With the basic exclusion

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1 Estate Planning When Federal Estate Tax Is Not a Concern A variety of other areas of estate planning gain greater focus as fewer individuals expect to be affected by the federal estate tax. JORDON ROSEN With the basic exclusion amount at $5.49 million (in ) and growing, along with the availability to port a married decedent s unused exclusion, most individuals will not have a federal estate tax liability. In addition, many states piggyback the federal rules, thereby eliminating all federal and state estate taxes for most Americans. The result is that many of these same people are now (wrongfully) re-thinking the need for any estate planning. A married couple with a combined $7 million estate would be knocking down an estate planner s door in 2001 to find ways to save estate taxes, but not necessarily today, and that is a big mistake. Among other considerations, clients tend to forget that (1) estate values grow, either naturally or by inheritance, and (2) laws change. They also think they do not need to plan because: 1. They think they are too young to plan their estate. JORDON ROSEN, CPA, MST, AEP, is a director at the accounting firm of Belfint, Lyons & Shuman, P.A. in Wilmington, Delaware, where he heads the firm s estate and trust section. He is also the immediate past president of the National Association of Estate Planners & Councils, chairman of the Delaware State Chamber of Commerce tax committee, and a member of the AICPA Technical Resource Panel on Trust, Estate and Gift Taxes. Copyright 2017, Jordon Rosen All of their property is jointly held with their spouse. 3. They think estate planning is only for the super-rich. 4. They think it is too expensive. 5. They had wills drawn up when they were first married (probably years ago). 6. They do not want to think about it (i.e., death). Estate planning advisors, however, need to recognize the various reasons (other than for federal estate taxes) why proper estate planning could be critical for clients (and Americans in general). This article looks at why clients still need to do estate planning and where estate planners can continue to provide value to their clients in the process. Estate planning documents The starting point is having the proper documents in place. Basic documents. In its basic form, the documents of an estate plan should include a will, durable power of attorney, and medical directive. The will, of course, can address the disposition of real and tangible personal property along with the payment of final expenses, etc. It gives direction to the executor and expresses the final wishes of the decedent. Many individuals also use the will as a vehicle to pass along family and cultural values. The use of trusts such as a revocable trust, charitable trust, or credit shelter trust can also be a valuable tool for accomplishing an individual s estate planning goals. In states such as Delaware, having assets held in a revocable trust at the time of

2 17 death avoids the 1.75% administrative probate fee. 2 Revocable trusts can also be used to hold out-of-state property to avoid the expense of opening an ancillary estate in another jurisdiction. Finally, although smaller estates will not need the estate charitable deduction to reduce taxes, interested individuals should be encouraged to consider the use of split-interest charitable trusts or foundations both to accomplish their charitable goals and, at the same time, to pass along their philanthropic values to the next generation by involving children and grandchildren in the decision making. Most charitable planning techniques such as a charitable remainder annuity trust (CRAT), charitable remainder unitrust (CRUT), or donor-advised fund (DAF) can be established during the individual s lifetime or take effect at death. Commonly overlooked is the fact that every single adult child over the age of 18 (especially those away at college) should have basic estate planning documents in place, especially a durable power of attorney and medical directive. More sophisticated planning should be considered if the adult child stands to receive a large inheritance in the near future. When naming executors, trustees, and attorney-in-fact, consider using the three-deep rule. For example, in addition to naming an executor (or co-executors), name at least two contingent persons to act in case the primary or secondary choices are unable or unwilling to act in that capacity. Outdated documents. Older estate planning documents may have required funding of the credit shelter trust in such amounts as to bring 1 Rev. Proc , IRB Del. Code (A)(16). 