Tuesday, June 20, 2017 Probate Track Rooms: Income Tax Considerations In Estate Planning 10:30 a.m. 11:00 a.m. Presented by Jessica Doro 2007

Transcription

1 Tuesday, June 20, 2017 Probate Track Rooms: Income Tax Considerations In Estate Planning 10:30 a.m. 11:00 a.m. Presented by Jessica Doro 2007 First Avenue SE PO Box 2804 Cedar Rapids, Iowa Phone:

2 INCOME TAX PLANNING IN ESTATE PLANNING: UNCERTAIN TIMES Copyright 2016 Bradley & Riley PC - All rights reserved. WHERE WE ARE (FOR NOW) 20 year time span ( ) Federal estate tax exemption amount has fluctuated from $600,000 to an unlimited amount (briefly) to its current level of $5,490,000. Top marginal rate for estate tax moved from 55% to 0%(briefly) to its current level of 40%. Unlimited basis adjustment for date of death value to carry over basis (briefly and somewhat) back to unlimited basis adjustment. rights reserved. 1

3 WHERE WE ARE (FOR NOW) Permanent resolution reached to avoid fiscal cliff in early 2013 has provided us with 4 years of greater certainty related to planning for clients. Federal estate tax exemption amount of $5,250,000 indexed for inflation each year. Unlimited basis adjustment to date of death value for assets. Permanent portability election for surviving spouse related to unused exemption amount. WHERE WE ARE (FOR NOW) Portability of unused federal estate tax exemption: For decedents who leave a surviving spouse who is (a) US citizen or (b) resident of the US. Only with timely and properly filed Federal 706 Estate Tax Return. Unused GST exemption is NOT portable. Amount is NOT indexed for inflation (fixed at death of 1 st spouse). rights reserved. 2

4 WHERE WE ARE (FOR NOW) Result has been that significantly less individuals/estates are impacted by estate tax filing/payment of tax. In 2015, 4,918 estates paid estate tax (2.5 million individuals died that same year).197% of estates paying estate tax Under our current environment, very few individuals/estates are paying estate tax. Total of $11,000,000 in exemption for married couples to use currently. WHERE WE ARE (FOR NOW) Increased emphasis on readjustment in basis on decedent s death to limit capital gain taxes on sale of assets by beneficiaries. For 2017, long-term capital gains rates: 0% for 10-15% tax brackets; 15% rate for 25%, 28%, 33%, 35% tax brackets; 20% rate for 39.6% tax bracket. rights reserved. 3

5 WHERE WE ARE (FOR NOW) Decreased need for Credit Shelter/Family Trusts, except when warranted by size of estate and imposition of federal estate tax (for now). Trusts for non-tax reasons may still be needed, but in a different structure than Credit Shelter/Family Trust to preserve basis adjustment. The problem is that old plans still remain and some may not be able to still be revised or updated. OUTDATED PLANS If non-tax issues do not exist to require the Trust, then you have a Trust that needs to be created, funded and administered for the surviving spouse that reduces flexibility for him or her for their needs and planning purposes. More problematic is the income tax implications of the Family Trust/Credit Trust, especially if ALL assets must be used to fund that Trust due to the increased exemption amount. rights reserved. 4

6 OUTDATED PLANS Assets remaining in Credit Shelter/Family Trust at time of second spouse s death: Not included in surviving spouse s estate (GOOD) Pass under the terms of the first spouse s plan (usually GOOD) Do NOT receive a basis adjustment (BAD) Assets passing to the surviving spouse outright or in Marital Trust: Included in surviving spouse s estate (BAD) Pass under the terms of the surviving spouse s plan (can be GOOD or BAD, but gives flexibility) DO receive a basis adjustment (GOOD) OUTDATED PLANS Example: Long term married couple, first marriage and children are all children from their marriage. The majority of their assets consisted of farm property. They created and signed estate planning documents in early 1990 s. Their documents included langue to automatically create and fund Family Trust/Credit Shelter Trust. rights reserved. 5

