Using Portability to Create a Flexible Estate Plan

Transcription

1 Using Portability to Create a Flexible Estate Plan Presented by: Robert S. Keebler, CPA/PFS, MST, AEP Keebler & Associates, LLP (920) robert.keebler@keeblerandassociates.com

2 Earn CPE #AICPApfp 2

3 Helpful Hints #AICPApfp 3

4 About the PFP Section & PFS Credential The AICPA Personal Financial Planning (PFP) Section is the premier provider of information, tools, advocacy and guidance for CPAs who specialize in providing estate, tax, retirement, risk management and/or investment planning advice to individuals, families and business owners. (Learn more at aicpa.org/pfp.) The Personal Financial Specialist (PFS) program allows CPAs to gain and demonstrate competence and confidence in providing estate, tax, retirement, risk management and/or investment planning advice to individuals, families and business owners through experience, education, examination, and a resulting credential. (Learn more at aicpa.org/pfs.) #AICPApfp 4

5 Today s Speaker Robert S. Keebler, CPA/PFS, MST, AEP (Distinguished) Keebler & Associates, LLP #AICPApfp 5

6 Portability Considerations after Rev. Proc Marital Deduction (U.S. Citizen Spouse) Asset Protection Estate Tax Inclusion at Second Death GST Exempt at First Death State Estate Tax Protection Step-up in Basis at Second Death Assets Available to Children- After First Death Portability IRA Rollover Designated Beneficiary Trust Spouse Outright Yes No Yes No Generally No. Yes Yes, via Gifts Yes Yes N/A Bypass Trust No Possible No Yes, with GST Exemption Allocation Yes No Yes, if Trust Document Allows Yes, Less Bypass Amount No Possible with Proper Drafting 4 Bypass Trust with Formula GPA 5 No Varies by state GPA Portion 1,5 Yes, for Non-GPA Portion with Exemption Allocation Yes, for Non-GPA Portion Yes, for GPA Portion Yes, if Trust Document Allows Yes, Less Bypass Amount No Possible with Proper Drafting 4 Portability QTIP 6 Yes Possible Yes 2 Yes, via a Reverse QTIP Election 3 Generally No Yes No Yes No Possible with Proper Drafting 4 This work is not intended to provide legal or accounting or any other professional advice. 1. IRC IRC IRC 2652(a)(3) 4. Treas. Reg (a)(9)-4, Q&A 5 5. GPA limited to an amount which does not incur estate tax at the second death. 6. Requires elections reported on Form 706 at the first death. #AICPApfp 6

7 The Portability QTIP Rev. Proc Yes, excess of BEA 1,2 Rev. Proc Portability QTIP Yes Yes Will a bypass trust be funded due to state estate tax? Yes No Will the decedent incur estate tax if the marital deduction is not used? No Yes, up to BEA 2 Could inclusion of the assets in the surviving spouse s estate incur estate tax greater than the income tax savings of basis step-up? Yes 3 No Should the decedent allocate GST exemption? 4 No Is a trust prudent to protect the decedent's assets? No Bypass Trust Outright to Spouse 1. Basic Exclusion Amount (BEA) 2. Assumes asset protection is desirable. 3. May be prudent to elect portability, give assets to the surviving spouse and then fund the trust in order to allow for a grantor trust. 4. Note that the GST exemption cannot port to the surviving spouse, however a reverse-qtip election is available. #AICPApfp 7

8 Rev. Proc After portability was enacted, it might be prudent to fund a QTIP even when it does not reduce or eliminate estate tax owed at the first death. However, before portability funding a QTIP was only prudent if it reduced or eliminated estate tax owed at the first death. Rev. Proc sought to void such unnecessary QTIPs; it was a taxpayer friendly ruling. #AICPApfp 8

9 Rev. Proc After portability was enacted, planners feared that Rev. Proc could void now prudent QTIP elections. Rev. Proc confirms that Rev. Proc is not the position of the service and will not be used to void such elections. #AICPApfp 9

