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How Do I Create An Estate Plan Combining All of These Assets?

How Do I Create An Integrated Estate Plan?

We now know what the federal estate tax laws will be this year and in the future.  Our federal government has stated that these estate tax rules are now permanent after a decade of uncertainty.  (A cynic may say that these federal tax laws are permanent until our federal government says they are not!). Anyway, here are some of the more important federal estate tax law changes made on December 31, 2012 along with some related estate planning strategies:

  • The federal estate and gift tax exemption is now permanently (there is that word again) $5,000,000, with annual inflation adjustments.  These inflation adjustments generate exemptions of $5,120,000 in 2012 and $5,250,000 in 2013.
    • A husband and a wife each have this exemption, so a family can transfer $10,500,000 free of federal estate taxes in 2013. These very generous tax exemptions will allow the opportunity to transfer large amounts of wealth during lifetime or at death free of federal taxes.
    • Planning Point:  Taxpayers who used their full $5,120,000 exemption in 2012 can now make more gifts of $130,000 in 2013.
    • Planning Point:  With inflation adjustments each year, taxpayers can continue to transfer more each year.
    • Important Shift in Focus To State Inheritance Taxes:  Understand that we are only talking about federal estate and gift taxes and that these large exemptions are only applicable at the federal level. With these large federal exemptions, for most people, estate tax planning now will focus more on minimizing state inheritance taxes. For example, Pennsylvania does not follow the federal exemption rules and taxes almost all assets owned by a decedent.  To learn more about Pennsylvania inheritance tax rules see Pennsylvania Inheritance Tax: The Basics.
  • Once assets are above the exemption threshold the estate tax rate is 40%.  This results in a very heavy tax bite and is a real concern for anyone above the threshold.  The following taxpayers may end up above the threshold:
    • A taxpayer or a surviving spouse with assets above the exemption threshold or
    • A family (husband and wife) that has accumulated wealth above the $10,500,000 threshold, or
    • A taxpayer that has made lifetime gifts that have exhausted or substantially depleted their exemption.  See the following Example 1.
  • The tax law changes have once again unified the exemption for lifetime gifts and transfers at death.  So, if you use your exemption during your lifetime it is not available when you die.
    • Example 1:  Generous John, gave away his shares of stock of his business corporation valued at $5,000,000 to his son in 2012.  He uses his $5,000,000 exemption to transfer such shares free of gift tax.
    • Example 1A: Generous John dies in 2013 with other assets of $1,250,000 that make up his taxable estate. In 2013, he has a remaining exemption of $250,000 (2013 exemption of $5,250,000 less the $5,000.000 of his exemption used in 2012). Generous John has a taxable estate of $1,000,000 which results in a $400,000 in federal estate tax liability.
  • Portability is now permanent.  Portability allows for the exemption that was not used by the first spouse to die to be used by the surviving spouse.  In theory, this provision protects those who have failed to plan or for those who have made errors in estate planning.
    • Important Planning Point:  Portability should be looked at as a fallback position where there was no estate planning done.
      • Employing traditional estate planning techniques may prove more advantageous and in some cases is essential in crafting a well conceived estate plan. For example, in most situations the combined use of a unified credit and a marital deduction trust (or the use of a disclaimer trust mechanism) would result in better tax outcome than relying on portability.
      • In second marriages, it is often imperative to use  a certain form of marital deduction called a Qualified Terminable Interest Property (QTIP) trust, to provide for both the surviving spouse and children of a first marriage.
      • Where assets are expected to appreciate in value over time, use of a by-pass or unified credit trust would offer a better result than relying on portability.
    • There are some very important limitations and concerns with using portability, especially in second marriages or where the surviving spouse remarried.  These issues are more fully explored in my article entitled Estate Planning Mistakes: 5 Not So Easy Pieces.
    • Portability Does Not Save the GST Exemption:   The new tax act provides that the Generation-Skipping Transfer (GST) tax exemption also remains at the same level as the gift and estate tax exemption ($5,000,000, adjusted for inflation). The GST tax, which is in addition to the federal estate tax, is imposed on amounts transferred (by gift or at death) to grandchildren or others more than one generation below the decedent.  The important point here is that “portability” does not apply to the generation skipping transfer (GST) tax rules. Where grandchildren and future generations are part of an estate plan, portability will not save the unused GST tax exemption of the first spouse to die.  In such cases, using something called a “dynasty” or GST exempt trust is the better course of action.
      • Caveat:   In situations where there the estate size is large and there are many generations who are going to share the estate, failure to understand and use the more traditional dynasty trust could result in a very expensive and disastrous mistake.
  • Annual Donee Exclusion:  Although not part of the tax law changes, this traditional estate and gift tax planning tool allows for annual tax-free gifts of $14,000 in 2013 (up from $13,000 in 2012 as a result of the annual inflation adjustment).  As a result, taxpayers can now give up to $14,000 to as many people as they wish each year and not use up their unified credit or pay a gift tax.
    • Important Note:  Only gifts that qualify as “present interest” gifts are eligible for the annual donee exclusion.
    • Planning Point:  If you are married, your spouse can join you and, together, you can give up to $28,000 per person per year.
    • Planning Point:  This exclusion is in addition to the $5,250,000 estate tax exclusion and can be combined with such exclusion.  For more insight into how to combine these exclusions as well as the lack of marketability and minority interest discounts please read Gifting Shares of Stock In A Bad Economy.
  • Capital Gains and Basis Implications:  Lifetime Gifts versus Transfers At Death:  Although not an estate tax rule, under the new federal tax rules, capital gains on appreciated assets will now be taxed at a 20% rate for taxpayers with income above certain thresholds.  Capital gains below these thresholds will be taxed at the previous 15% rate.  These rules bear heavily in the estate tax planning context especially where recipients receive lifetime gifts versus gifts received at death.
    • Important Tax Basis Rule:  Taxpayers who receive appreciated property by a lifetime gift take a carryover basis, while beneficiaries who receive assets at the decedent’s death get a step up in basis to the date of death value of such assets received.
    • Tax Disaster for the Uninformed, Do It Yourself Estate Planners:  Many times elderly people transfer real estate to children during their lifetime in trying to avoid probate.  For a recipient of such lifetime gift, a disastrous income tax result awaits the uninformed taxpayer as illustrated by the following Example 2.
    • Example 2:  Sam Senior is very sick and wants to avoid probate.  He transfers by quit-claim deed his real estate to his son, Sad Son.  Sam Senior bought his house in the 1970s for $17,000 and made improvements over time of $23,000.  As a result his adjusted basis is $40,000.  The house is now worth $540,000.
      • Sam Senior transfers the house to Sad Son in 2012.  Sad Son takes a carryover basis for the house of $40,000. Sad Son sells the house for $540,000 shortly afterwards and has a capital gain of $500,000 which he surprisingly and sadly finds out will cost him $100,000 (20% x $500,000) in federal taxes alone.  His accountant tells him there will also be state income taxes on this gain. Since he is a Pennsylvania resident, he will pay an extra $15,350 in Pennsylvania income taxes.
      • Alternate Universe:  Sam Senior consults with his tax/estate attorney who drafts a will that transfers the house to son at death. Sad (who now legally changes his name to Happy), has a basis of $540,000 upon his receipt of the house from the estate.  Happy, now sells the house and has zero, yes, zero capital gain (Sale Price, $540,000 less basis of $540,000 = 0)!
        • Note, state inheritance taxes may be applicable in certain states.  For example, in Pennsylvania there would be a 4.5% inheritance tax on the real estate, but this is a lot smaller cost than the capital gains that results from taking a carryover in basis via a lifetime gift.