3 Section the taxable estate to zero. With the exclusion now over $5 million, this may leave little or no funds for a marital trust or to be left outright to the surviving spouse, which many not have been the decedent s original intention. Furthermore, older documents may have been drawn up before the individual was married, divorced, or widowed; while the children were still minors; or before grandchildren. A good rule of thumb is to encourage clients to have their estate plan reviewed at least once every five years or upon the occurrence of a life-cycle event as noted above, including retirement or upon a significant increase in net worth such as from the sale of a business or from an inheritance. Basis planning Income tax and basis planning is now the new norm for smaller estates. The top federal income tax rate is 39.6% and long-term capital gains could be taxed at 0%, 15%, or 20% (and as high as 28% for collectibles. A 3.8% surtax on investment income also applies for individuals with AGI over $200,000 ($250,000 if married filing a joint return). 3 The problem can be compounded if the individual lives in a high income tax state such as California or New York. For estates not subject to the federal estate tax, the focus is whether to give assets away during the individual s lifetime or at death. Making lifetime gifts results in carryover basis. Thus, if the donor had a low basis in the assets, the donee could incur a substantial federal and state tax burden when the assets are sold. Passing the assets at death and obtaining a basis stepup for low basis or hard-to-value assets might be a better alternative, resulting in little or no tax when the assets are sold. Furthermore, individuals and executors may not want to be as aggressive in obtaining deep discounts of hard-to-value assets being transferred by gift or bequest, including shares of family limited partherships (FLPs), if there is otherwise no ultimate federal estate or gift tax savings. In the case of inherited assets, this would translate to a higher basis in the hands of the beneficiary. Individuals and executors may not want to be as aggressive in obtaining deep discounts of hardto-value assets being transferred by gift or bequest. Basis planning needs to be done asset by asset. It is important to look at which assets are best to be left in an individual s estate (such as Roth IRAs, tax-exempt bonds, life insurance, and high-basis assets) and which are preferably not left in the estate (such as traditional IRAs and Series EE U.S. Savings Bonds which are considered income with respect to a decedent (IRD) and do not get a basis step-up, in addition to creating ordinary income for the beneficiary). Section 454(a), for example, would allow the estate executor to elect to switch the reporting method of EE bond interest and report all accrued bond interest through the date of death on the decedent s final income tax return. This would work well if the decedent died early in the year or otherwise did not have much income and would pay little or no tax on the bond interest as opposed to the beneficiary who may be in a high tax bracket and would otherwise pick up the bond interest as IRD. Likewise, converting a traditional IRA to a Roth IRA (or traditional employ- F E B R U A R Y V O L 4 4 / N O 2 E S T A T E S U N D E R $ 1 0 M I L L I O N

3 18 er plan to a Roth account) might be beneficial, especially if the beneficiary will be in a higher tax bracket than the account owner. Reporting requirement. The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 ( 2015 Act ) added Section 1014(f) which requires consistent basis reporting between estates and persons acquiring property from a decedent and Section 6035 which requires the executor of an estate that is required to file a return under Section 6018, to file a statement with the IRS and provide each legal or beneficial owner of such property with a statement identifying the value of the property. 4 At least with regard to new Section 1014(f) consistent basis rules, the law and Proposed Regulations provide that the taxpayer s initial basis in property acquired from a decedent cannot exceed the property s final value for estate tax purposes, or, if the final value has not been determined, the value reported on the statement required by Section This rule applies only to property that increases the estate s liability (after credits) by reason of inclusion in the gross estate. (The law also exempts those assets subject to the estate marital or charitable deductions.) Therefore, estates that do not rise to the level of the basic exclusion amount ($5.49 million in 2017) would not be subject to the basis consistency rules under Section 1014(f). New Section 6035, created by the 2015 Act, now requires the executor of an estate to file a statement of value (new Form 8971) with the IRS and to each beneficiary (a copy of Schedule A) regarding the value of the property the beneficiary acquires from the decedent. Form 8971 is due to the IRS with a copy of Schedule A to each beneficiary no later than 30 days after the federal estate tax return is filed or should have been filed and applies to all estate tax returns filed on or after 8/1/ The Proposed Regulations clarify and confirm that the reporting requirement under Section 6035 does not apply if a federal estate tax return is otherwise not required to be filed, including where returns are filed solely to make the portability election or a GST tax election or exemption allocation. 