10 Rev. Proc Example: John & Jane have a $7,000,000 net worth. John has $5,000,000 of assets and Jane has $2,000,000. John dies and his remaining basic exclusion amount is $5,000,000. John s estate funds a trust with the $5,000,000, makes a QTIP election, and elects portability for his remaining BEA. Due to the marital deduction & portability, John does incur estate tax, lose his exclusion amount, or definitely create a future estate tax liability for Jane. The QTIP also provides asset protection and dead-hand control. Jane dies 5 years later. Her assets have not increased in value, however the assets in the QTIP have not been drawn upon and are now worth $7,000,000. By using the QTIP election to include the assets in Jane s estate Any unrecognized appreciation in the trust is eliminated by the 1014(a) basis adjustment. #AICPApfp 10

11 Portability Basics Portability allows the executor to either utilize the decedent s estate tax exclusion amount ($5,450,000 in 2016) or to transfer it to the decedent s surviving spouse. However, the new law does not allow the decedent to transfer his/her unused GST tax exemption to the surviving spouse. See 26 USC 2010(c)(4). #AICPApfp 11

12 Portability Basics Key Mathematical Concepts Basic Exclusion Amount (BEA) Deceased Spousal Unused Exclusion Amount (DSUE) Bypass trust Marital Deduction IRA Management #AICPApfp 12

13 Portability Basics Basic Exclusion Amount (BEA) Prior to 2011, the basic exclusion amount was referred to as the applicable exclusion amount In simple terms, the BEA is the minimum estate tax exclusion amount allowed for a single decedent In 2016, the BEA is $5,450,000 Like the prior applicable exclusion amount, the BEA is reduced by prior taxable gifts #AICPApfp 13

14 Portability Basics Deceased Spousal Unused Exclusion Amount (DSUE) DSUE is the unused estate tax exclusion that the deceased spouse transfers to his/her surviving spouse. #AICPApfp 14

15 Portability Basics DSUE is limited to the lessor of: A. The basic exclusion amount (BEA): $5.45 M in 2016 B. The excess of: (i) the BEA of the last deceased spouse of the surviving spouse over (ii) The taxable estate of the last deceased spouse Example: BEA = $5.45 M Deceased s estate = $3.00 M $5.45 M 3.00 M = $2.45 M #AICPApfp 15

16 Portability Basics Indexing for Inflation The basic exclusion amount (BEA) is indexed for inflation DSUE is not indexed for inflation BEA DSUE 2016 $ 5,450,000 $ 5,450, $ 5,560,000 $ 5,450, $ 5,670,000 $ 5,450, $ 5,780,000 $ 5,450, $ 5,900,000 $ 5,450, $ 6,020,000 $ 5,450,000 #AICPApfp 16

17 Portability Basics Key Issues The election to transfer the unused estate tax exemption amount must be made on a timely-filed estate tax return No election can be made on a late-filed return #AICPApfp 17

18 Portability Issues Last Deceased Spouse At a decedent s (D2 s) death, if the decedent s spouse (D1) predeceased him/her and that decedent (D1) did not use his/her estate tax exclusion, the surviving decedent (D2) may be permitted to take advantage of the predeceased spouse s (D1 s) unused exemption (i.e. DSUEA) To assure that the decedent s (D2 s) estate will only benefit from one such DSUEA, and to provide clarity as to which DSUEA can be utilized, only the DSUEA of the last deceased spouse can be used In other words, the surviving decedent s estate cannot pick which prior decedent spouse s DSUEA to use #AICPApfp 18

19 Portability Issues Last Deceased Spouse Example H1 and W1 are married at the time H1 s death in Although H1 s taxable estate is $5,000,000, the executor of H1 s estate transfers the entire estate to W1 (via the unlimited marital deduction) and elects to transfer H1 s entire estate tax exclusion amount ($5,000,000) to W1 (i.e. DSUEA). W1 then marries H2. In 2012, H2 dies with a taxable estate of $3,000,000, whereby the executor of H2 s estate chooses to utilize $3,000,000 of H2 s $5,120,000 estate tax exclusion amount. Based on these facts, the DSUEA available to W1 is $2,120,000 (i.e., H2 s remaining estate tax exclusion amount). #AICPApfp 19

20 Portability Issues Privity The use of the DSUEA requires marriage. Thus, a spouse of a surviving spouse cannot use that surviving spouse s prior DSUEA if the surviving spouse dies before the taxpayer in question In other words, a decedent cannot aggregate the DSUEAs of prior deceased spouses #AICPApfp 20