Final Thoughts and Recommendations:

Federal Estate Tax Implications: The federal estate tax law changes provide for some very generous federal estate tax breaks.  For those close to or above the federal estate tax threshold, the discussion above has explored some of the many planning opportunities to save federal estate taxes.  Such taxpayers should not rely on portability and should meet with an estates attorney to plan the proper course of action based on their particular family situation, needs and goals.

Shift In Focus To State Inheritance Tax Matters: Taxpayers below the federal estate tax thresholds also must continue to plan but the tax focus needs to shift to minimizing state inheritance taxes.

Create An Estate Plan That Fits Your Particular Family and Financial Situation:  It is most important to recognize that everyone has a unique situation with various assets, family members and ideas on how their family members are to be provided for and who should be in charge once they are gone.  As a result, all taxpayers still need to set up an estate plan for non-tax issues such as making sure their assets go to their loved ones in the way they wish.  They need to choose the proper people to administer their estates and any trusts they create.

Young Families:  In younger families, determining a proper guardian for their children and setting up trusts for the protection of their assets and a distribution scheme for such children is of paramount importance and has little to do with taxes.  An objective and unbiased assessment of how much life insurance is required is often needed.

Second Marriages:  Many with second marriages face unique challenges.  An estate plan needs to be developed and implemented to meet the diverse needs and goals of such blended families.

Special Needs Trust:  Those with disabled children or those receiving government benefits may need special needs trusts.

Do Not Try This On Your Own:  Get an Experienced Estate Attorney:  Having experienced estate counsel explore these issues and offer various strategies is at the heart of estate planning.  Coordinating probate and non-probate assets into an integrated estate plan is often overlooked and little understood.

