Estate Planning

Don’t let the chaos of the holiday season prevent you from avoiding federal gift tax by making “annual exclusion” gifts, medical payments gifts, and educational gifts.
 
Make Annual Exclusion Gifts

• “Annual exclusion” gifts are transfers of money or property in an amount that does not exceed the annual gift tax exclusion.
• In 2014, the annual gift tax exclusion is $14,000 per recipient, and it will remain at $14,000 per person in 2015. Therefore, you can give up to $14,000 to as many individuals you choose on or before December 31, 2014, and then give another $14,000 to the same people on or after January 1, 2015, and you will not have to file a federal gift tax return (IRS Form 709). In other words, the IRS doesn’t consider gifts that are equal to or less than the annual exclusion amount to be taxable gifts at all.
• Married couples can take double advantage of the annual exclusion and gift $28,000 in 2014 and then another $28,000 in 2015. But note that in some situations, a couple may still need to file a gift tax return to report any “split gifts” – they’ll need to consult with their estate planning attorney or accountant to be sure. Also, you may need to file a gift tax return if you make gifts that exceed the annual exclusion amount or if you make gifts that don’t qualify for the annual exclusion – your attorney or accountant can guide you through this.

Make Payments that Qualify for the Medical Exclusion

• Another type of transfer that the IRS doesn’t consider to be a gift for gift tax purposes is a payment that qualifies for the medical exclusion.
• Payments that qualify for this exclusion are ones that are made directly to an institution that provides medical care to an individual or to a company that provides medical insurance to an individual. In general, medical expenses that qualify for this exclusion are the same as those that are deductible for federal income tax purposes.
• One incredibly important detail – in order to qualify for the medical exclusion you must make payment directly to the institution providing the medical care or company providing the medical insurance. If you give the money to the individual receiving the medical care or insurance benefit, even with explicit instructions that it be used to pay for the medical care, your payment will be considered a gift.

Make Payments that Qualify for the Educational Exclusion

• Another type of transfer that the IRS doesn’t consider to be a gift for gift tax purposes is a payment that qualifies for the educational exclusion.
• Payments that qualify for this exclusion are ones that are made directly to a qualifying domestic or foreign institution as tuition for the education of an individual.
• Two incredibly important details – in order to qualify for the educational exclusion
  (1) You must make payment directly to the institution providing the education, not to the individual receiving the education, and
  (2) Your payment must be for tuition only, not for books, supplies, room and board, or other types of education-related expenses.
  If you fail to follow either of these restrictions, the payment will be considered a gift.

If you have any questions about how to make the most out of gifts to your family, please contact our office.

The Internal Revenue Service has released the official inflation adjustments that will affect 2015 federal reporting for estate taxes, gift taxes, generation-skipping transfer taxes, and estate and trust income taxes.
 
2015 Federal Estate Tax Exemption

• In 2015 the estate tax exemption will be $5,430,000. This is an increase of $90,000 above the 2014 exemption.
• What this means is that when the value of the gross estate of a person who dies in 2015 exceeds $5,430,000, the estate will be required to file a federal estate tax return (IRS Form 706). Form 706 is due within nine months of the deceased person’s date of death.
• The maximum federal estate tax rate remains unchanged at 40%.

2015 Federal Lifetime Gift Tax Exemption

• In 2015 the lifetime gift tax exemption will also be $5,430,000. This is an increase of $90,000 above the 2014 exemption.
• What this means is that if a person makes any taxable gifts in 2015 (in general a taxable gift is one that exceeds the annual gift tax exclusion – see more on that below), then they will need to file a federal gift tax return (IRS Form 709). For taxable gifts made in 2015, Form 709 is due on or before April 15, 2016.
• The maximum federal gift tax rate remains unchanged at 40%.

2015 Annual Gift Tax Exclusion

• In 2015 the annual gift tax exclusion will be $14,000. This is the same as the 2014 exclusion.
• What this means is that if a person makes any gifts to the same person that exceed $14,000 in 2015, then they will need to file a federal gift tax return (Form 709). For taxable gifts made in 2015, Form 709 is due on or before April 15, 2016.
• Note that if the taxable gift does not exceed $5,430,000, then no gift tax will be due; instead, the lifetime gift tax exemption of the person who made the gift will be reduced by the amount of the taxable gift.
• As mentioned above, the maximum federal gift tax rate remains unchanged at 40%.

