Image of money wrapped in a bowAlong with the recent talk of health care and income tax reform, there has been much discussion of repealing “death” taxes or estate taxes (see our earlier post regarding that topic here). We are yet to find out if there is enough political support to make that happen or how transferring wealth at death will look without it. More certain, however, is that another wealth transfer tax, the gift tax, is here to stay, primarily because the gift tax has long been considered a “backstop” for the income tax. For example, potential gift tax consequences complicate plans to transfer property to an individual in a lower income tax bracket solely to sell the property before transferring the proceeds back to the original owner.

While the estate tax is a tax on the transfer of property at death, the gift tax is a tax on the transfer of property during life. Subject to certain exceptions, a transfer of property to another individual during life is subject to gift tax when the person making the transfer (the “transferor”) does not receive adequate consideration (i.e., property having an equal value to the transferred property) in return.

A gift tax return (Form 709) is required to be filed in many cases, even when no gift tax is due. The return is generally due on April 15 following the year of the gift. When gift tax is due, it must be paid by the transferor – not the person receiving the gift – and the highest gift tax rate is equal to 40 percent of the value of the gift.

The exceptions to the gift tax are significant enough that few people ever have to file a gift tax return, and even fewer ever owe gift tax. Those exceptions are as follows:

  • Marital deduction: Gifts to a U.S. citizen spouse, including outright gifts and gifts to qualifying trusts, receive a 100 percent marital deduction, meaning they are entirely exempt from gift tax.
  • Charitable deduction: Gifts to qualifying charities also receive a 100 percent charitable deduction, again meaning they are entirely exempt from gift tax.
  • Payments for medical care and tuition: Payments made on behalf of another individual directly to an institution or person providing medical care to that person, and payments made directly to a qualified educational institution for tuition (not room and board) for another individual are excluded from gift tax consequences.
  • Annual exclusion: As of 2017, each individual can give away up to $14,000 worth of property to as many individuals desired during a single year without gift tax consequences. The “annual exclusion amount” is indexed to inflation, but it only moves in $1,000 increments. A requirement of this “annual exclusion” from gift tax is that the gift must be of a present interest in property, meaning that gifts to many trusts do not qualify for the annual exclusion. This is why beneficiaries of certain trusts, such as Irrevocable Life Insurance Trusts, are often provided “Crummey” notices, or notices of present withdrawal rights, when the donor contributions money or property to the trust. Spouses can “split” gifts, meaning that one spouse can give $28,000 to an individual, and, on a timely filed gift tax return, the spouses can elect to treat the gift as if it was made one-half by each spouse. Lastly, a donor can contribute five years’ worth of annual exclusions (currently $70,000) to a 529 account in one year and elect, on a timely filed gift tax return, to have the gift treated as if it was made in equal amounts over a five-year period.
  • Lifetime exemption. As of 2017, each individual can give away up to $5,490,000 worth of property during his or her lifetime without paying gift tax. Under current law, this amount, known as the “applicable exclusion amount,” or the “exemption amount,” is also the amount that can pass at an individual’s death free of estate taxes. If the estate tax is repealed, this number may change since it is based on the current estate tax. We will watch legislation closely and will provide an update if this amount changes.

Even if your plan to transfer property to another individual such as your spouse, child, or grandchild does not fit within one of the above exceptions, our attorneys are experienced with techniques that avoid negative gift tax consequences such as installment sales and low-interest loans. Additionally, since the gift tax is based on the value of property transferred, we can discuss legal techniques to reduce, or discount, the value of property transferred in order to reduce the gift tax consequences.

If you would like to discuss questions related to the gift tax, please contact an attorney in our Trusts & Estates practice group.

IRS releases AFRs for May 2017The Internal Revenue Service has released the Applicable Federal Rates (AFRs) for May 2017. AFRs are published monthly and represent the minimum interest rates that should be charged for family loans to avoid tax complications.

