Posts Tagged ‘tax’

A Unique Opportunity

December 23, 2010

The new tax law (2010 Tax Relief Act) creates an once-in-a-lifetime planning opportunity that ends at midnight, December 31, 2010.

 

Generally, transfers (greater than $13,000 per year) to generations younger than children are subject to what is known as the generation-skipping transfer tax (GSTT), an onerous tax equal to the maximum gift or estate tax rate.  The purpose of this tax, enacted in the late 1980s, is to prevent wealthy individuals from transferring assets to younger generations for the purpose of avoiding application of the estate tax at every generation.

 

The 2010 Tax Relief Act creates a unique opportunity to make gifts through December 31, 2010 that are not subject to the generation-skipping transfer tax.  This is because, under the new law, the tax rate is zero for any generation skipping transfer made in 2010. Beginning January 1, 2011, the tax rate for these transfers with be 35%.  In two short years the rate goes back to 55%.

 

There are three common scenarios offering planning opportunities.  First, make gifts before December 31, 2010 to Skip Trusts.  These are trusts that you create for grandchildren, great grandchildren or more remote generations.  There will be no generation skipping transfer tax.  The gift tax is 35%, after use of the $1 million lifetime gift exclusion.  This strategy is most effective for large taxable estates.  On the gift tax return, you will want to elect out of automatic Generation Skipping Transfer (GST) allocation rules.  For 2010, you will allocate nothing to the GST Exemption because there is no estate tax.  Use a Trust Protector with the power to add beneficiaries (e.g. children/spouse).

 

The second planning scenario deals with the unique planning opportunities for those who are beneficiaries of trusts that will be subject to GSTT upon distribution from the trust.  Distributions should be made from these trusts before December 31, 2010 because the tax rate is 0%.  After this year, the distribution will be subject to at least a 35% tax rate.  Sometimes, there is concern about beneficiaries getting outright distributions.  Some of these concerns may be alleviated if the trustee invests trust assets in limited partnerships or limited liability companies (LLCs) and then distributes the partnership interests or LLC membership interests.

 

The third planning opportunity deals with clearing any loans made to trusts.  The most common scenario involves Irrevocable Life Insurance Trusts.  Until the passage of the 2010 Tax Relief Act, there was no way to allocate the GSTT exemption, so loans were used.  With the new act, you can now allocate the GSTT exemption on a timely-filed gift tax return.  If you unwind the loans now, you can save the 2010 annual exclusion that would otherwise be lost.

 

I strongly encourage you to take advantage of this rare gift from Congress and consider making transfers to generations younger than children, even if you do not yet have grandchildren.  We can help you structure these gifts so that they meet your goals and objectives, regardless of amount.

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Qualified Disclaimers

October 22, 2010

Whether in the context of gift and estate tax planning or probate and trust administration, we have been talking with our clients about qualified disclaimers more than ever.  It is an effective planning technique, but it must be implemented carefully.  The biggest hurdle is that the person making the disclaimer cannot take any benefit from the property to be disclaimed.

 

Estates & Trusts is one of the leading magazines in this area.  The following is a recent article on qualified disclaimers:

 

Qualified Disclaimers in 2010

Use this simple and unique solution to add flexibility in dealing with estate tax uncertainty

By Joe Luby, founder and manager of Jagen Investments, LLC in Henderson, Nev.

What a remarkable time to be in the business of advising wealthy families on financial, tax and estate issues!  It’s remarkable both in terms of the changes and significant developments in the field, as well as for the opportunity afforded us as advisors to set ourselves apart and proactively solve client concerns.  Many practitioners are hamstrung this year with indecision, worry and fear about what may or may not happen with income taxes, estate tax, generation-skipping transfer (GST) tax, etc.  It’s unfortunate for their clients because we’re situated in the perfect tsunami of wealth transfer opportunities.  Asset values are way down, tax rates are the lowest they’re going to be in most of our lifetimes and interest rates are near zero.  Wealth transfer strategies should be on the top of advisors’ minds right now.