21 Portability Issues Privity Example H1 and W1 are married at the time H1 s death in The executor of H1 s estate transfers the entire estate to W1 (via the unlimited marital deduction) and elects to transfer H1 s entire estate tax exclusion amount ($5,000,000) to W1 (i.e. DSUEA). W1 then marries H2. In 2012, W1 dies with a taxable estate of $2,000,000, whereby the executor of W1 s estate chooses to utilize $2,000,000 of W1 s $10,120,000 estate tax exclusion amount ($5,000,000 DSUEA from H1 + $5,120,000 BEA),. Based on these facts, the DSUEA available to H2 is $3,120,000 (i.e., W1 s remaining BEA). #AICPApfp 21

22 Portability Issues Privity Example (cont.) While W1 had a $10,120,000 total estate tax exclusion amount ($5,000,000 DSUEA from H1 + $5,120,000 BEA), only $2,000,000 was used Of the $2,000,000 estate tax exclusion that was used, the entire amount was attributable to W1 s BEA Therefore, only $3,120,000 of W1 s total estate tax exclusion amount (i.e. $5,120,000 BEA - $2,000,000 BEA used) may be utilized by H2 It is important to note that the remaining $5,000,000 estate tax exclusion amount (passing from H1 to W1) is completely lost and cannot be used by H2 #AICPApfp 22

23 Portability It s a balancing Act Estate Tax Income Tax #AICPApfp 23

24 Portability Core Concepts Saving Transfer Tax Estate Tax: 40% GST Tax: 40% Gift Tax: 40% State Estate/Inheritance Tax: 0% - 20% State Gift Tax: 0% - 12% #AICPApfp 24

25 *Map Source: Minnesota House Research Department #AICPApfp 25

26 Portability Core Concepts Protecting Property Asset Protection Bloodline Protection Spendthrift Protection Power of Appointment #AICPApfp 26

27 Portability Core Concepts Saving Income Tax Carryover basis IRC 1015 Step-up in basis IRC 1014 Federal Capital Gains Tax State Capital Gains Tax Taxation of Trusts and Estates State Estate Tax State Portability State Exemption #AICPApfp 27

28 Mathematics of Portability Core Concepts: BEA DSUE GST Exemption Basis reset to FMV at Death Capital Gains Rates (including state rates) Tax characteristics of assets (tax deferred, tax free, depreciable, etc ) #AICPApfp 28

29 Mathematics of Portability Seven Strategies 100% to Spouse 100% to Bypass Trust 100% to Bypass Trust with formula contingent general power of appointment 100% to QTIP Trust 100% to Clayton QTIP Trust 100% to Spouse followed by a large gift Combined Approach #AICPApfp 29

30 Algebra to Chart Portability AA 1 = AA ii AA 2 = AA ii AA 3 = AA ii RR yy RR yy RR yy BB 2 = BB 1 RR ii + 1 yy DD = BB 1 CC = BB 2 + DD Where: y equals years A 1, A 2, and A 3 equal the future value of the estate assuming different growth rates as defined by R 1, R 2, and R 3 B 1 equals the deceased spouse s BEA B 2 equals the surviving spouse s BEA R i equals the assumed inflation rate of the BEA D equals DESU C equals the combined exemption (BEA+DESU) #AICPApfp 30

31 Consider a couple with a combined estate of $5,000,000 and note the effect of a long life expectancy and or a high rate of return. #AICPApfp 31

32 Algebra to Compare Portability to the Bypass Trust AA 1yy = AA 1ii RR yy AA 2yy = AA 2ii RR yy BB 1 = TT ii Where: y equals years A 1i equals the deceased spouse s estate A 1y equals the deceased spouse s estate at time y A 2i equals the surviving spouse s assets at the first death A 2y equals the surviving spouse s estate at time y B 1 equals the deceased spouse s BEA B 2 equals the surviving spouse s BEA TT yy = TT ii RR yy 1 II yy BB 2 = BB 1 RR ii + 1 yy DD = BB 1 CC = BB 2 + DD T i equals the amount contributed to trust T y equals the value of the trust at time y I equal the marginal income tax rate R i equals the assumed inflation rate of the BEA D equals DESU C equals the combined exemption (BEA+DESU) #AICPApfp 32