7 OUTDATED PLANS Husband passes away first in mid 1990 s (say 1997). Wife survived him and is still living 20 years later. ½ interest in farm property moved to Family Trust following Husband s death. Wife owns ½ interest in her own Revocable Trust. Value of ½ interest passing to Family Trust is locked into 1997 value and will receive NO adjustment at wife s death. Other ½ held in wife s Revocable Trust WILL receive a basis adjustment at her date of death (at least currently). OUTDATED PLANS 1997 basis for property shown on inventory was approximately $1500 per acre. Current value would be approximately $6300 per acre (on low end). The property totals approximately 180 acres. If following wife s death, the property is sold, then: ½ of the property has no gain associated with it; ½ of the property has basis equal to $1500 per acre. Gain is $6300 x 180 = $1,134,000/2 =$567, $1500 x 180 = $ 270,000/2= $135, $432, If top rate, then approximately $86,000 in capital gains tax due on sale. rights reserved. 6

8 OUTDATED PLANS Difference in basis in the two interests that children will receive at mother s death is very significant. They probably will not sell unless a need exists, but if needed to sell, then significant gain related to the ½ interest received from their father s Family Trust. OUTDATED PLANS Funding considerations are very important if stuck with these outdated documents for a decedent and the estate/tax has assets in excess of the exemption amount remaining so that not all assets are forced into Family Trust/Credit Shelter Trust. You need to consider which assets are likely to appreciate such that the step up in basis is most valuable and likely to be needed and used. Must be balanced with duty to income beneficiary of the Trust and income needs. rights reserved. 7

9 OUTDATED PLANS What if you did not draft the plan and instead merely inherit it when the first spouse dies? What if you inherit a client who is the surviving spouse already has a Family Trust/Credit Shelter Trust established at their spouse s death? STUCK WITH OUTDATED PLAN OR INHERITING OUTDATED PLAN TO ADMINISTER Iowa Trust Code provisions. Trust Code Section 633A.2203 Termination of Irrevocable Trust or Modification of Dispositive Provisions of Irrevocable Trust by Court Need consent of all of the beneficiaries; Consent of a person who may bind a beneficiary is considered consent of the beneficiary; If terminated, then court shall order distribution of property in accordance with settlor s probable intention. rights reserved. 8

10 STUCK WITH OUTDATED PLAN OR INHERITING OUTDATED PLAN TO ADMINISTER Trust Code Section 633A.2203(5) Continuance of the trust on the same or different terms must not be necessary to carry out a material purpose of the trust; A spendthrift provision, or provision giving Trustee discretion to distribute income or principal to beneficiary or among beneficiaries, is presumed to constitute a material purpose of the Trust. Drafting pointer regarding spendthrift provisions. STUCK WITH OUTDATED PLAN OR INHERITING OUTDATED PLAN TO ADMINISTER Trust Code Section 633A.2203(5) If have a spendthrift provision, consider whether can request modification to grant surviving spouse a general power of appointment which includes in his or her estate. rights reserved. 9

11 STUCK WITH OUTDATED PLAN OR INHERITING OUTDATED PLAN TO ADMINISTER Trust Code Section 633A.2206 Reformation-Tax Objectives Court can reform the Trust s terms, even if unambiguous, to conform to the settlor s intent if it is proved by clear and convincing evidence that the settlor s intent and terms of the trust were affected by a mistake of fact or law whether expressed or induced. Terms may be construed or modified in a manner that does NOT violate the settlor s probable intent, to achieve the settlor s tax objectives. OUTDATED PLANS Remember that some documents have the exemption amount passing other than to surviving spouse and that formula can cause havoc due to increased exemption amount. Also will be problematic if estate tax repeal happens. rights reserved. 10

12 INCOME TAX PLANNING FOR LOW BASIS ASSETS Client in good health and in late 60s/early 70s. Client wishes to travel and engage in other activities during the next 5-7 years while health is good and has need for liquid assets to satisfy those wishes/objectives. Client has some cash/liquid assets, but not enough to satisfy needs/intent. INCOME TAX PLANNING FOR LOW BASIS ASSETS Client has real property (farm property) that she has owned for a significant period of time. Client had been trying to retain it to get the basis readjustment at Client s death. Property provides a steady amount of rental income, but not enough to satisfy the outlining amounts needed for plans. rights reserved. 11

