Death: The Final Tax Frontier. Patrick Lee, CPA Senior Manager - Kruggel Lawton CPAs

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1 Death: The Final Tax Frontier Patrick Lee, CPA Senior Manager - Kruggel Lawton CPAs CFO Summit November 8, 2017

2 2 The Unified Transfer Tax

3 Unified Transfer Tax Includes estate and gift transfer taxes Both use the same tax rate schedule and basic exclusion amount Highest tax rate over basic exclusion 40% 2017 basic exclusion amount - $5,490,000 Indexed for inflation $5,600,000 for

4 Unified Transfer Tax Estate and Gift Estate Transfer Tax 40% tax on estates over $5,490,000 Tax calculated on the Fair Market Value (FMV) of all assets held at date of death Alternative FMV date six months after date of death Gift Transfer Tax 40% tax on gifts over $5,490,000 Tax calculated on the Fair Market Value (FMV) of all gifts on the date of the transfer Gifts made during life will reduce the exclusion amount for estate tax 4

5 Estate Transfer Tax Around 1 out of every 700 estates pay estate transfer tax Tax reform proposal does include repeal in six years Historical Perspective: 5 Basic Exclusion Top Tax Rate $134,000 70% $600,000 55% $625,000 55% $2,000,000 45% $5,000,000 35% $5,490,000 40%

6 Estate Transfer Tax (cont.) What does a taxable estate include? Business interests Qualified plans IRA s, 401(k) s, etc. Certain life insurance policies Personal property Real estate Certain trust property All assets deemed to be owned by an individual at death, including intangible assets. 6

7 Estate Transfer Tax Example Mary passed away in Her estate included the following items: Cash and investments - $300,000 IRA - $500,000 Life insurance - $1,000,000 Personal residence - $500,000 Business interest - $5,000,000 Deductions - $200,000 Assuming no lifetime gifting, Mary s taxable estate is $7,100,000. 7

8 Estate Transfer Tax Example (cont.) Mary s total taxable estate is $7,100,000. No lifetime gifts were made; therefore, the full $5,490,000 basic exclusion is available. The tax is calculated as follows: $7,100,000 - $5,490,000 = $1,610,000 $1,610,000 x 40% = $644,000 Where is this cash coming from? Could this have been avoided? 8

9 9 Estate Planning Considerations

10 Three Categories Three Categories of Estate Plans: Estates under $5,490,000 Focus on income tax planning considerations Married couples between $5,490,000 and $10,980,000 Focus on income tax planning considerations Utilizing marital deduction and portability Couples over $10,980,000 or individuals over $5,490,000 Minimizing estate transfer tax 10

11 Marital Deduction and Portability Surviving spouses are allowed an unlimited marital deduction on the estate of the first spouse. No estate transfer tax due on first to die. In our estate tax example, assume Mary s husband Fred was alive and inherited all of the assets. Mary would not have a taxable estate if Fred took advantage of the unlimited marital deduction. Surviving spouses are also allowed to retain any unused exclusion from the deceased spouse. This is referred to as portability or DSUE (Deceased Spousal Unused Exclusion). 11

12 Portability (DSUE) Example Don s wife, Laura, passed away in 2017 with a $2,000,000 estate. We are assuming that the $2,000,000 estate was passed to individuals other than Don. A portability election was made on Laura s form 706, allowing the $3,490,000 (2017 exclusion of $5,490,000 - $2,000,000) of unused exclusion to add to Don s lifetime exclusion. Therefore, Don could die in 2017 with an estate of up to $8,980,000 ($5,490,000 + $3,490,000) without any tax being due. 12

13 Charitable Deduction An individual is generally allowed an unlimited charitable deduction for estate and gift tax purposes. These donations reduce the individual s estate without reducing the lifetime basic exclusion amount. Charitable trusts allow for current income tax deductions. Charitable Lead Trust Mark makes a $500,000 gift to a trust that pays 5% of total assets annually to XYZ Charity for 20 years. After 20 years, the remainder goes to Mark s daughter, Rachel. Charitable Remainder Trusts Mark makes a $500,000 gift to a trust that pays 5% of total assets annually to his daughter, Rachel, for 20 years. After 20 years, the remainder goes to XYZ Charity. 13

14 Medical and Educational Gifts Medical expenses paid directly to the medical institution for another This is not considered a taxable gift and does not reduce the lifetime basic exclusion. Education expenses paid directly to the institution receives the same treatment as medical expenses This applies to tuition only (not room and board). Funding of a 529 plan should be considered as well. 14

15 Step-Up in Basis Assets that are included in an individual s estate for tax purposes receive a step-up in basis. Assume Adam was going to sell $100,000 of investments that have $50,000 of tax basis. If Adam were to sell these assets, he would have a $50,000 capital gain that would be subject to capital gains tax. Before the sale takes place, Adam passes away. At death, the asset was held by Adam s estate. Therefore, the assets now have a basis equal to the FMV on date of death. This would $100,000. The estate sells the assets three months later at $102,000, with a $100,000 basis. The capital gain is now only $2,

16 Gifting A gifted asset is removed from one s estate while lowering the basic lifetime exclusion if over the annual gift exclusion amount. Annual Gift Exclusion - $14, ; $15, No reduction of basic lifetime exclusion. No gift tax reporting requirement. Example: Cindy and Chris are married and have four kids. Cindy and Chris can both give $14,000 to each child in 2017 for a total of $112,000 ($14,000 x 8). Does an estate currently have assets that are expected to appreciate in value? Gifting should be considered.

