts and the basics of the estate, gift and generation skipping taxes.
  • Income tax, including how trusts are taxed both by the federal government and the state.

A trustee must also be able to productively communicate and work with the beneficiaries on their financial wellness and distribution needs, which is an area that can be full of conflict.

It is a daunting list. Talk with an experienced estate planning attorney to discuss your situation in detail.

Reference: Forbes (May 31, 2022) “How To Be An Effective Trustee”

 

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Is Your Estate Plan Ready for Tax Changes? – Annapolis and Towson Estate Planning

After December 1, 2025, the federal estate tax exemption will fall back to $5 million (indexed for inflation) from the current $12 million level. Now is the time to use available estate planning strategies and ensure that your plan factors in changes in tax law, advises a recent article titled “Are Clients’ Current Estate Plans Soundproof for the Future?” from Financial Advisor.

For many families, structured and leveraged gifting is one of the most useful wealth transfer vehicles. A parent could use their GST and gift tax exemptions to make gifts to children, grandchildren and other family members before this tax law changes.

Here is an example, using a high-net-worth family. Bill and Sue are married, so they can make combined lifetime gifts of $24,120,000. They own a family business worth $10 million in equal shares. They transfer 20% of the business to their children. This is a minority stake, meaning the minority owners have no right to make relevant business decisions and vote on important issues. As a result, the minority stake is discounted and worth $1.3 million instead of $2 million for gift and estate tax purposes and Bill and Sue retain $700,000 more of their allotted exemption.

For lifetime transfers, the valuation date is the date of the gifting, but for transfers at death, the valuation date is the date of death. By using this valuation discount while they are living, Bill and Sue have reduced the value of their company for estate tax purposes, giving their children a percentage of the company in a manner costing less in terms of transfer tax.

By making these gifts in 2022, Bill and Sue have removed $24,120,000 from their estate tax free. They have also removed the appreciation on the assets gifted away from their estate. However—if the gift is not made and the federal estate tax exemption reduces to $6 million per person before their deaths in 2040, then when the second spouse dies, heirs or beneficiaries will receive significantly less than what they would have received if the gift was made prior to the reduction of the federal exemption.

There was concern about tax outcomes if the taxpayer makes gifts now and the exemptions are reduced sooner. However, the IRS Treasury Decision 9884 confirms there will be no claw backs under these circumstances.

If the parents are concerned about making outright gifts to chosen beneficiaries who are too young, immature, or vulnerable to creditors, other strategies can be used to allow them to maintain control, while protecting assets and locking in these estate and gift tax advantages. The grantor can execute a plan ensuring that the donor receives an income from the transferred asset and/or maintaining access to principal.

Speak with an experienced estate planning attorney to learn what strategies are available now to prevent overly burdensome estate taxes in the future. After all, 2025 is not as far away as it seems.

Reference: Financial Advisor (June 8, 2022) “Are Clients’ Current Estate Plans Soundproof for the Future?”

 

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What Can a Trust Do for Me and My Family? – Annapolis and Towson Estate Planning

A trust is defined as a legal contract that lets an individual or entity (the trustee) hold assets on behalf of another person (the beneficiary). The assets in the trust can be cash, investments, physical assets like real estate, business interests and digital assets. There is no minimum amount of money needed to establish a trust.

US News’ recent article entitled “Trusts Explained” explains that trusts can be structured in a number of ways to instruct the way in which the assets are handled both during and after your lifetime. Trusts can reduce estate taxes and provide many other benefits.

Placing assets in a trust lets you know that they will be managed through your instructions, even if you are unable to manage them yourself. Trusts also bypass the probate process. This lets your heirs get the trust assets faster than if they were transferred through a will.

The two main types of trusts are revocable (known as “living trusts”) and irrevocable trusts. A revocable trust allows the grantor to change the terms of the trust or dissolve the trust at any time. Revocable trusts avoid probate, but the assets in them are generally still considered part of your estate. That is because you retain control over them during your lifetime.

To totally remove the assets from your estate, you need an irrevocable trust. An irrevocable trust cannot be altered by the grantor after it has been created. Therefore, if you are the grantor, you cannot change the terms of the trust, such as the beneficiaries, or dissolve the trust after it has been established.

You also lose control over the assets you put into an irrevocable trust.

Trusts give you more say about your assets than a will does. With a trust, you can set more particular terms as to when your beneficiaries receive those assets. Another type of trust is created under a last will and testament and is known as a testamentary trust. Although the last will must be probated to create the testamentary trust, this trust can protect an inheritance from and for your heirs as you design.

Trusts are not a do-it-yourself proposition: ask for the expertise of an experienced estate planning attorney.