33 Mathematics of Portability In Florida Income Tax Estate Tax 23.8% * vs. 40.0% * 20% + 3.8% #AICPApfp 33

34 Consider a couple with a combined estate of $10,000,000 and note the effect of a long life expectancy and or a high rate of return. If the spouse survives just 2 years a Bypass Trust might be advisable! #AICPApfp 34

35 Mathematics of Portability In California Income Tax 37.1%* vs. Estate Tax 40.0% * 20% + 3.8% +13.3% = 37.1% #AICPApfp 35

36 Consider a couple with a combined estate of $10,000,000 and note the effect of a long life expectancy and or a high rate of return. If the spouse survives just 4 years a Bypass Trust might be advisable! #AICPApfp 36

37 100% to Spouse Advantages Step-up at second death Spouse controls property IRA Rollover Available Spousal Rollover/Stretch IRA possible Disadvantages First spouse s DSUE is frozen at DOD value, while assets appreciate GST exemption cannot port #AICPApfp 37

38 100% to Bypass Trust Advantages Growth is exempt from estate tax GST Exemption Preserved Non-Mathematical Advantages Asset, bloodline, & spendthrift protection Disadvantages No step-up in basis at the second death Annual Income taxation at the trust level At best, IRA distributed over life of oldest beneficiary #AICPApfp 38

39 What is the Value of a Step-up? Tax savings Federal Capital Gains Tax Federal Net Investment Income Tax State Capital Gains Tax #AICPApfp 39

40 What is the Value of a Step-up? Highest Combined Marginal Rates Populous City/State Examples: California: 23.8% % = 37.1% New York City: 23.8% % = % Florida: 23.8% = 23.8% Texas: 23.8% = 23.8% #AICPApfp 40

41 What is the Value of a Step-up? Example: Tom, a Florida Resident, purchased an apartment building for $900,000. Later, the fair market value of the property increases to $2,200,000. If he were to sell the property at $2,200,000, he incurs income tax. Basis 900,000 Fair Market Value 2,200,000 Gain 1,300,000 Tax Rate 23.8% Tax 309,400 Alternatively, if Tom dies before the apartment is sold, the original basis would step-up to reflect the current fair market value. Tom is therefore able to pass more property to his heirs. Basis 2,200,000 Fair Market Value 2,200,000 Gain 0 Tax Rate 23.8% Tax 0 #AICPApfp 41

42 What is the Value of a Step-up? The higher the tax rate the greater the value of any step-up in basis #AICPApfp 42

43 What is the Value of a Step-up? Example: The value of a step-up varies by state. For example, if Tom from the previous example was subject to a 23.8% tax. However, if he were in California, however, the rate is 37.1% Florida California Basis 900, ,000 Fair Market Value 2,200,000 2,200,000 Gain 1,300,000 1,300,000 Tax Rate 23.8% 37.1% Tax 309, ,300 #AICPApfp 43

44 What is the Value of a Step-up? Summary: Managing Highly Taxed Capital Assets Option 1 pass assets to surviving spouse Basis follows the assets Appreciated assets incur tax if disposed of prior to the second death Opportunity for a larger step-up in basis is the asset appreciates between the first and second death Option 2 fund bypass trust Basis is reset to FMV at the first death Any income (yield) from assets is a subject to a higher trust tax brackets No opportunity for step-up at the second death, but step-up locked-in at first death #AICPApfp 44

45 General Power of Appointment IRC 2041 General Powers of Appointment ( GPA ) A GPA grants the authority to designate the recipients of property held by an estate or trust. The GPA is a broad power which allows the beneficiary to allocate the estate/trust property to any individual or organization. #AICPApfp 45

46 General Power of Appointment IRC 1014 Basis of Property Acquired From a Decedent includes property subject to GPA The holder of a GPA over trust property will be subject to estate tax on that property whether or not the GPA is exercised #AICPApfp 46

47 General Power of Appointment 2041 Requires the holder of a power appointment to choose assets to include in the taxable estate 1014 If property if is included in one s taxable estate, the basis of the asset is adjusted to FMV The flexibility of a GPA therefore can be used to funnel the maximum amount of built in gain to the taxable estate to receive a tax-free stepup. #AICPApfp 47