2015 Estate and Trust Income Tax Brackets

Finally, estates and trusts will be subject to the following income tax brackets in 2015:

If Taxable Income Is:

• Not over $2,500, the tax is 15% of the taxable income
• Over $2,500 but not over $5,900, the tax is $375 plus 25% of the excess over $2,500
• Over $5,900 but not over $9,050, the tax is $1,225 plus 28% of the excess over $5,900
• Over $9,050 but not over $12,300, the tax is $2,107 plus 33% of the excess over $9,050
• Over $12,300, the tax is $3,179.50 plus 39.6% of the excess over $12,300

 
As you can see, an income of only $12,300 inside a trust could be taxed at a marginal rate of 39.6%. In addition, many trusts paying at the top bracket are also subject to the 3.8% net investment income tax, making the top marginal rate 43.4%. Many states also impose an income tax on trusts. So, depending on which state the trust pays income taxes, the marginal income tax rate could be over 50% for trusts earning just $12,300.
 
What this means is that Trustees should give careful consideration to the timing of income and deductions and whether distributions of income to beneficiaries should be made to avoid paying excessive trust income taxes. Any income tax planning, of course, has to be balanced against a Trustee’s fiduciary duties to the trust.
 

With the end of the year fast approaching, now is the time to fine tune your estate plan before you get caught up in the chaos of the holiday season. One area of planning that many people overlook is their beneficiary designations.
 
Have You Checked Your Beneficiary Designations Lately?

• Do you own any life insurance policies? If so, have you named both primary and secondary beneficiaries for your policies?
• How about retirement accounts – are any of your assets held in an IRA, 401(k), 403(b) or annuity? Or how about a payable on death (“POD”) or a transfer on death (“TOD”) account? If so, have you named both primary and secondary beneficiaries for these assets?
• If you have gotten married or divorced, had any children or grandchildren, or any of the beneficiaries you have named have died or become incapacitated or seriously ill since you made beneficiary designations, it is time to review them all with your estate planning attorney.

Beneficiary Designations May Overrule Your Will or Trust

• It is critically important for your estate planning attorney to review your beneficiary designations as your life changes because your beneficiary designations may overrule or conflict with the plan you have established in your will or trust. Also, naming your trust as a primary or secondary beneficiary can be tricky and should only be done in consultation with your estate planning attorney.

What Should You Do?

• Whenever you experience a major life change (such as marriage or divorce, or a birth or death in the family) or a major financial change (such as receiving an inheritance or retiring) or are asked to make a beneficiary designation, your beneficiary designations should be reviewed by your estate planning attorney and, if necessary, updated or adjusted to insure that they conform with your estate planning goals.
• If you have gone through any family or monetary changes recently and you’re not sure if you need to update your beneficiary designations, then consult with your estate planning attorney to ensure that all of your bases are covered.

Due to this unfavorable income tax treatment of irrevocable, non-grantor trusts, Trustees of this type of trust must plan carefully to minimize annual income taxes. Since trust income distributed to the beneficiaries is not taxed at the trust level, distributions may be made to beneficiaries who are in a lower income tax bracket and/or not subject to the 3.8% surtax. This, in turn, will lower the income that is taxed inside of the trust. Nonetheless, any distributions aimed at reducing a trust’s income tax liability must be made within the distribution parameters established in the trust agreement and applicable state law.
 
With these limitations in mind, income-reducing strategies Trustees should consider include:
 
• Distributing trust income to beneficiaries who are in a lower tax bracket and/or not subject to the 3.8% surtax
• Making in-kind distributions of low basis trust property to beneficiaries who are in a lower tax bracket or plan to hold on to the property and not sell it any time soon
• Invoking the 65-day rule and distributing trust income to beneficiaries who are in a lower tax bracket and/or not subject to the 3.8% surtax by March 6, 2015, which will allow the trust to deduct the income as a 2014 distribution and thereby lower the trust’s 2014 taxable income (however this 65-day rule may not apply for state income tax purposes, so Trustees should make distributions before December 31 in states that don’t allow the 65-day rule for state income tax purposes)
• Exploring options to permit capital gains to pass to beneficiaries instead of being taxed inside of the trust, such as reforming or decanting the trust to broaden the Trustee’s discretion to allocate between trust income and principal
• Shifting trust investments to minimize taxable income and gains
• Terminating small, uneconomic trusts under the terms of the trust agreement or applicable state law
 
Final Considerations for Trustees of Irrevocable, Non-Grantor Trusts
 
Planning to minimize trust income taxes is a delicate balancing act. Trustees must carefully weigh the tax benefits of making distributions or changes to the trust’s provisions against the grantor’s intent, the ongoing needs and tax status of the current beneficiaries, and what will be left for the remainder beneficiaries. In addition, income, gains, losses, and tax brackets must be reviewed annually since the needs and expenses of the trust beneficiaries will undoubtedly change from year to year.
 
