Tag Archives: unified credit

College Tuition: Discover How Grandparents Can Help Their Grandchildren and Save Taxes Too

College-Tuition-Tax-Breaks

With college tuition coming due, families should consider tax efficient ways to pay for these expenses. Grandparents who wish to help their children with tuition costs can take advantage of some special gift tax breaks.

Grandparents have the usual annual present interest gift tax exclusion (now $14,000) and a lifetime exclusion (now $5,340,000). When a spouse joins in the gift (the called “spousal joinder”), these amounts double .

But these are not the only tax breaks available to a grandparent who wants to help the family. In addition, grandparents have an unlimited gift tax exemption for amounts paid for tuition. By using this special educational exclusion, such payments do not count against the annual gift tax or lifetime exclusions.

Here are the basic rules to qualifying these gifts for such unlimited educational exemption:

Unlimited Exclusion For Tuition Only

This exclusion from the gift tax for gifts of tuition is unlimited in amount. However, the scope of the exclusion applies to tuition only.

Books, Supplies and Other Items Not Covered

There is no exclusion for amounts paid for the following:

  • Board or other similar expenses that are not direct tuition costs.
  • Books
  • Supplies
  • Laboratory fees
  • Dormitory fees

See Treasury Regulations 25.2503-6(b)(2) for more details.

While Only Tuition Qualifies, This Educational Exemption Can Be For Part-Time or Full-Time Tuition

The gift tax is not imposed on amounts paid as tuition for a student to a qualifying domestic or foreign educational organization for the education or training of such person. See Code Section 2503(e)(1) and (2)(A).

Tuition payments for the student qualify where enrollment is part-time or full-time.

Qualifying Educational Organization

A qualifying educational organization is one which:

  • Normally maintains a regular faculty and curriculum and
  • Normally has a regularly enrolled body of students in attendance at the place where its educational activities are regularly carried on.

See Code Section 170(b)(1)(A)(ii) and Treasury Regulation 25.2503-6(b)(2).

Direct Payment of Tuition to Educational Organization

The tuition payment must be made directly to the educational organization to qualify for this exclusion.

Critical Point:

Neither a payment to the student for delivery to the organization nor a payment Continue reading

Philip Seymour Hoffman: Estate Planning Lessons For Us and Especially Women

Estate Planning For Philip Seymour Hoffman

Attribution: Josh Jensen      CC-By-SA-2.0

The sad and tragic death of Philip Seymour Hoffman at age 46 last month is yet another reminder of the importance of estate planning. Most of us go along each day not thinking or worrying about what would happen to our loved ones if we suddenly died.  Some, in an attempt to be conscientious, draft an estate plan but fail to keep such plan up to date.  But most people die without ever doing any estate planning leaving state laws and the courts to decide who should get their estate. When these matters are neglected, surviving family members can be left with momentous legal, tax and financial problems resulting in uncertainty and expensive attorney fees to sort it all out.

Background

Although Mr. Hoffman drafted his will in 2004, he failed to update it after having two children and even after some significant estate tax law changes.  Such changes and ten years usually triggers a meeting with your estate planning attorney. For more on a checklist of events that should result in a meeting with your estate planning attorney please explore Estate Planning Triggers.

Mr. Hoffman’s 2004 will leaves everything to the mother of his children, Marianne O’Donnell.  He was not married to her and this is where the problems start, at least from an estate tax perspective.

Federal and State Estate Taxes

It is estimated that Mr. Hoffman’s estate was around $35,000,000.  Currently, $5,340,000 is exempt from federal taxes (the so-called unified credit) with amounts above that amount being subject to a federal estate tax rate of 40%.  It would appear then that roughly $30,000,000 of his estate would be subject to estate tax at a 40% rate.  This would generate a whopping $12,000,000 in federal estate taxes!

New York also has an estate tax with an exemption of $1,000,000. This New York estate tax has graduated tax rate that goes as high as 16%.  It is estimated that roughly another $3,000,000 in will be paid in New York estate taxes.

Combined estate taxes: $15,000,000.

(Liquidity Side Bar:  Be aware that estate taxes are due nine (9) months after the date of death so hopefully Mr. Hoffman’s estate has enough liquid assets to avoid a forced sale of assets to meet his tax obligations.  Estate Planning Point:  It is not known if Mr. Hoffman had life insurance but having life insurance to provide for liquidity is sometimes essential.  In certain cases, the use of an irrevocable life insurance trust would allow for excluding the life insurance proceeds from being subject to estate tax.)

The point is that even though a meeting in 2004 may have explored marriage as a simple way to save estate taxes, Mr. Hoffman may, for whatever reason, not wanted to be married at that time.  It also could have been that his wealth was not that great in 2004.

But here is the object lesson:  Things change and so should one’s estate plan.