Attention To Details and Documentation: Finally, make sure that you have an experienced estate attorney that can create an integrated estate plan.  Such attorney should have the skills to draft appropriate wills, trusts, durable powers of attorney, living wills and other related documents tailored to your specific family and financial needs.

Please feel free to post comments or ask questions.

Liking and sharing this blog with others in cyberspace is always welcomed and appreciated.

As always, do not hesitate to contact me if you want further insight or need my advice or legal assistance.

Copyright © 2013 – Steven J. Fromm & Associates, P.C., 1420 Walnut Street, Suite 300, Philadelphia, PA 19102. All rights reserved.

As required by United States Treasury Regulations, you should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm’s full disclaimer.

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In the wake of the sad and tragic deaths of Michael Jackson and Farrah Fawcett, we are all reminded how fragile our lives can be and how quickly things can change. The death of these two iconic figures should be a call to many to put their estate plan in order. It should be noted that the reality is that most people die without wills in our country. Some really smart and famous people, Abraham Lincoln, Howard Hughes, and Pablo Picasso, die without taking the time to draft a will.

Many of us procrastinate, minimize our personal need or the legal importance of drafting wills, trusts, living wills, and durable powers of attorney. The complexities of combining and coordinating diverse assets such as individual assets, jointly held assets, retirement plans, life insurance, annuities and business interests seem just too daunting for some. For others, they do not realize the importance of looking at all of their assets from an overall perspective; namely, when all is said and done who ends up with what.  Is the division of assets fair and equitable to all concerned after the payment of taxes, debts and estate administration costs?

For many, Michael Jackson’s untimely death has raised these and many other estate planning issues. At this point, no one knows whether he had a will and/or trust for his kids, or whether his estate plan was up to date. But by looking at his situation (and speculating a bit), some important estate planning considerations for the rest of us can be explored:

Guardianship: It is unclear what provisions Mr. Jackson had in his will (assuming there is a valid will) for his children. The early word from the media is that this will be a messy battle in the courts over the issue of guardianship of his children, even if his will indicated his preference for guardian.  Even if  challenged, the designation of guardian in a will would still be a very significant factor in any court challenge and laying out your wishes is always a prudent thing to do in any event.  The object lesson is clear: Parents with young children clearly should see the need for a will that indicates their choice of guardian for their children.

Trusts: No one knows whether Mr. Jackson had set up trusts for his children. Although it appears that his estate is now insolvent, this situation will probably change with post-mortem sales of his music someday providing assets and wealth for his children (think after-death income of the Elvis Presley estate).  Hopefully, he set up trusts that will protect and manage his assets.  To increase the possibilities of becoming competent adults, perhaps he drafted provisions in his trust in a way that develops their sense of personal initiative and responsibility yet still provides for their basic needs.  Experienced estate planning attorneys explore this type of forward looking planning when it comes to dealing with children and their anticipated needs if parents die prematurely.

Specific Bequests: The media has speculated that a very large asset of his estate (his Beatles song rights) was gifted to Paul McCartney. This generosity may be commendable, but from an estate planning perspective this bequest may raise problems. First, if his estate is in fact insolvent, this bequeathed asset would not be available to his estate to be sold and the proceeds used to pay down estate debts and/or benefit his children. Secondly, generally, bequests like these are often times given in a way that they bear no estate taxes. This could distort how the assets are divided between beneficiaries. The point here is that this bequest may have made sense when the will was originally drafted when Mr. Jackson was wealthy, but this bequest could be quite problematic in the current situation. The lesson here is that an estate plan needs to be looked at periodically as the family needs and financial situations change over time.

Special Needs Trusts: Farrah Fawcett died leaving a son who is in jail with addiction problems. The issues for people with children with special needs is often minimized, overlooked or not fully considered. As her only child, did she leave all of her wealth to her son? Did her will provide that he was to get his inheritance at her death or did she provide for a trust for his benefit? If she established a trust, what kind of provisions and conditions did she make in providing benefits to him? These tough questions arise not only for children with addiction issues, but for children with cognitive impairments, physical disabilities and emotional issues.  In addition, special needs trusts may be required where children are receiving public assistance from state and local governments.

The Bottom Line: Protect your family and protect your hard earned wealth. Spend the time to plan your affairs with an experienced estate planning attorney.  Remember, if you die without a will and trust, your state intestacy laws will control who will get your assets and how they get your assets. When young children are involved, courts generally place the children’s inheritances in trust in accordance with what a judge deems appropriate.  In addition, the judge will determine who will be the trustee of any trust they impose on your children and they will determine who should be the guardian of your children. These and other important considerations should be determined by you and not by a court of law, so do it and do it now so you do not leave problems like the ones Michael Jackson and Farrah Fawcett may have left behind.

© Steven J. Fromm, 2009

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