As of this writing, it doesn’t look like Congress will act anytime soon on estate tax reform legislation.  Common expectations in the industry expect Congress to eventually enact some version of the law we had in 2009, perhaps with some minor variations.  No one knows for sure, but that seems to be the consensus lately.  One fear commonly expressed by practitioners nationwide is that Congress could try to enact retroactive legislation and thereby disrupt any transactions put in place today.  For example, if they retroactively raised the gift tax to 45 percent or 55 percent from the current 35 percent, then gifts made today become more expensive.  The same fear applies to a retroactive GST tax, which could create a double whammy for gifts made in 2010.

Simple Solution

There’s a simple but unique solution to these concerns: the qualified disclaimer (QD).  In short, to be a QD under Internal Revenue Code Section 2518(b), the QD must:

 

  • be in writing; and
  • be made within nine months of the date of gift or the date the recipient reaches age 21, whichever is later.

 

Additionally, the recipient may not have accepted the gift, used the gifted asset(s) or benefited from them.  The recipient may not direct where the gifted asset(s) goes upon receipt of the QD (that is, the gift either reverts back to the giver or to the next designated beneficiary, if applicable).

Most of us think of QDs for post-mortem planning opportunities.  For example, the primary beneficiary of a retirement account may use a QD to redirect the funds to the contingent beneficiary for a variety of reasons.  Or, a surviving spouse may use a QD for all or some of the assets in a disclaimer trust,” which specifically incorporates the QD as part of the upfront planning.

In 2010, clients can use QD planning for lifetime gifts to add flexibility and a solution to the issues described above.  Taxable gifts made between now and Dec. 31 are subject to the current gift tax rate of 35 percent under 2010 law.  If we wait to see whether Congress acts retroactively with an increased gift tax rate or GST tax, we will wait ourselves and clients right into 2011 when we know the rate is scheduled to go up.  The time to act is NOW.  Clients can use the QD procedure to undo the gift later, should Congress enact a retroactive tax increase.

Example

Take the following example: Tom Clark would like to gift $2 million of marketable securities to his son Bill.  He establishes a trust naming Bill as primary beneficiary and his wife, Mary Clark as contingent.  The trust is drafted to qualify as a completed gift for tax purposes, and Tom funds the trust with the $2 million securities portfolio.  The family now has nine months (assuming Bill is age 21 or older) to decide if they want the gift to stand.  Should Congress enact a retroactive increase in the gift tax, Bill will simply disclaim his interest in the trust, which then flows to Mary as contingent beneficiary.  The entire transaction is gift tax-free if this option is triggered since the gift is now between spouses.  And if the gift tax rate isn’t increased retroactively, the Clarks have locked in the lower gift tax rate by completing the transaction in 2010.

The same set of circumstances applies to gifts made to grandchildren in the event a retroactive GST is enacted.  Grandparents can use this opportunity to shift significant wealth using the reduced gift tax rate in effect for 2010 and no GST tax, while still retaining flexibility in their planning if necessary to undo the gift.

Additional opportunities are present when using QD planning this year as well.  Assume Congress doesn’t act retroactively and thus the current 2010 gift tax rate of 35 percent applies.  However, Tom’s $2 million portfolio suffers significant losses and drops significantly.  The QD option allows the family to reconsider whether paying the gift tax on $2 million (even at the lower rate in 2010) is really the best strategy.  It may make sense to undo the gift via QD and structure a new gift of the now devalued assets, even though the nominal tax rate may be higher in 2011.  If the assets are depressed in value already due to market turmoil over the last few years, the reverse may apply.  If the $2 million portfolio recovers significantly in value, the family wins by having locked in the gift now in 2010 at the lower value and reduced gift tax rate.

Discounted Value Assets

Lastly, any gifting strategy using QDs can be greatly enhanced with the use of discounted value assets.  The net after-tax impact of the gifting strategies described above is even higher when the asset gifted is subject to valuation adjustments.  Examples of such assets are fractional real estate interests, closely held business interests and private investment funds. For example, an asset subject to a 30 percent discount results in a net effective federal gift tax rate on the full asset value of less than 25 percent.  So not only can the client lock in 2010’s lower gift tax rate with the flexibility to undo the transaction later, but also he can even reduce the effective rate via proper advanced planning.