48 General Power of Appointment Example: At David s death in 2016, 100% of his $3,000,000 estate passes to a bypass trust and $2,450,000 of DSUE ports to his wife Viola. Viola has assets of $5,000,000 at her death in Her total BEA + DSUE equals $7,860,000. #AICPApfp 48

49 General Power of Appointment Example: Total Estate $5,000,000 Total Exemption $7,860,000 Excess Exemption $2,860,000 Viola will therefore have a GPA over $2,860,000 at her death this property now receives a STEP-UP at the second death! #AICPApfp 49

50 General Power of Appointment Excellent strategy for estate below the combined exemption Does not work for items of IRD (IRC 691(a)) Does not work for IRA assets must be a restricted limited power of appointment May raise asset protection concerns #AICPApfp 50

51 Formula Contingent General Power of Appointment At the death of my spouse she shall have a general power of appointment to the extent it will not result in a higher federal estate tax. * *This language is merely to illustrate the concept. DO NOT use this language in a trust document. It is insufficient. #AICPApfp 51

52 QTIP Trust The corpus of a QTIP trust is not subject to estate tax at the grantor s death Instead, the corpus passes tax-free to the surviving spouse The surviving spouse is entitled for life to all income from the trust At the surviving spouse s death, the corpus of the trust passes to beneficiaries controlled by the grantor s wishes See 26 USC 2056(b)(7). #AICPApfp 52

53 QTIP Trust Follow the Money: Grantor QTIP Trust Corpus Grantor Controlled Beneficiaries Grantor s Spouse Follow the Estate Tax: Tax Free Transfer using the Marital Deduction Client Grantor s Spouse QTIP Corpus Included IRS Spouse s Estate Estate Tax + Spouse s Assets + QTIP Corpus Spouse s Basic Exclusion Amount = Taxable Estate x 40% = Estate Tax #AICPApfp 53

54 100% to QTIP Trust Advantages Step-up at second death GST protection with REVERSE QTIP election (Treas. Reg ) 15 months to make a QTIP election (with a 706 extension) Non-Mathematical Reasons Asset & bloodline protection Disadvantages Property taxable at death of surviving spouse (IRC 2044) Estate tax exposure for FMV of property at second death Difficult to QTIP an IRA #AICPApfp 54

55 100% to Spouse followed by a Gift to a Grantor Trust Strategy Explained: At first death, 100% of property passes to the surviving spouse Spouse then gifts DSUE amount to Grantor Trust for family Spouse pays income tax until death Tax -burn creates tax-free wealth transfer (See Rev. Rul ) #AICPApfp 55

56 100% to Spouse followed by a Gift to a Grantor Trust Unique Advantages Tax burn associated with a grantor trust (might be an excellent strategy for income producing assets) Locks in the value of the deceased spouse s estate tax exemption which prevents erosion of its value if assets appreciate faster than inflation Unique Disadvantages GST does not port to spouse; Trust is a one generation trust #AICPApfp 56

57 100% to Spouse followed by a Gift to a Grantor Trust st Death $ 11,000,000 $ 1,000,000 Gift to Spouse $ (11,000,000) $ 11,000,000 Gift to Grantor Trust N/A $ (5,450,000) Net Estate $ 0 $ 6,550,000 Example The spouse who is expected to pass first (spouse 1) has an estate of $11,000,000 while other spouse (spouse 2) has an estate of $1,000,000. Note: The surviving spouse uses DSUE to fund the trust & retains their BEA. #AICPApfp 57

58 100% to Spouse followed by a Gift to a Grantor Trust Example (cont) Assumptions: 7% Growth Rate, 30% Effective Tax Rate for Surviving Spouse, 40% Effective Tax Rate for Trust, 2% Inflation Rate for BEA $20,000,000 $18,000,000 $16,000,000 $14,000,000 $12,000,000 $10,000,000 $8,000,000 $6,000,000 $4,000,000 $2,000,000 Wealth Transfer & Years Spouse Survives $ % to Spouse followed by a Gift to a Grantor Trust 100% to Bypass Trust 100% to Spouse #AICPApfp 58