Here are the rates for May 2017:

 

Annual

Semiannual

Quarterly

Monthly

Short-term

1.15%

1.15%

1.15%

1.15%

Mid-term

2.04%

2.03%

2.02%

2.02%

Long-term

2.75%

2.73%

2.72%

2.71%

   

The Section 7520 interest rate for May 2017 drops to 2.4 percent. The Section 7520 interest rate is the interest used in a common estate tax planning technique called a “grantor retained annuity trust” or “GRAT.” In general, the lower the interest rate, the more effective the transaction is for reducing estate taxes.

For more information, see the full listing from the IRS here.

Image of moving van filled with moving boxesMoving from one state to another is often time-consuming. You may spend days looking for the right home or apartment, and more time painting, remodeling or ripping down outdated wallpaper — not to mention countless hours bubble-wrapping and then unpacking fragile items.

But to really make sure your move is perfect, you need to review your estate plan with an attorney. While trust and estate laws may be similar from state to state, no two legal systems are identical.

Most states will recognize and probate a will drafted elsewhere that complies with the former state’s execution requirements. However, if a dispute arises, a judge unfamiliar with your old state’s law may be called upon to resolve the issues and may not interpret your documents as you intended. Further, your new state could have restrictions or burdens on out-of-state executors serving under your will.

Likewise, though many states have similar laws regarding financial and health care powers of attorney, there are no guarantees that your new bank or medical provider will follow your powers of attorney based on another state’s laws.

Perhaps one of the biggest concerns when moving is going from a common law property state to a community property state, or vice versa. Most states follow the common law property theory  — basically, that each spouse’s separate property obtained during marriage remains separate. Some, however, follow the community property theory, which generally holds that all assets acquired during marriage are considered jointly held by both spouses. Moving between states with different property laws can confuse your estate plan by making it unclear who owns what property at death. There can also be significant tax consequences at death depending on whether property is classified as community or common law. 

There are other tax issues to consider as well. Several states impose no income tax, while others have high income tax rates, creating opportunities for planning. Also, some states have implemented their own estate or inheritance taxes, which may have lower exclusions than the federal estate tax exclusion of $5,490,000 in 2017. An old estate plan drafted with only the federal exclusion amount in mind may be taxable by your new state.

Moving can be tedious and nerve-wracking. By speaking to an estate planning attorney about your move, you can avoid future estate planning surprises and rest a little easier in your new home.

Probate is the process by which estate assets pass to a person’s surviving heirs after death. With certain exceptions, any asset the decedent owned in his or her individual name must go through probate.

If a decedent dies with a valid will in place, it is referred to as a testate estate. If the decedent dies without a valid will, it is known as an intestate estate. In either case, probate of the estate will be necessary.

Probate requires an estate to be opened in the probate court of the county and state where the person was domiciled at the time of his or her death. For a testate estate, the decedent’s will governs the distribution of the estate assets. But for an intestate estate, the default rules of the state where the decedent was domiciled will determine how the estate assets are distributed.

The probate rules vary from state to state, and in some cases even county to county. However, most probate laws tend to follow a similar process and rules. Those rules typically include filing requirements for the decedent’s will, formal notice requirements to interested parties (such as heirs and creditors of the decedent), and timelines and deadlines for administering the estate. Unless the court grants independent administration, the estate’s executor or administrator will be required to report regularly to the court and sometimes even must get the court’s permission before taking any official action for the estate. Probate filings and proceedings are also open to the public, and additional court fees and legal expenses can be incurred.

So how can you avoid probate?

Assets titled jointly with any other individual(s) and assets with a beneficiary designation attached (e.g. life insurance policies with a designated beneficiary, retirement accounts with a designated beneficiary, and transfer on death designations) will pass to the surviving owners or designated beneficiaries at the decedent’s death without probate. Also, assets owned by a trust will not be subject to probate and therefore can pass to designated beneficiaries outside of probate at the decedent’s death.

Avoiding probate can help avoid the rules and timelines it requires, which can often help save time and money by expediting the administration of the decedent’s legal affairs. It can also help ensure more privacy of your loved one’s affairs, as well as reduce the stress and emotions of dealing with everything.  

Please feel free to contact any of our estate planning attorneys to help you design an effective strategy for avoiding probate in your own estate plan.