13 INCOME TAX PLANNING FOR LOW BASIS ASSETS Client does not have family members who have interest in or ability to purchase the real property. Basis is extremely low given the amount of time the property has been held by the client. Property can be easily sold due to quality, but sale will: Eliminate income stream from rental of property. Result in significant income tax liability for Client due to basis amount. INCOME TAX PLANNING FOR LOW BASIS ASSETS Solution proposed was use of Charitable Remainder Annuity Trust in connection with the property s sale. Charitable component helps with the gain due to the sale. The structure provides steady income stream not realized with a regular sale that can continue for beneficiaries if Client dies before end of term. rights reserved. 12

14 INCOME TAX PLANNING FOR LOW BASIS ASSETS It is important to note that this client did have charitable intentions and interests which is key to having this work to achieve a favorable result. INCOME TAX PLANNING FOR LOW BASIS ASSETS Prior to sale, created two trusts. Revocable Trust for Client; Charitable Remainder Annuity Trust; Charitable Remainder Annuity Trust Term of 15 years (remember term cannot exceed 20 years). Payout rate of 6.6% per year (remember it needs to be at least 5% of the initial FMV of the Trust s assets). Transferred 20% interest to Revocable Trust; Transferred 80% interest to Charitable Remainder Annuity Trust; rights reserved. 13

15 INCOME TAX PLANNING FOR LOW BASIS ASSETS Property was sold through auction (recommended method of sale). After expenses, 20% of sale proceeds paid to Revocable Trust and 80% of sale proceeds paid to Charitable Remainder Annuity Trust. INCOME TAX PLANNING FOR LOW BASIS ASSETS Number of acres totaled approximately 75 acres (74.74). Basis in property was $1,338 per acre. Property was extremely high quality property. Sale price at auction was $8,000 per acre, for total amount received totaling $597,920. rights reserved. 14

16 INCOME TAX PLANNING FOR LOW BASIS ASSETS Client (via Revocable Trust) Charitable Remainder Annuity Trust Sale Price $119, $478, Expenses (Approximately 7%) ($8,370.88) ($33,483.52) Income Taxes Due ($5,514.00) ($0.00) Net Received $105, $444, INCOME TAX PLANNING FOR LOW BASIS ASSETS Client (via Revocable Trust) Net Amount Proceeds Received Total Annuity Payments for 15 year period Total Net Amount + Payouts $105, $473, (per year payment of $31,570.18) $579, rights reserved. 15

17 INCOME TAX PLANNING FOR LOW BASIS ASSETS Client (via Revocable Trust) Proceeds $597, Expense ($41,854.40) Net Received $556, Basis $100, Taxable Gain $456, Federal Income Tax Liability (23.4%) State Income Tax Liability (8.0%) Net Amount Received by Client ($106,719.35) ($36,485.25) $412, INCOME TAX PLANNING FOR LOW BASIS ASSETS In addition to receiving $105, in cash outright, the client also received/receives: Annuity payments for 15 year period. Charitable deduction (received because occurred in 2016 and still available for now) Approximately $81,020 (assuming June AFR of 2.4%; our actual transaction happened last fall when rate was 1.4% and deduction was approximately $63,788) rights reserved. 16

18 CHARITABLE INCOME TAX PLANNING CONSIDERATIONS Using tax deferred assets to satisfy any charitable intentions maximizes dollar for dollar benefit of those assets. Also has the advantage of providing flexibility for clients who want to alter amounts as they continue to need assets or continue to pull from those assets. CHARITABLE INCOME TAX PLANNING CONSIDERATIONS Charitable rollover is now Permanent. IRA owner must be at least age 70 ½. Can transfer up to $100,000 per year. Amount is excluded from income. Amount counts towards and can be used to satisfy Required Minimum Distribution (RMD). Amount is NOT eligible for charitable deduction, however, since it is not included in income. rights reserved. 17

19 CHARITABLE INCOME TAX PLANNING CONSIDERATIONS Transfer must be directly from IRA Trustee to recipient. Recipient must be qualified charity: Public charity requirement. Donor advised funds do NOT qualify. Supporting organizations do NOT qualify. Non-operating private foundations do NOT qualify (unless conduit rules apply). CHARITABLE INCOME TAX PLANNING CONSIDERATIONS Timing for charitable contributions may become more important than ever. If estate tax really does get repealed, then some attractiveness (at least tax-wise) of bequests disappears. Still MAY save taxes if death is in fact a triggering event for capital gains purposes. While income tax benefits still exist, client may need to move forward to take advantage of that benefit now. rights reserved. 18