6 Therefore, again, smaller estates will probably not have to deal with these reporting requirements. One drawback to making the portability election is that it suspends the tolling of the statute of limitations. Portability election Along the same lines of income tax considerations is whether to make the portability election of any deceased spouse unused exclusion (DSUE) amount. Even though an estate under the filing threshold is not required to file an estate tax return, a timely and properly prepared estate tax return needs to be filed by the executor in order to elect portability. 7 Porting the unused amount to the surviving spouse (or to a QTIP trust) would qualify the assets for the marital deduction and provide for a second basis step-up upon the death of the surviving spouse. This needs to be weighed against (or in conjunction with) using the assets to fund a credit shelter trust which, while providing many asset protection and control benefits and avoiding the surviving spouse s taxable estate, will not provide for a second basis step-up. Potential advantages of the portability election over funding a credit shelter trust might include: 1. Getting a second basis step-up at the surviving spouse s death. 2. Providing ultimate federal and state capital gains tax savings. 3. Lowering administrative expenses. 4. Allowing for spousal rollover of IRA/retirement plan assets. 5. Allowing for stretch IRA for non-spousal beneficiaries. 6. Allowing more control and use of a general power of appointment over assets. 7. Subjecting income to individual tax brackets rather than condensed trust brackets. 8. Obtaining potential savings/avoidance of net investment income tax. Navigating the portability rules can be a challenge. First, the executor must compute the DSUE amount, which is the lesser of (1) the basic exclusion amount ($5.49 million in 2017) or (2) the excess of the applicable exclusion amount of the last such deceased spouse of the such surviving spouse, over the amount with respect to which the tentative tax is determined under Section 2001(b)(1) on the estate of such deceased spouse (Section 2010(c)(4)). Electing portability is actually not an affirmative election. It is a deemed election made upon the filing of a timely and complete and properly prepared 706, where there is a DSUE amount and a surviving spouse. The election is not available to a nonresident surviving spouse who is not a U.S. citizen, except to the extent allowable by treaty with his or her country. For purposes of assets being transferred to a qualified domestic trust 4 Section 6035(a)(2). 5 Section 6035(a)(3). 6 Prop. Reg (a)(2). 7 Section 2010(c)(5). E S T A T E P L A N N I N G F E B R U A R Y V O L 4 4 / N O 2

4 19 (QDOT) for the benefit of a non- U.S. surviving spouse, the calculation of the DSUE amount is preliminary and does not become fixed until either the surviving spouse becomes a U.S. citizen or the trust makes a final distribution. 8 The portability election, once made, is irrevocable as of the due date of the Form 706 (or date filed, if extended). 9 The election can be made only by a duly appointed executor or administrator of the estate, which raises the potential conflict if the surviving spouse and executor are at odds as to whether to make the election. 10 The portability election is applicable to only the regular estate tax; there is no provision for porting any unused generation-skipping transfer exclusion amounts to a surviving spouse. One drawback to making the portability election is that it suspends the tolling of the statute of limitations until such time as the statute of limitations has run on the the estate tax return of the surviving spouse, but only with respect to the computation of the DSUE amount being claimed by the surviving spouse s estate. 11 As noted above, a timely filed Form 706 needs to be filed in order to elect portability, even though the filing of Form 706 is not otherwise required. An executor may also opt out of electing portability. Opting out can be accomplished by either checking the opt-out box on Form 706, Part 6, Section A, or simply not filing an estate tax return at all (because the election cannot be made on a late-filed return). State inheritance tax considerations Portability is a federal concept, and to the author s knowledge, no state has yet adopted a portability statute, although states may allow it by reference if they otherwise piggyback the federal rules. Several states, however, do not provide exclusions as generous as the federal exclusion. Examples include New Jersey, Maryland, Pennsylvania, and Massachusetts. In such cases, consideration should be given to funding a credit shelter trust to the extent of the state s exclusion amount to protect those assets. Another strategy would have the assets left to a marital trust, followed by a gift from the surviving spouse to a children s trust. (This strategy would work in some states only if the surviving spouse survives the gift by more than one year, and Connecticut residents would also have to consider state gift tax implications.) Specialized planning Clients may have any number of particular family situations that they want their estate plans to address. Need to provide for a surviving spouse and children. Does the