As a result of legislation enacted in 2015, the filing deadlines for certain tax returns due in 2017 have changed. Congress included tax return due date legislation as a revenue provision in the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015. The legislation, signed into law in July 2015, made changes to certain tax return due dates generally effective for tax years beginning after Dec. 31, 2015, making the changes applicable to 2016 tax returns filed in 2017.

Of particular significance in the trusts and estates area is the new extension deadline date for filing Trust and Estate Form 1041. The standard filing deadline remains April 15 (April 18 for 2017 due to a weekend and holiday). However, the new extension deadline is 5½ months from that date, or Sept. 30. Previously, the filing deadline was five months, or Sept. 15.

There are also a variety of changes to other due dates, including for Partnership Form 1065, which is now due March 15, and Form 1120 for C corporations that report on a calendar year, which is now due April 15. There are no changes for S corporations nor are there changes to the deadlines for individuals filing Form 1040.

Below is a chart that summarizes several of the significant changes. (((Here))) is a link to the AICPA website that gives a more detailed analysis of the changes.

Original and Extended Tax Return Due Dates

Changes are generally effective for taxable years starting after Dec. 31, 2015 (2016 tax returns prepared during the 2017 tax filing season).

Table showing original and extended tax return due dates for 2017

The Internal Revenue Service has released the Applicable Federal Rates (AFRs) for April 2017, reflecting increases from the March rates. AFRs are published monthly and represent the minimum interest rates that should be charged for family loans to avoid tax complications.

Here are the rates for April 2017:

 

Annual

Semiannual

Quarterly

Monthly

Short-term

1.11%

1.11%

 1.11%

1.11%

Mid-term

2.12%

2.11%

2.10%

2.10%

Long-term

2.82%

2.80%

2.79%

2.78%

   

The Section 7520 interest rate for April 2017 rises to 2.6 percent. The Section 7520 interest rate is the interest used in a common estate tax planning technique called a “grantor retained annuity trust” or “GRAT.” In general, the lower the interest rate, the more effective the transaction is for reducing estate taxes.

For more information, see the full listing from the IRS here.

Image of father and soon holding piggy bankIn most states, including Missouri and Illinois, 18 is the legal age of majority. At that age, a person becomes an adult in the eyes of the law and gains all of the rights that go along with adulthood. Any person under 18 is a minor and, generally, does not have the legal capacity (or right) to control or manage his or her assets, including an inheritance.

On occasion, a minor child ends up as the beneficiary of a family’s wealth. Sometimes this happens because a minor’s parent dies unexpectedly without a will or trust. Direct inheritance by a minor under these circumstances is unavoidable. Other times, however, the minor is designated by a well-meaning family member as a beneficiary of a life insurance policy or a retirement account. This, unfortunately, can create a major problem for the minor.

By law, a minor cannot take control of inherited assets that are left directly to the minor. An individual adult or, possibly, a financial institution (in Missouri, a “conservator;” in Illinois, a “guardian of the estate”) must be appointed by a probate court to manage the minor’s estate until the minor reaches age 18. This type of probate estate can be expensive and time-consuming, as the minor’s estate will be supervised by the probate court. Court supervision requires the ongoing involvement of an attorney to file detailed, annual accountings on behalf of the conservator. These are scrutinized by the court to ensure proper management of the assets, particularly with respect to investments and expenditures.

Nearly all expenditures from the minor’s funds require court authorization, which is often difficult to obtain, as the objective of most courts is to preserve and protect the minor’s assets until the age of majority is reached. Despite such an objective, however, ongoing administration of a minor’s estate, particularly of a very young minor, can result in significant expenses and fees, which are properly paid from the minor’s assets. Years of administrative expenses can reduce the minor’s inheritance over the long term. Finally, when the minor reaches age 18, all of the assets of the estate will be distributed at once directly to the minor, now adult, to be managed (or more likely spent) as he or she pleases. This result, in particular, is one most families would prefer to avoid.