  • A later meeting to review his estate plan would have explored the huge estate tax benefit to being married.  No one is suggesting that people should get married only for tax reasons, however, under federal estate tax rules, inheritances to a surviving spouse are not subject to estate tax.
  • Double Estate Taxation:  Since they were not married, the amounts Ms. O’Donnell receives will be taxed twice.  First, the amount she receives above the unified credit will be taxed at Mr. Hoffman’s death.  When she dies the balance in her estate above her unified credit will be taxed a second time.  Marriage eliminates this double estate tax.
  • Marriage would have provided possible social security, retirement plan, income tax and other financial benefits.
  • If Mr. Hoffman wanted to get married but did not want his wife to have absolute control of his assets, a qualified terminable interest trust (a QTIP trust) could have been used to obtain the estate tax savings while providing income and principal to her during her lifetime.  The assets in this trust would pass to his children at her death.  This would have been the best of both worlds: saving estate taxes but still providing for his wife and children.
  • Sidebar:  A QTIP trust is often used in second marriages where there are children from a prior marriage.

One Strategy To Eliminate Estate Tax At His Death

In a perfect world, Mr. Hoffman could have created a so-called marital deduction trust and a unified credit or by-pass trust by funding each trust based on a formula clause tied to the unified credit applicable in the year of his death.  (Or he could have used the disclaimer trust discussed below to achieve this same result if he was married.) If he had implemented this estate planning strategy his 35,000,000 would have been split between Continue reading

Estate Planning: Now What? A Must Read For Everyone

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.

Michael Jackson & Farrah Fawcett: Estate Plan Wake Up Call

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

THE SILVER LINING OF A BAD ECONOMY: GIFTING OF SHARES OF STOCK IN A CLOSELY HELD BUSINESS

As with most things in life, when things are bad, there usually is something good that can come out of it.  Our current economic troubles have resulted in many closely held or small businesses being worth far less then they used to be.  This is not a good situation for businesses that are hanging on to survive or have to be sold for various reasons.  However, for people wanting to minimize estate and gift taxes and have been putting off taking a cold hard look at their estate plan, now may be the perfect time to explore the gifting of shares in their businesses.

For example, some businesses have senior family members who own all or most of the shares of the outstanding stock of their corporation.  With the value of the business being down right now, more shares could be gifted to younger family members involved in the business.

Example:  Mr. Senior owns 80% of Deflated, Inc., while his two sons who work in the business own 10% each.  Deflated was worth $3,000,000 in 2007.  By the end of 2008, it was worth $2,500,000.  Mr. Senior talks to tax counsel and after exploring the tax strategies and planning tools discussed below decides to gift 20% of his shares worth $500,000 to each of his sons, leaving him with a 40% stock interest.

The tax advantages are as follows:

1.  The stock gifted to each son was previously worth $600,000. The current market value of such stock to each son is now only $500,000.  If Deflated, Inc. goes back to its value once the economy recovers, then Mr. Senior has just transferred $200,000 ($100,000 to each son) to his sons estate and gift tax free.  At a current marginal estate tax rate of 45%, Mr. Senior’s family can save $90,000 (45%*$200,000).

2.  The gifts to each son are gifts of a minority interest in Deflated, Inc. and such gifts lack marketability due to the limited market for such shares.  Estate and gift tax rules allow discounts for these factors that reduce the value of assets transferred.  (Caveat: There are some legislative proposals being floated in Washington seeking to limit this tax strategy. Stay tuned.) These discounts for minority interests and lack of marketability conservatively can be 25%, sometimes more.   With such discounts the gift of each $500,000 is reduced by $125,000. At a current marginal estate tax rate of 45%, Mr. Senior’s family can save another $112,500 (45%*$250,000).

3.  Outright gifts of stock are eligible for the annual donee exclusion of $13,000.  In addition, Mr. Senior has a spouse who will join in this gift, which will allow for a second $13,000 exclusion.  So the taxable gift to each son is now reduced by $26,000 (Mr. Senior’s annual exclusion of  $13,000 and his spousal joinder of another $13,000).  Additional savings to the family is $23,400 (45%*26,000*2 sons).

4.  If Mr. Senior makes no further gifts and dies with his reduced ownership interest of 40%,  his estate can claim the minority interest and lack of marketability discounts against his remaining shares.  If Mr. Senior dies in 2014, when deflated is worth $4,000,000, his family can take a 25% lack of marketability/minority interest discount, saving his family another $180,000 (45%*$400,000 marketability/minority interest discount[$1,600,000 forty-percent interest*25%]).

Bottom Line:  Mr. Senior can take advantage of the lousy economy, the lack of marketability and minority interest discounts and the annual donee exclusions with a spousal joinder to save his family a tremendous amount of future estate and inheritance taxes.

Caveat:  Remember that this type of planning depends on the particular factual setting of each client.  One difference in the facts can change the outcome.  Also, be aware that state inheritance taxes have not been considered in the above example.  Finally, the above should not be considered as legal advice.  Please consult with tax counsel to discuss your particular factual situation.

Copyright © 2009, Steven J. Fromm.