client want assets left outright or in trust? At what age should heirs inherit? A couple s combined estate of $10 million may not result in any federal estate tax liability, but it still is a large sum of money, which could be wasted if left in the hands of a surviving spouse or children who do not know how to handle such wealth. Circling back to the discussion of leaving assets outright to a surviving spouse and making a portability election, funding a trust and naming an independent trustee might be appropriate if the surviving spouse cannot handle his or her own finances or may be vulnerable to scams or financial abuse. Likewise, leaving large sums of money to children can be challenging. No doubt, assets should held in trust for the benefit of minors, but adult children may not be ready or financially mature enough to handle an inheritance as well. A solution might be to continue to hold assets in trust after the death of the parents and allow annual distribution of income and incremental distributions of principal to the adult child, say at ages 25, 30, and 35. Second (or third, or fourth) marriage. Blended families can create their own challenges where, for example, a husband wants to provide security for his second wife, but also wants the remainder of his estate to pass to the children of his first marriage at his second wife s death. In such cases, a qualified ter- 8 Reg (b)(4). 9 Reg (a)(4). 10 Reg (a)(6). 11 Regs (d) and (d). F E B R U A R Y V O L 4 4 / N O 2 E S T A T E S U N D E R $ 1 0 M I L L I O N

5 20 minable interest property (QTIP) trust would be advisable. The assets held in the trust would be for the benefit of the surviving spouse during her lifetime (and be included in her taxable estate at death), and then be distributed to the children of the husband s former marriage. Another important factor is the jurisdiction in which the trust is administered, particularly with respect to the taxation of the trust s income and the powers given to the trustee. Family dynamics. Every family has them. Consideration and proper planning needs to be done to address heirs with drug or alcohol addictions, unstable relationships, spendthrifts, and those that may otherwise be vulnerable to predatory practices. A will or trust can provide that the inheritance be held back until the beneficiary has met certain criteria such as completing college, getting married, being drug-free for a stated period, or attaining a certain age. Caring for a special needs person. This can be accomplished by creating a special needs trust (SNT sometimes referred to as a supplemental needs trust) or funding a state program (where available), which does not supplant means-tested government benefits such as Supplemental Security Income, but rather provides funds to maintain the beneficiary s quality of life such as paying for haircuts, vacations, trips to the zoo, etc., without jeopardizing federal or state aid. SNLs are either selfsettled, meaning they are established with assets belonging to the beneficiary or the result of litigation proceeds; or a third-party trust, which is funded with assets from a person other than the beneficiary. A self-settled trust must be established by a parent, grandparent, guardian, or a court before the beneficiary is age 65; be for the sole benefit of the beneficiary and upon the death of the beneficiary; and must reimburse Medicaid for any and all medical benefits paid on behalf of the beneficiary. 12 Although setting up an SNT is beyond the scope of this article, careful consideration also needs to be given to finding capable individuals or institutions to (1) manage the funds and (2) be an advocate for the beneficiary after the primary caregivers are no longer alive. It is therefore important to work with a lawyer knowledgeable in this area when establishing an SNT. Beneficiary designations. Individuals need to make sure that beneficiary designations, including contingent beneficiaries, are up to date for IRAs, employer retirement plans, insurance policies, and annuities. This is especially important after a divorce, death of a spouse, or any inheritance of IRA/retirement plan assets. It is very hard, if not impossible to change beneficiaries after death and having the wrong beneficiary, including having retirement plan assets payable to one s estate or former spouse, could ruin an otherwise perfectly good estate plan. Asset protection. Creating a trust to protect a beneficiary from predators or even from themselves if they are not good at handling money is critical. This can be done either during the trustor s lifetime or at death. Two major considerations are the selection of a trustee and where the trust is administered. There are benefits and drawbacks to consider when selecting individual or corporate trustees, including investment experience, fees, flexibility, and objectivity. As such, consideration should always be given to using both an individual and corporate trustee as cotrustee, giving the individual trustee or beneficiaries the right to change corporate trustee. Another important factor is the jurisdiction in which the trust is administered, particularly