If you would like to discuss how to structure your estate plan, including your beneficiary designations for life insurance and retirement accounts, to ensure the minors in your family do not inherit a major headache, contact our Trusts & Estates group.

AFRsThe Internal Revenue Service has released the Applicable Federal Rates (AFRs) for March 2017, reflecting decreases from the February rates. AFRs are published monthly and represent the minimum interest rates that should be charged for family loans to avoid tax complications.

Here are the rates for March 2017:

 

Annual

Semiannual

Quarterly

Monthly

Short-term

1.01%

1.01%

 1.01%

1.01%

Mid-term

2.05%

2.04%

2.03%

2.03%

Long-term

2.78%

2.76%

2.75%

2.74%

   

The Section 7520 interest rate for March 2017 drops to 2.4 percent. The Section 7520 interest rate is the interest used in a common estate tax planning technique called a “grantor retained annuity trust” or “GRAT.” In general, the lower the interest rate, the more effective the transaction is for reducing estate taxes.

For more information, see the full listing from the IRS here.

Hands making the shape of a heart over the EarthAn often-overlooked estate planning trap involves including individuals who are not U.S. citizens as part of an estate plan.

If someone who is not a U.S. citizen or resident is given control over a trust, either as a trustee or a beneficiary, then the trust will be treated as a foreign trust and will be subject to additional income taxes.

While some people have the option of naming individuals who are U.S. citizens or U.S. residents in their trusts, others do not. For them, planning alternatives may be available so they can avoid the additional income tax of a foreign trust. Options may include naming a corporate trustee, naming individuals who are U.S. citizens or U.S. residents to serve as co-trustees with the individual who is not, or limiting the powers of a trustee or beneficiary who is not a U.S. citizen or U.S. resident.

If a client’s spouse is not a U.S. citizen, this raises a different type of tax issue. Generally, a deceased spouse is able to pass an unlimited amount of assets to the surviving spouse estate tax free, through an unlimited marital deduction from estate taxes. However, if the surviving spouse is not a U.S. citizen, that unlimited marital deduction is not available. To avoid this, the spouse should consider leaving his or her assets for the surviving spouse in a qualified domestic trust, commonly known as a QDOT.

If you would like to discuss creating an estate plan that includes individuals who are not U.S. citizens, please contact our Trusts & Estates group.

Q: What do you think about the future of the estate tax now that Trump is president? I heard one of his proposals was to eliminate the estate tax. Do I need to even be concerned with estate tax planning going forward?

A: I understand your concern. President Trump’s tax reform proposal, as described on his campaign website, stated that, “The Trump Plan will repeal the death tax, but capital gains held until death and valued over $10 million will be subject to tax to exempt small businesses and family farms. To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives will be disallowed.”

Q: So is the death tax the same as the estate tax? What about capital gains at death? How will that work?

A: It is probably safe to assume that the death tax in his proposal is referring to the estate tax. With respect to the capital gains tax at death on assets valued over $10 million, it is not as clear. One possibility is that assets valued over $10 million will be treated similar to how assets are taxed in Canada at death. In Canada, there is no estate or inheritance tax. Instead the Canada Revenue Agency treats the decedent’s estate as though the decedent disposed of all their assets immediately before death, in a taxable transaction like a sale. Thus, gain is recognized to the extent the value of the assets exceed their basis, unless the estate is subject to an exception such as being inherited by the surviving spouse or common-law partner. Therefore, it’s possible under Trump’s plan unrealized gains would be recognized at death, but only on assets exceeding a $10 million threshold.

However, another take on this is that instead of gains being recognized at death, the appreciated property in excess of $10 million will be subject to a carryover basis, subjecting beneficiaries to income tax on the gains when they dispose of the property in the future. Recall that when the estate tax was repealed for 2010, carryover basis took effect (i.e., no basis step-up). It is not clear, though, that carryover basis will be enacted if the estate tax is repealed. Some say it will be a question of cost.

Q: Trump also mentions in his proposal that he will disallow certain contributions to a private charity established by the decedent or the decedent’s relatives. What is this about?

