Estate Taxes

Estate and Trust Planning in 2021: News You Can Use

January 4, 2021 By Doug Welty

The Tax Cuts and Jobs Act of 2017 (TCJA) made some significant changes to federal estate and gift tax lifetime exclusion amounts. However, the TCJA fell short of repealing federal death taxes, and leaves the door open for Congress to decrease (or increase) the exclusions, or increase (or decrease) estate and gift tax rates, at any time. Unfortunately, the 3.8% Net Investment Income Tax, which affects married couples with incomes exceeding $250,000 and trusts or estates with retained income exceeding $12,950 (for tax year 2020), is likely to remain until the Affordable Care Act is repealed or amended.

Substantial lifetime exclusion amount for estate and gift taxes

Our current federal Internal Revenue Code unifies the estate tax and the gift tax, providing for a combined tax credit that allows people both to make taxable gifts during their lifetimes and to transfer estate property to heirs at their deaths free of federal taxes up to a certain total amount. That amount increases each year to adjust for inflation, and for persons dying in 2021, the exclusion amount will be $11.7 million.

You might think this amount is high enough to prevent you from having to think about federal estate taxes. However, keep in mind that Congress could lower the exclusion amount at any time. (Indeed, if Congress does nothing, it will automatically revert to $5.49 million on January 1, 2026.) Furthermore, the federal death tax exclusion amount includes not just the value of financial assets and real estate that you own yourself (personally, or in your Living Trust), but also the payout values of your retirement plans and any life insurance that you own at your death. When calculating how close you are to taxability, be sure to include the value of any death benefits and group life insurance that your employer might provide.

Increase in the annual exclusion amount for gifts

The Code’s gift tax provisions are written to apply to even small gifts. However, Congress in its beneficence has provide for an annual exclusion that exempts from gift taxation and reporting gifts up to a specified amount. That amount is also adjusted for inflation, but only when thousand-dollar increments are exceeded. For 2021, the annual exclusion remains at $15,000.

A few reminders about the annual gift tax exclusion. First, you can still give up to $15,000 to as many different people as you want. So if your estate is at, above, or near the lifetime exclusion amount mentioned above, making annual gifts to your children, grandchildren, nieces and nephews might be a good way to make sure they come to visit you often (as well as keeping your family’s money out of Uncle Sam’s wallet).

Also, there are several categories of gifts that can exceed this amount without incurring gift taxes or using up your lifetime exemption. Most people can make unlimited tax-free gifts to their spouses (except for noncitizen spouses – tax-free gifts to them are limited to $159,000 in 2021). Moreover, money you spend on medical care or education for someone else isn’t treated as a taxable gift so long as you pay the school, college, or medical care provider directly. (Directly means you write the check or incur the credit charge. Reimbursements of other people’s payments don’t qualify.)

As always, contact me if you have any questions about maximizing or using your lifetime or annual exclusions from estate and gift taxes.

[Revised: January 4, 2021]

Your Estate Plan, Your Trusts, and Your Retirement Accounts

April 11, 2017 By Doug Welty

You should read this excellent short column by financial writer Arden Dale of The Wall Street Journal, “Minding Retirement Accounts in Estate Plans,” on integrating IRAs, 401(k) plans, federal employee Thrift Savings Plan (TSP) accounts, and similar retirement savings accounts into estate and trust plans. The article deals primarily with choosing primary beneficiaries in a way that will minimize estate and income taxes. For most married retirement plan beneficiaries, that will mean choosing their spouses to receive the plan proceeds outright and free of trust, via a rollover after the first spouse’s death. Safeguard Your Retirement Plan For Children