20 CHARITABLE INCOME TAX PLANNING CONSIDERATIONS President Trump s proposal contains annual cap on itemized federal deductions of $100,000 for single individual/$200,000 for married couples filing joint returns. House plan eliminates all itemized deductions other than home mortgage interest and charitable gift deductions. GIFTING Most commentators and information circulated indicates that the gift tax will NOT be repealed regardless of what happens with estate tax repeal efforts. It was retained in EGTRRA. Should gifting continue during this time? rights reserved. 19

21 GIFTING If instead of estate tax regime have capital gain regime, we currently do not know the triggering timing for capital gains and definitively whether basis adjustment will be retained. If death will be the trigger for the capital gains tax and amount will exceed anticipated $10 million exemption, then timing wise gifting of appreciating assets makes sense because future appreciation will be shifted to donee and capital gain would be deferred until sale of asset or donee s death. GIFTING If the asset will get full step up at death (because total value of assets is under 10 million) and income tax NOT triggered at death, but rather sale of asset, then it makes more sense to hold onto to the asset until death, let the transferee receive it and defer taxes if planning to hold onto asset. rights reserved. 20

22 GIFTING The proposed 2704 regulations issued in 2016 regarding discounts are likely dormant and no longer as pressing for moving forward with gifting. WHERE ARE WE GOING??????? President Trump repeatedly has indicated he wants the estate tax repealed. Website states: The Trump Plan will repeal the death tax, but capital gains held until death and valued over $10 million will be subject to tax to exempt small businesses and family farms. rights reserved. 21

23 WHERE ARE WE GOING Death tax assumed to be estate tax. Proposal is silent regarding GST tax repeal. Proposal is silent regarding gift tax repeal. $10 million exemption mentioned N/A to small businesses and family farms (those enjoy an unlimited amount?) Or that amount contemplates small business and family farms? WHERE ARE WE GOING Questions regarding timing of trigger of capital gains tax: At death if over the $1o million exemption amount? (Like Canada) At time of sale by recipient? rights reserved. 22

24 WHERE ARE WE GOING House Plan eliminates estate tax; House Plan eliminates GST tax; House Plan silent regarding gift tax; Carry over basis adjustment for assets held by estate; House Plan seemingly only implies the capital gains tax upon sale of asset by heir, not upon death. WHERE ARE WE GOING Income tax changes proposed to reduce the current seven tax brackets to three brackets with tax rates of 12%, 25%, and 33%. Cap the qualified dividends and long-term capital gains tax rates at 20% with a lower rate for individuals not in top brackets. Eliminate 3.8% tax on net investment income. rights reserved. 23

25 WHERE ARE WE GOING Permanent repeal is unlikely due to numbers. Republicans currently lack the 60 votes in Senate necessary to overcome a filibuster. Will likely need to use budget reconciliation process (similar to EGTRRA). This means we would have a situation similar to EGTRRA where the world would shift again in 10 years. WHERE ARE WE GOING Bottom line is uncertainty abounds and in some ways we are in a world similar to the world we were in during the fiscal cliff time. Our period of certainty has shifted back to uncertainty. Flexibility and frequent review will be keys to planning until we have more certainty. rights reserved. 24

26 OTHER CONSIDERATIONS/ACTIONS Documents that contain formulas/funding tied to federal estate tax amount will need to be reviewed and revised if estate tax is repealed (similar to actions and review that occurred in 2012). Consideration of postponing income recognition events until 2018 when lower income tax rates will likely apply. OTHER CONSIDERATIONS/ACTIONS Exercise caution related to modifying or reducing life insurance coverage even in light of repeal. Insurance proceeds may still be needed, but for a different purpose. Prior policies purchased or maintained intended for coverage for estate tax liability may be needed in the future for payment of income tax liability if carryover basis comes back in some variant and capital gains are triggered at time of death. rights reserved. 25

27 THANK YOU Follow up questions can be directed to Jessica A. Doro at or Cedar Rapids 2007 First Avenue SE PO Box 2804 Cedar Rapids, Iowa Ph: Fax: Iowa City Tower Place One South Gilbert Iowa City, Iowa Ph: Fax: rights reserved. 26