Reference: US News (Feb. 7, 2022) “Trusts Explained”

 

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Can You Get a Tax Deduction for Giving a Gift? – Annapolis and Towson Estate Planning

Despite multiple proposals and countless legislative revisions, changes to everything from realizations of gains at death, lower federal transfer tax exemptions, raised estate tax rates and eliminating benefits of irrevocable grantor trusts, to name a few, have failed to become reality. However, that does not mean the proposals have disappeared for good, according to the article “Five Situations When Taxable Gifts Make Sense” from Wealth Management. In this environment, estate planning still needs to be done, although the tools to do so may be slightly different in case the tax laws change—or if they don’t.

Here are five different situations where making taxable gifts over the current $16,000 gift tax annual exclusion makes sense.

If you want to make a gift. You may want to make a gift, so a child can buy a home or start a business venture. Perhaps you want to bring a child into the ownership of a family business, or you simply want to share your wealth, more than the $16,000 exclusion. The federal gift tax exemption has never been this high, and the only tax downside might be the need to file a gift tax return.

What about the Step Up in Basis? The main reason not to make taxable gifts now is the step-up in income tax basis. Under current rules, assets transferred at death receive a step-up in income tax basis to the value at the time of death. Assets transferred by gift do not receive this benefit. If you wanted to give a $2 million property with a $100,000 tax basis, you will need to be prepared for the tax consequences.

Do you own rapidly appreciating assets? The main reason to make taxable gifts concerns appreciation. If your estate is well over the estate tax exemption, your heirs will save 40 cents for every dollar of appreciation, better in the hands of heirs rather than part of your estate. In this case, giving early makes all the difference. Business owners may give stock based on the growth they hope to achieve for a company.

Do you have a very large estate with high-basis assets and haven’t used your exemption? By all means, be generous! Under the current rules, even with no legislative changes, everything will be cut in half in 2026.

Are you sure your tax liability is going to increase in the future? Then making gifts today will help in the future.

Gifting can be a good way to spread income among family members, while avoiding having assets subject to a wealth tax. Gifting may also work to establish structures, like irrevocable grantor trusts or family limited partnerships, which might be more complicated in the future.

It is hard to say what the transfer tax rules will be five, fifteen, or fifty-five years from now. However, there are situations where making significant gifts makes sense. Remember, while the only sure things in life are death and taxes, tax laws do change.

Reference: Wealth Management (Feb. 2, 2022) “Five Situations When Taxable Gifts Make Sense”

 

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Estate Planning when So Much Is Uncertain – Annapolis and Towson Estate Planning

Negotiations in Washington continue to present a series of changing scenarios for estate planning. Until the ink is dry in the Oval Office, taxpayers face an uncertain legislative environment, says a recent article titled “Estate Planning in an Uncertain Time” from CPA Practice Advisor. Many people hurried to use lifetime gifting strategies because of estate tax provisions contained in earlier versions of the infrastructure bill, but even with these provisions dropped (for now), there are still good reasons to use lifetime gifting strategies.

The current $11.7 million estate/gift tax exemption will still be reduced on January 1, 2026, even if Congress takes no other action. Taxpayers who have not taken advantage of this “extra” exemption before then will lose the opportunity forever.

Any post-appreciation transfer on gifted assets accrues outside of the taxpayer’s estate. For younger individuals and for transferred assets with high potential for appreciation, this could have a major impact. Taxpayers who reside in states with a state estate tax, but no state gift tax, may find that lifetime gifting could reduce state estate tax liability.

For those who have already used all of their estate/gift tax exemption, the current low interest rate environment makes certain advanced estate planning techniques more appealing. Sales to IDGTS (Intentionally Defective Grantor Trusts, a type of irrevocable trust), intra-family loans and GRATS (Grantor Retained Annuity Trusts) are more effective when interest rates are low.

The two interest rates to watch for these strategies are the federal Section 7520 rate and the short-term, mid-term and long-term applicable federal rate (AFR). If transferred assets appreciate faster than the benchmark interest rate, any excess appreciation passes without any estate/gift tax exemption being used.

Interest rates have increased in recent months. However, by historical standards, they remain low.

IDGTs are expected to remain popular for making lifetime transfers. They are a type of trust outside the taxpayer’s estate for estate tax purposes and are considered to belong to the grantor for income tax purposes. The grantor is responsible for paying the income tax of the trust, which permits the grantor to make a tax-free gift, while the assets of the IDGT may grow without income taxes.

The grantor may also sell assets to an IDGT without creating a realization event for income tax purposes. Congress may consider this a little too effective for estate taxes, but for now, this strategy is still available.

Speak with an experienced estate planning attorney to review your current lifetime gifting plan and see if it needs to be revised. Of course, if you do not have an estate plan, now is the time to get that underway.

Reference: CPA Practice Advisor (Nov. 17, 2021) “Estate Planning in an Uncertain Time”

 

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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”

 

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