If you are the Trustee or beneficiary of an irrevocable, non-grantor trust, I am available to speak with you about strategies that can be used to reduce your trust’s income tax bill.
 

WARNING: Many people believe once they set up a Revocable Living Trust and transfer assets into the Trust, those assets are protected from lawsuits. This is absolutely not true.
 
While Trusts commonly provide asset protection for beneficiaries, few Trusts protect assets owned by the person who created the Trust.
 
No Immediate Asset Protection? Why Should You Create a Revocable Living Trust?
 
Fully funded Revocable Trusts are dynamite tools. Here’s why:
 
1. You can protect assets passing to your spouse and children. Yes, you can provide protections for loved ones that they can’t yet for themselves.
 
2. Your Trust includes an incapacity plan, avoiding court interference, maintaining your control, and saving your loved ones time, money, and stress.
 
3. Your Trust allows your assets to avoid probate, minimizing the time, stress, and cost of settling your final affairs.
 
4. By avoiding the public probate court process, your Trust keeps all details about who is getting what, a private family matter.
 
What Can You Do to Protect Your Assets?
 
Comprehensive estate planning has a solid foundation of insurance, including homeowners/renters, umbrella, auto, business, life insurances, disability, and the like. Business entities such as the Limited Liability Company are commonly used for asset protection and Domestic Asset Protection Trusts are sometimes used as well.
 
Your Revocable Living Trust creates a powerful value and can be drafted to provide asset protection for your loved ones. To protect yourself, use insurance, business entities, and, perhaps, a Domestic Asset Protection Trust.

Leaving your hard-earned assets outright to your children, grandchildren or other beneficiaries after you die will make their inheritance easy prey for creditors, predators, and divorcing spouses. Instead, consider using discretionary trusts for the benefit of each of your beneficiaries.
 
What is a Discretionary Trust?
 
A discretionary trust is a type of irrevocable trust that is set up to protect the assets funded into the trust for the benefit of the trust’s beneficiary. This can mean protection from the beneficiary’s poor money-management skills, extravagant spending habits, personal or professional judgment creditors, or divorcing spouse.
 
Under the terms of a typical discretionary trust, the trustee is limited in how much can be distributed to the beneficiary and when the distributions can be made. You can make the terms and time frames as limited or as broad as you want. For example, you can provide that distributions of income can only be made for health care needs after the beneficiary reaches the age of 21, or you can provide that distributions of income and principal can be made for health care needs and educational expenses at any age.
 
An added bonus of incorporating discretionary trusts into your estate plan is that the trusts can be designed to minimize estate taxes as the trust assets pass down from your children to your grandchildren (this is referred to as “generation-skipping planning”). In addition, you can dictate who will inherit what is left in each beneficiary’s trust when the beneficiary dies, which will allow you to keep the trust assets in the family.
 
While the distribution choices that can be included in a discretionary trust are virtually endless (within certain parameters established under bankruptcy and creditor protection laws), the bottom line is that a properly drafted discretionary trust will protect a beneficiary’s inheritance from creditors, predators, and divorcing spouses, avoid estate taxes when the beneficiary dies, and ultimately pass to the beneficiaries of your choice.
 
Where Should You Include Discretionary Trusts in Your Estate Plan?
 
Discretionary trusts should be included in all of the trusts you have created that will ultimately be distributed to your heirs, including:
 
• Your Revocable Living Trust
• Your Irrevocable Life Insurance Trust
• Your Standalone Retirement Trust
 
What Should You Do?
 
If you are concerned that your children, grandchildren, or other beneficiaries will not have the skills required to manage and invest their inheritance or will lose their inheritance in a lawsuit or divorce, then talk to your estate planning attorney about how to incorporate discretionary trusts into your estate plan.