 

College Financing 101

October 5, 2010

College might still be in the distant future, but it’s not too early to start thinking about how you’re going to pay for your child’s education. Here are a few interesting facts I found in a recent article in the Wall Street Journal

Over any 17-year period, college costs go up by about a factor of three. The average in-state tuition for a public four-year university for the 2009-2010 school year was $7,020, which means children born in 2009 going to school 17 years later should reasonably expect to pay an average of $21,060. New parents looking to start saving for college now should probably save at least $200 a month from the birth of their child to cover the cost of a public four-year university and $430 for a non-profit four-year university.

The Free Application for Federal Student Aid, or FASFA, determines a student’s eligibility for federal financial aid, which includes Pell grants, Stafford loans and Perkins loans, by looking at the applicant’s “available income.” Available income includes taxed and untaxed income, but excludes some tax credits such as the Earned Income Tax Credit and funds from public assistance such as Temporary Assistance for Needy Families. IRA deductions, child support, and capital gains from investments are included in the calculation.

There are several different types of savings plans designed to help families set aside funds for future college costs.

There are two different types of 529 Plans—a prepaid program and a savings plan. The prepaid plan works like an annuity contract, essentially allowing you to pay for one to four years of college at today’s cost. These don’t tend to be as popular, because the guarantee is usually based on tuition at in-state public schools and most people can’t predict where their kids will ultimately go to school. The savings plan is similar to an IRA or 401(k), where savers invest their contributions in products like mutual funds and can make withdrawals tax-free if the money is used for higher education.

Coverdell Education Savings Accounts – also known as Education IRAs – are trusts that can be used to cover qualified education expenses for college as well as for kindergarten through 12th grade. Currently, the maximum contribution allowed for a Coverdell is $2,000 per year per beneficiary and can be made until the beneficiary is 18 years old, but this is slated to change at the end of the year when a 2001 tax law expires. At that time the contribution limit will fall to $500 a year unless Congress acts to extend the benefit. The law’s expiration also means that withdrawals to pay for K-12 expenses will no longer be tax-free, but they will remain tax free for college expenses.

What is the difference between a 529 college-savings plan and a Coverdell Education Savings Account?  Income-based contribution phase-outs for Coverdells begin between $95,000 and $110,000 for single filers and between $190,000 and $220,000 for those who are married filing jointly. In contrast, there are no income limits for 529 college savings plans, and contributions are considered completed gifts, meaning that generally speaking, an individual can contribute up to $13,000 annually per beneficiary or a married couple can contribute $26,000 annually per beneficiary without incurring a gift tax. A special rule for 529 plans allows a contributor to make five years’ worth of gifts in one year to the plan without incurring a gift tax. Also, tax-free withdrawals from 529 savings plans can be used only for college-related expenses, such as tuition and fees, room and board, books and required supplies.

College savings plans like a 529 or Coverdell can affect financial aid. FASFA looks at both the assets of the parents and the students to determine eligibility for financial aid, and savings plans are generally considered to be assets, not income. However, distributions from savings plans not used for qualified educational expenses would be considered taxable income. College savings plans in either the parents’ or child’s name are reported as parental assets on FASFA, while those held by others like an aunt or grandparent are not reported, despite the child being the beneficiary.

Families often overlook Hope Scholarship Tax Credit, which is a program targeted at middle-income families. The credit is worth up to $2,500 per student per year for qualified higher-education expenses during the first four years of college, and income phase-outs start at $80,000 up to $90,000 for single filers, and $160,000 up to $180,000 for those married filing jointly. As of 2009, the credit is not subject to the Alternative Minimum Tax.

Estate Tax Problem… no laughing matter

May 5, 2010

Bloomberg BusinessWeek has published an interesting article titled “Mind the Estate Tax Gap.” The article focuses on some of the significant carryover basis issues under current law, suggesting that allocation questions fall to personal representatives and trustees, who face potential lawsuits from disgruntled heirs and penalties from IRS. Also, as has been said for some time, this presents a record-keeping nightmare. Imagine trying to track capital improvements to a home or determine all the stock splits that occurred in a stock over 50 years.

People have been making morbid jokes about bumping off their rich relatives in 2010, a year that has no federal estate tax, but few are laughing about it now. The tax is set to return, at a 55% rate, on January 1, 2011. While heirs of the ultra-rich who die this year may enjoy an estate tax break, this gap year is having unintended consequences. Far larger numbers of affluent families who suffer deaths this year could wind up paying stiff capital-gains taxes on inheritances. That’s because of the disappearance of what’s known as the “step-up” in basis, which allowed assets to be revalued to fair market value for income tax purposes at the time of death. Many people are going to be worse off than before.