59 Portability Considerations after Rev. Proc Marital Deduction (U.S. Citizen Spouse) Asset Protection Estate Tax Inclusion at Second Death GST Exempt at First Death State Estate Tax Protection Step-up in Basis at Second Death Assets Available to Children- After First Death Portability IRA Rollover Designated Beneficiary Trust Spouse Outright Yes No Yes No Generally No. Yes Yes, via Gifts Yes Yes N/A Bypass Trust No Possible No Yes, with GST Exemption Allocation Yes No Yes, if Trust Document Allows Yes, Less Bypass Amount No Possible with Proper Drafting 4 Bypass Trust with Formula GPA 5 No Varies by state GPA Portion 1,5 Yes, for Non-GPA Portion with Exemption Allocation Yes, for Non-GPA Portion Yes, for GPA Portion Yes, if Trust Document Allows Yes, Less Bypass Amount No Possible with Proper Drafting 4 Portability QTIP 6 Yes Possible Yes 2 Yes, via a Reverse QTIP Election 3 Generally No Yes No Yes No Possible with Proper Drafting 4 This work is not intended to provide legal or accounting or any other professional advice. 1. IRC IRC IRC 2652(a)(3) 4. Treas. Reg (a)(9)-4, Q&A 5 5. GPA limited to an amount which does not incur estate tax at the second death. 6. Requires elections reported on Form 706 at the first death. #AICPApfp 59

60 The Portability QTIP Rev. Proc Yes, excess of BEA 1,2 Rev. Proc Portability QTIP Yes Yes Will a bypass trust be funded due to state estate tax? Yes No Will the decedent incur estate tax if the marital deduction is not used? No Yes, up to BEA 2 Could inclusion of the assets in the surviving spouse s estate incur estate tax greater than the income tax savings of basis step-up? Yes 3 No Should the decedent allocate GST exemption? 4 No Is a trust prudent to protect the decedent's assets? No Bypass Trust Outright to Spouse 1. Basic Exclusion Amount (BEA) 2. Assumes asset protection is desirable. 3. May be prudent to elect portability, give assets to the surviving spouse and then fund the trust in order to allow for a grantor trust. 4. Note that the GST exemption cannot port to the surviving spouse, however a reverse-qtip election is available. #AICPApfp 60

61 To be added to our newsletter, please visit our website: keeblerandassociates.com/speaking #AICPApfp 61

62 Questions? Personal Financial Planning Planning Section Section #AICPApfp

63 AICPA PFP Section Member Resources PFP Section members, inclusive of CPA/PFS credential holders, have access to resources on the latest planning strategies and trends in personal financial planning services so that they can practice competently and profitably. Visit aicpa.org/pfp/resources. Estate Tax Retirement Investment Insurance & Risk Management Practice Management Legislative/ Regulatory Professional Responsibilities Consumer Content #AICPApfp 63

64 Upcoming PFP Section Events Webcasts (4 free events per year with CPE for PFP/PFS members) February 8 1-2pm ET February :45pm ET April :15pm ET Success Tips for Young Advisers Protecting Your Clients from Financial Fraud and Abuse Advising Clients on Planning for Education Conferences January 22-25, 2017 June 12-14, 2017 AICPA Personal Financial Planning Leadership Summit AICPA Advanced PFP Conference (ENGAGE) For the full calendar of upcoming PFP Section events, visit aicpa.org/pfp/events. PFP/PFS Members can access the archives (no CPE) for free at aicpa.org/pfp/library. #AICPApfp 64

65 CPA/PFS News and Events PFS Referral Program Receive 100% credit to apply toward future CPA/PFS dues by referring a CPA to become a PFS or sit for the PFS exam PFS Exam Register now for upcoming exam windows Discounts, sponsorships and volume pricing available Education Opportunities In-depth courses in estate, retirement, tax, investments, insurance, and PFP process In-person and online PFP Boot Camp Self-study PFS exam review course Learn more at aicpa.org/pfp/pfs #AICPApfp 65

66 A CPA Financial Planner is a trusted advisor who Operates at the highest professional level when delivering PFP services to clients, acting in the clients best interest. Adheres to high standards as required by the Code of Professional Conduct and the Statement on Standards in PFP Services through the application of objectivity, integrity, due care and competence required by CPAs. Is regulated by state boards of accountancy. Integrates advanced planning concepts, including tax and business considerations, with the entire financial plan. #AICPApfp 66