with respect to the taxation of the trust s income and the powers given to the trustee. Closely held business or farm operations. In many cases, some but not all children of the business owner will continue in the family-owned business. The challenge here may be creating equal inheritances for all heirs if the value of the business comprises the bulk of the taxpayer s estate (think life insurance). The issue, however, may not just be about equalizing the values to each beneficiary, but rather which of them will have ultimate control over future operations and the potential sale of the business. Consideration should also be given to the possibility that none of the heirs will want the business. As with all estate planning, but especially in the case of business owners, the conversation of succession planning in coordination with one s estate planning should be done as early as possible. It should not be left to the last minute when options could be limited. Educational needs. An individual may be paying the educational cost for their children or grandchildren (or others), which should be done by making the payments directly to the educational institution to avoid any gift tax implications. The indi U.S.C. section 1396p(d)(4)(e). E S T A T E P L A N N I N G F E B R U A R Y V O L 4 4 / N O 2

6 21 vidual may want to make sure that future educational costs are covered after his or her death. One alternative is to create and fund an education trust. A planning concern here, however, is that the trust income tax rates are compressed, so any undistributed income left in the trust at the end of the year could be taxed as high as 43.4%, in addition to state income taxes. An alternative is to fund a Section 529 plan. The rules allow for the funding of up to five times the annual exclusion amount to be made in a single tax year to a 529 plan, with an election made on a timely filed gift tax return to spread the gift over a five-year period. 13 This would allow a parent or grandparent to set aside up to $70,000 per beneficiary (and up to another $70,000 by a spouse, and gift splitting is available in all cases) in 2017 into a 529 plan. The process could then be repeated again in Should the donor die within the fiveyear period, a pro-rata portion of the original contribution would be recaptured and added back to the decedent s gross estate. Caution should be taken however, for 529 plans created by a grandparent since under current rules, the distribution from such plans is considered income of the student, which could jeopardize financial aid. The same rule does not apply to plans set up by the student or his or her parents. Guardianship for minors and incapacitated persons. The decedent s will should express who he or she wishes to take care of any minor children, rather than leaving it up to state law. Consideration usually goes to those relatives or friends who the parents feel will provide care, love, and an atmosphere sim- 13 Section 529(c)(2)(B) IRB REG , 8/4/16. ilar to how they themselves would raise their children. This does not mean, however, that the same persons who care for the children should also manage the funds that will be used to pay for their care and upbringing. A person can provide a loving and nurturing environment for a child but not be able to manage money or investments. Naming an independent trustee to manage the funds earmarked for the children s upbringing should be a serious consideration, if for no other reason than to ensure that the funds will be used for the proper purpose. Insurance certainly has its place in planning for smaller estates, specifically life and long-term care insurance. Charitable intent. Even without consideration of the charitable deduction to reduce a taxable estate, most charitable planning techniques can be created either during the individual s lifetime or upon his or her death by including a charitable clause in the will or trust. This would include outright gifts of cash, securities, or real estate, creating a charitable remainder trust, donor-advisor fund, or an endowment. For example, notwithstanding estate tax savings, the creation of a charitable remainder trust (CRAT) can provide: 1. A current income tax deduction. 2. Capital gains tax savings. 3. Diversification of an otherwise highly concentrated investment portfolio. 4. A steady income stream. 5. A possible higher return on investments. Although CRATs do not fare well from an income tax deduction in a low-interest environment, they can provide a level of asset protection and annuity for a surviving spouse or other individual beneficiary. Recently issued Rev. Proc contains a sample provision, which if included in the CRAT document, will prevent the CRAT from being subject to and possibly failing the 5% probability of exhaustion test. The big winner of any of these vehicles is the charity, which, while many individuals may be hesitant to give up income-producing assets during their lifetime, may want to create a legacy by endowing a particular organization or field of interest after their death, regardless of the lack of tax deduction. Hard-to-value assets. Individuals with hard-to-value