Under last year’s rules, estates below $3.5 million (or $7 million for a couple) were exempt from the estate tax; people above those limits were hit with rates as high as 45%, but assets were revalued at the time of death, and “stepped up” to their full current value and not subject to capital-gains tax on past appreciation. When the estate tax went on hiatus, the “step-up in basis” rule for valuing assets went, too, so heirs are suddenly liable for capital gains on the past appreciation of assets they inherit and sell. For those who are bequeathed homes that have grown in value, family businesses that have expanded, or stocks that have risen in price, the old “step-up” rule let them start with a clean slate, owing no capital-gains taxes when they sold the assets. Not anymore.

A copy of the article can be found here.

A remedy for estate tax problem?

April 16, 2010

I received an email today about Senate Bill 670, stating that the Elder Law Section of the Wisconsin Bar Association is joining the RPPT Section in support in principle of this bill relating to disposal of a decedent’s property.

The Elder Law Section works to develop and improve laws that affect the elderly, and promotes high standards of ethical performance and technical expertise for those who practice in the area. RPPT pertains to the law of real property, probate and trusts. They support this bill as a remedy for problems experienced by families with estate planning gone awry because of the repeal of the federal estate tax in 2010.

Congressional inaction has resulted in a great deal of uncertainty as to the application of thousands of Wisconsin estate plans (and millions nation-wide) which were premised on, and designed around, the existence of such a tax. Many other states have taken, or are considering, legislative solutions to resolve the issues created in testamentary plans.

The primary issue is that for decades, estate planning attorneys and other planning solutions have utilized formula clauses when creating estates plans or trusts. These formula clauses determine the distribution of assets in an estate or trust while accounting for taxation of such estates or trusts. With no federal estate tax in 2010, there can be (1) significant ambiguity in the interpretation and implementation of these formulas; and (2) the inadvertent disinheritance of children, spouses and charities.

Wisconsin law has long provided that the intentions of a deceased person regarding the disposition of assets are to be respected. Plus, greater certainty in the application of estate planning instruments is in the public interest. SB 670 will further longstanding public policy, reduce protracted litigation and court proceedings, and minimize family and financial dislocations because it says estate planning instruments are to be administered in a manner that is most likely consistent with a deceased person’s expectations and intent.

A Burning Issue . . .

April 8, 2010

“The fault of most men is not that they aim too high and miss, but that they aim too low and hit.”   – Michelangelo

An article in the Sunday edition of the Milwaukee Journal Sentinel addressed an issue that is particularly relevant in our area. For some time it has been fairly common for owners of tear-downs to make a charitable contribution of the house to their local fire departments for a tax deduction. The fire department burns it down for practice. Lately that strategy has been under attack by IRS.

This is something that has been done for a long time, but IRS is looking at it differently now. For years, IRS allowed deductions for homes donated to fire departments, based on a 1973 court opinion interpreting the IRS code written in 1968. But the tax code changed in 1969 to specify that donating anything less than the entire interest in a property, such as its use, is not deductible as a charitable contribution. Around 2004, IRS started disallowing deductions for homes donated for fires.

The heart of the issue is the value of the house. Usually when you give to charity, you can deduct the fair market value of the property that is gifted. In this case, what is the value of something that is going to be destroyed anyway?

This article tells the story of a Chenequa couple that bought an old house on Pine Lake in 1996. In 1998, they let the Chenequa Fire Department burn it down and claimed a charitable deduction of $76,000. Replacement value was about $235,000. IRS disallowed the deduction, saying that because the home was going to be torn down anyway, it had negative value, or was worth approximately $1,000 if someone was willing to move it. The owner decided to fight the case. It was argued before a tax judge in 2005, but they’re still waiting for a decision.

If the U.S. Tax Court agrees with IRS, the decision will likely end the symbiotic relationship between owners of tear-downs and their local fire departments.