17 Gifting Example Let s revisit Mary s $7,100,000 taxable estate. Assume five years before she died, Mary decided to gift the business to her four children. Also, assume she is unmarried at her date of death. The FMV was $2,500,000 at the time with expectations of strong growth in the next 10 years. NOTE: Business interest FMV doubled to $5,000,000 in five years. The lifetime exclusion is reduced by the gift of $2,444,000 ($2,500,000 - $56,000 of annual exclusion). 17

18 Gifting Example (cont.) The estate no longer holds the $5,000,000 business interest when Mary passed away. Therefore, the total estate is reduced from $7,100,000 to $2,100,000. The $2,444,000 of lifetime gifts must be added to this total, bringing the total for estate transfer tax purposes to $4,544,000. The total lifetime exclusion is still $5,490,000. Therefore, no taxable estate exists. Compare this to the $644,000 of estate tax paid in our original example. 18

19 Freezing Estate Value GRAT Grantor Retained Annuity Trust A GRAT allows the grantor to freeze the value of an asset by moving it out of one s estate and gifting it to a trust. The trust then pays an annuity back to the grantor. The gift is valued as the FMV of the asset as of the date of the gift less the present value of the future annuity payments received. This allows for the gifting of an asset while still retaining cash flow from the asset itself over a period of time. 19

20 GRAT Example Example: Lisa owns a real estate entity valued at $3,000,000. She would like to transfer her interest out of her estate while retaining a cash flow from the entity. Lisa sets up a GRAT for the benefit of her children and funds it with the $3,000,000 asset. Lisa receives an annual annuity of $135,000 for 5 years assume present value of annuity is $585,000. Lisa shows a gift on her 2017 gift tax return of $2,415,000 ($3,000,000 - $585,000). Lisa s basic lifetime exclusion is now $3,075,000 ($5,490,000 - $2,415,000). 20

21 Retirement Plan Consideration When considering charitable giving as a part of an estate plan, qualified plans are a great vehicle for those donations. Most assets within an estate receive a step-up in basis as of date of death, and can be sold and distributed with little tax consequence. However, when distributions are taken from qualified plans, they are taxable to the beneficiary. If the designated beneficiary of a qualified plan is a charity, no income tax will have to be paid on those funds. Therefore, if charitable giving is part of the estate plan, one should consider taxable assets like an IRA first. 21

22 Other Considerations Buy-Sell agreement can impact FMV of asset Agreement would need to be made between unrelated parties. S Corporation considerations Only a qualified trust can be a shareholder of S Corporation stock; otherwise, the S election is terminated. If a trust is going to own S Corporation stock, make sure it is a qualified trust i.e. QSST (Qualified Subchapter S Trust) or ESBT (Electing Small Business Trust). Life Insurance Trust Should a life insurance trust be considered to remove life insurance from an individual s taxable estate? 22

23 Other Considerations (cont.) If under the basic exclusion for estate planning purposes, gifting may not be as beneficial. When an asset is gifted, the basis carries over to the recipient. Inherited assets receive a step-up in basis. Are valuation discounts on business interests always a good thing? Verify whether the individual lives in a state with a state death tax. 23

24 Beneficiary Designations and Asset Titling 24

25 Beneficiary Designations Are all beneficiary designations correct on retirement plans and life insurance? Beneficiary designations are the final authority. Avoid titling to trusts and estates! Name a charity? If an estate plan exists, are all assets properly titled? Many times, this would involve a revocable living trust. If assets aren t properly titled, the best estate plan may not fulfill its purpose. 25

26 Beneficiary Designations Horror Stories Egelhoff, Supreme Court, 2001 $46,000 of life insurance proceeds to ex-spouse Washington state law automatically disinherits ex-spouse upon divorce; however, beneficiary designation was not updated. Beneficiary designation overruled state law Kennedy Estate, Supreme Court, 2008 $400,000 from company savings and investment plan to ex-spouse Divorce decree specifically waived any interest in this asset; however, beneficiary designation was not updated. Beneficiary designation overruled divorce decree 26

27 27 Questions?

28 Patrick Lee, CPA Senior Tax Manager Phone: , ext Experienced in tax services for trusts, estates, individuals, corporations, and partnerships including tax information reporting and compliance, tax planning, and research. EXPERIENCE Patrick is involved at the manager level in tax engagements, focusing on fiduciary tax services as well as closely-held businesses and their owners. Other areas of service include: Trust and estate tax preparation Tax information reporting and compliance Estate planning Corporate tax preparation Individual tax preparation Tax forecasts and projections Multi-state taxation Research for both federal and state tax issues Property tax preparation PROFESSIONAL MEMBERSHIPS American Institute of Certified Public Accountants Indiana CPA Society Elkhart County Estate Planning Council COMMUNITY INVOLVEMENT First Baptist Church of Goshen, member Boys and Girls Club of Elkhart, board member and treasurer Elkhart Christian Academy, board member Elkhart Chamber Leadership Academy, 2015 graduate INTERESTS Patrick enjoys time away from the office with his wife and four small children. Patrick is also an avid sports fan who loves to watch both baseball and football on a regular basis. EDUCATION Grace College, Winona Lake, IN B.S. Accounting, Business Administration & Statistics SOUTH BEND, IN 210 S. Michigan St., Ste 200 P: ELKHART, IN 317 W. Franklin St. P: ST. JOSEPH, MI 805 Van Brunt Ave. P: Rev. 8.16