assets including business interests, artwork, antiques, coin or book collections, and certain publicly traded partnership investments, should consider obtaining current valuations for estate planning purposes. If the individual created a family partnership, consideration also needs to be given to applicable valuation discounts. Conventional wisdom was to take deep discounts on certain gifts, including shares of closely held stock or units of a family partnership. With many estates now falling under the maximum exclusion, aggressive discounting may be more counterproductive compared to getting a step-up in basis for the shares. It is also a good idea to get certain assets appraised for insurance purposes. Furthermore, the recent release of Proposed Regulations under Section (Chapter 14) will certainly have an effect, at least on the extent of a lack of control F E B R U A R Y V O L 4 4 / N O 2 E S T A T E S U N D E R $ 1 0 M I L L I O N

7 22 discount that can be applied on transfers of ownership in closely held family entities. International considerations. For estate tax purposes, there is no marital deduction for assets left to a nonresident spouse. Thus, a qualified domestic trust (QDOT) needs to be used to qualify the assets for the marital deduction. (The assets will be taxed at the surviving spouse s death.) The use of life insurance may be an alternative for providing for the nonresident spouse who may otherwise not have access to the assets in the trust. Annual gifts of up to $149,000 (in ) can also be made to provide funds to a nonresident spouse. Other considerations, beyond the scope of this article, need to be considered in the case of non-u.s. citizen spouses owning assets in the U.S. as well as for U.S. citizens owning assets outside of the country. Insurance coverage. Insurance certainly has its place in planning for smaller estates, specifically life and long-term care insurance. Life insurance can be used in two ways: 1. As a wealth replacement vehicle in cases where parents want to leave a large portion of their estate to charity but still want to provide for their children or grandchildren. 2. As the great equalizer, such as when a family business makes up a large portion of the parents estate, but not all of the children are involved or will inherit the business. In these cases, the life insurance could be left to the nonparticipating beneficiaries. In both instances, the use of an irrevocable life insurance trust (ILIT) would be advisable because the proceeds would then avoid being included in the decedent s gross estate and possibly causing the estate to exceed the allowable exclusion amount. Often overlooked is long-term care insurance. These policies can help defray the cost of daily skilled nursing and in-home care, if and when needed. Long-term care policies are generally priced based on several factors, such as maximum daily benefit, length of coverage (generally three to five years), and the elimination period before benefits are paid (e.g., 90 or 180 days). Serious consideration for obtaining a policy should be given by those who will not have someone around to care for them (maybe a spouse or partner), or with children who live far away. Although long-term care premiums can be expensive, the cost of even paying $4,000 per year for 20 years ($80,000) before receiving any benefits, could be greatly outweighed after only one year of payments to a skilled nursing facility, thus greatly depleting the assets that would otherwise be left to the beneficiaries. If paying the premiums for either life or long-term care insurance becomes a strain for the parents, consideration should be given to asking the children to pay all or a part of the premiums because maintaining the policies protects their inheritance. Pets. Leona Helmsley (the queen of mean), who left $12 million for the care of her dog, Trouble, was not the only person to make provisions for the care of pets. The issues here are how much, who will care for the pet, who will hold and disperse the funds, and what happens when the pet dies. If the funds are left in trust, who will be the trustee and how is the income taxed (Fluffy never had a federal ID number)? Post-mortem elections. Just because the estate is not taxable, other elections could provide a benefit to the estate and beneficiaries. Such elections include: 1. Electing to report Series E and EE U.S. Savings Bond interest on the decedent s final income tax return. 2. Selecting the proper fiscal year for the estate. 3. Making a Section 645 election to combine the estate and revocable trust tax filings. 4. Use of disclaimers. 5. Properly allocating the generation-skipping transfer tax exclusion. 6. QTIP election. Conclusion Individuals cannot ignore the need for basic estate planning merely because their estate is under the federal estate tax threshold. Estate planning professionals need to understand the nontax considerations and challenges and be able to work with the client s other professional advisors to help put together a meaningful estate plan. 16 Rev. Proc , supra note 1. E S T A T E P L A N N I N G F E B R U A R Y V O L 4 4 / N O 2