Estate Tax Reform Update

April 6, 2010

You may be interested in the April 1 AALU Bulletin (No: 10-37), Update on Estate Tax Reform: Developments and Dynamics, which states that three factors shape the ongoing environment for the federal estate tax:

  1. A packed congressional schedule;
  2. A focus on deficit reduction; and
  3. The upcoming mid-term elections.

The AALU concludes that we may have a clearer picture once Congress returns to session this week but that the Senate may be hesitant to pass a reconciliation bill (which could include the estate tax) because of the recent health care reconciliation bill. If it is not included in a reconciliation bill (which requires only 51 votes), 60 votes would be necessary to pass estate tax legislation:

“The difficulty in finding 60 votes may lead to either (1) reversion in 2010 to a $1 million exemption and 55% rate or (2) a short-term extension of tax cuts, including the estate tax on a two-year basis at $3.5 million exemption and 45% rate, possibly during a lame duck session (when Congress returns after November elections).”

A copy of the complete bulletin is available online here.

IRA Conversions

March 4, 2010

With Congress in a stalemate, it looks like tax uncertainty will be around for awhile.  There was a good article in the Wealth and Personal Finance section of the New York Times on February 18.  A copy of that article can be found here.

One of the strategies covered in the article, which I have been recommending to my clients, is converting traditional IRAs to Roth IRAs. This results in the recognition of income and the payment of tax. This strategy requires some analysis to make sure it works for you, but later distributions from a Roth IRA are not taxable income and there are no minimum required distributions to worry about in retirement.

The greatest obstacle to this strategy in Wisconsin has been that Wisconsin law differs from federal tax law. Wisconsin law does not permit IRA conversions, which leads to problems like being subject to an excise tax.
The good news is that the Wisconsin legislature has passed a law conforming Wisconsin law to federal law. It is waiting for the governor to sign it. He said that he would. I will let you know as soon as he does.

There are ways to supercharge an IRA conversion. Split your IRA into separate IRAs according to investment type before doing the conversion. That is, create an IRA for your large cap investments, a separate one for  mid-caps, and so on. That gives you a right to a “do-over” depending on the performance of the investments.

For example, a taxpayer has two mutual funds in her IRA. One is a large cap fund and the other is an emerging growth fund. She splits the IRA into two IRAs. One holds the large cap mutual fund and the other holds the emerging growth fund. By converting the $100,000 large cap IRA in 2010, she will recognize income of $100,000 and pay tax on that amount (if no other tax planning is done). The same is true of the $50,000 emerging growth IRA. The taxpayer, however, has the right to re-characterize her IRAs by the due date of her tax return including extensions (October 15, 2011).  She can change back to a traditional IRA and recognize no income. So if the large cap fund declines in value to $60,000, she can re-characterize and not recognize $100,000 of income.  Then she can start all over again and convert her IRA in 2011, but at the lower value of $60,000. None of this affects her emerging growth IRA which doubled in value during the same period and which she wants to keep in a Roth IRA.

Good move. Who would want to re-characterize and then recognize more income in a later conversion?

Estate Tax Reform

January 6, 2010

There’s another fine mess you’ve gotten us into…

You can hardly pick up a newspaper right now without reading about the estate tax mess we’re in.

There are winners and losers. The Economic Growth and Tax Relief Reconciliation Act of 2001 lowered estate taxes and eliminated them entirely in 2010.

Unfortunately, Congressional budget rules required the act to have a sunset provision, which means the entire act would disappear on December 31, 2010. Then we would be back where we started in 2001 – no reform. But who cared in 2001? There were nine years to address the problem.

Well, here we are in 2010 and Congress has done nothing. Right now there are all sorts of predictions, but no one really knows what will happen. The question is what to do with people dying in 2010, before new legislation is enacted? Many in Congress want to adopt legislation in 2010 and make it effective retroactive to January 1, 2010, but that may be unconstitutional.

Regardless, you need to review your estate plan now, especially if you are in a second marriage, have a marital trust and/or family trust.  Otherwise your plan might not work as you intended.

Only put off until tomorrow what you are willing to die having left undone. – Pablo Picasso

For more detailed information, you can read our latest Wealth Counselor newsletter, Planning After “Repeal” of the Federal Estate Tax, available here.

(Swendson/Menting Law Ltd. offers this free monthly newsletter to our clients, friends and strategic partners that addresses current issues and developments in the law. If you would like to receive future editions, please contact us.)