A: That’s right. Under Trump’s plan, “contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives will be disallowed.” Unfortunately, it is unclear what “disallowed” means and whether this disallowance will apply only at death, or if it will also apply to lifetime transfers.

Q: Trump’s plan doesn’t mention anything about the gift tax? Will that also be repealed?

A: There is no mention of repeal of the gift tax in Trump’s proposal. Similarly, in the House Republican Blueprint, there is no mention of repeal of the gift tax.

Many commentators point out that the gift tax works as a “back stop” to the income tax. As an example, if the gift tax were repealed, a parent could gift an asset to a child in order to shift income to a child who is in a lower tax bracket. After the transfer, which will have no cost, the child could sell the asset, recognize a lower income tax than the parent and then gift a portion or all of the sale proceeds back to the parent. This is just one example of why a repeal of the gift tax could cause a significant reduction in government revenue from income tax receipts. As a result, many believe repeal of the gift tax is unlikely.

Q: You mention the House Republican “blueprint.” What is that?

A: In June 2016, House Republicans released a “blueprint” for tax reform. The blueprint generally makes a proposal to reduce tax rates for businesses and individuals. Under the U.S. Constitution, revenue measures must originate in the House. Because Republicans control the House and the Senate, it seems likely that the House will begin the tax reform process by proposing a bill based on the “blueprint,” modified to incorporate parts of the Trump proposal.

Q: In what other ways is the House blueprint similar to Trump’s proposal with respect to estate and gift taxes?

A: The House blueprint similarly proposes to repeal the estate tax. However, it leaves the basis step-up at death. It also seeks to repeal the generation-skipping transfer tax, which is the tax on transfers (like the estate tax) to those two or more generations younger than the transferor. As I mentioned, it doesn’t address the repeal of the gift tax.

Q: So if the House Republicans propose such a bill, and it includes such things as estate tax repeal, what is the likelihood of it being passed?

A: The House Republicans have set forth proposals and, as recently as April 2015, obtained the votes to pass a bill to repeal the estate tax. The 2015 bill, however, kept in place the “basis step-up ” provisions of the tax code. At that time, there were not enough votes in the Senate to pass the bill (60 votes needed), and then-President Obama would have vetoed it anyway. However, six Senate Democrats have voted for estate tax repeal in the past (there are now 52 Republican Senate seats and 46 Democratic seats).

Many commentators appear to concede that a repeal, coupled with a capital gains tax on death, may be able to get the Senate votes required. However, such a bill would need to be part of an overall tax reform effort, requiring a compromise on both sides. What is different now is the willingness on the part of a Trump administration to possibly agree to a loss of basis step-up for income tax purposes. This results in not just a repeal of the estate tax, but would in effect be replacing it with an income tax on inherited assets.  Thus commentators seem to agree that if repeals are of the estate and generation-skipping transfer tax with a carryover basis (i.e. no basis step-up at death), there’s some real potential for traction.

On the other hand, some believe it is likely that at least one or two Senate Republicans will vote no for any tax reform bill, and believe there is little chance a Democrat would vote yes if it included estate tax repeal.

Q: Wouldn’t a filibuster by the Senate Democrats stop any tax reform that includes estate tax repeal?

A: Maybe, but there may also be a way around it. Despite being the minority party in the House and Senate, the Democrats still retain the ability to filibuster legislation, requiring, like I mentioned, a compromise on both sides. However, it is possible the Republicans could ultimately pass tax reform as budget reconciliation legislation, which, under what is called the Byrd rule, would have to sunset after 10 years (recall President George W. Bush’s sunset provision on his 2001 tax reform). Under the Byrd rule, any reconciliation legislation that increases deficits in years beyond the period covered by the budget resolution is subject to a point of order that can only be waived by a three-fifths (60 percent) vote. The budget reconciliation bill will require a 10-year budget, hence the 10-year sunset.

You should also keep in mind that while tax reform is a priority for the Trump administration, it is second to health reform. It will likely only be after that health reform issue is resolved that tax reform will proceed.

Q: So with all this uncertainty, how do you plan?

A: Let’s save that for our next conversation.