However, trusts continue to be important contingent, or secondary, beneficiaries, especially for larger plans. The ability of your children or grandchildren (and in some cases, your spouse) to compound retirement plan investments over a long period of time makes IRAs and similar plans one of the most valuable tools for wealth succession planning for your family. Well-drafted retirement plan trusts help ensure that such plan “stretch-outs” will be administered property. I will normally recommend a separate IRA Inheritance Trust if you wish to

preserve and guard retirement plan assets from your beneficiaries’ “predators and creditors” – including remarriage spouses, your children’s and grandchildren’s creditors, and their improvidently-chosen spouses;
control distributions after your death (discourage or prevent a beneficiary from withdrawing all of the assets he inherits from you at once, absent a very good reason);
direct otherwise-reluctant retirement plan administrators to divide an account into separate accounts for your children;
limit payouts to any special-needs beneficiaries (including those who become disabled after your death) to protect ongoing government benefits; and
ensure that your retirement plan money stays in your family.

Generally speaking, if you and your spouse’s combined retirement plan assets exceed $250,000, it will be cost-effective for us to create stand-alone IRA Inheritance Trusts for each spouse in addition to your Revocable Living Trust. If you’d like to arrange an appointment or a phone call, or receive more information via email, please call or email me, or use the contact tool in the sidebar.

(Updated: December 2017)

The 3.8% Net Investment Income Tax is Still Here

March 4, 2017 By Doug Welty

One little-mentioned provision of the Patient Protection and Affordable Care Act is the 3.8% net investment income tax (NIIT) that went into effect on January 1, 2013. Various commentators refer to it as the “Obamacare surtax,” the “health care surtax,” or the “Medicare tax”; but whatever one chooses to call it, it is still going to be with us unless and until the ACA is repealed.

This surtax is assessed on Form 1040 (for individuals) and Form 1041 (for trusts and estates) upon the lesser of a) net investment income or b) the excess of modified adjusted gross income (MAGI) over a threshold amount. For married taxpayers filing jointly, the threshold amount is $250,000; married filing separately, $125,000; and all other individual taxpayers, $200,000. For trusts and estates, the threshold amount is the amount where the top income tax bracket for trusts and estates begins ($12,500 in 2018).

Does the Health Care Surtax affect me?

Stated another way: 1) If your modified adjusted gross income (MAGI) for 2018 is less than or equal to the threshold amount that applies to you, you will not pay the health care surtax. 2) If your MAGI is greater than the threshold amount that applies to you, you will pay the 3.8% tax on the lesser of a) your net investment income or b) the amount of your MAGI over the threshold amount.

What’s all this about MAGI? Basically, it means that your healthcare surtax liability is determined on your income before any tax deductions are considered. That means your deductions could put you in the lowest income tax bracket, yet you could still have investment income that is subject to the surtax. Also, the capital-gains income tax rate for high-income taxpayers stands at 20% in 2018, so the total federal tax on capital gains (with the surtax) could be 23.8% in 2018 and beyond. (Don’t forget to add state capital-gains taxes to get your true marginal tax rate on investment income.)

How Can I Avoid (Or Minimize) Investment Income Surtaxes?

The good news is that there are some steps Northern Virginia families can take right now to help you avoid or reduce the amount of your Obamacare surtax. Even though the Trump Administration and Congressional majorities have stated a goal of eventually eliminating Obamacare and the NIIT entirely, there are many slips ‘twixt cup and lip. Unless and until repeal is signed into law, there are no guarantees.

Now, more than ever, you need the assistance of experienced professionals to advise you and help you implement the best plan for you and your family. I stand ready to assist Virginia residents with the estate planning part of your project, and to work with your investment advisor and your CPA.

[Updated: December 2017]

Estate and Trust Planning in 2017: News You Can Use

January 21, 2017 By Doug Welty

Predictions As was the case in 2016, no major changes in federal and Virginia estate and gift tax laws arrived on January 1, 2017. However, there are big changes on the horizon. First off, President Trump promised during his campaign to work to repeal federal death taxes. In addition, repeal of the Affordable Care Act would most likely be accompanied by repeal of the Net Investment Income Tax, which affects married couples with incomes exceeding $250,000 and trusts or estates with retained income exceeding $12,400 (for tax year 2016).

At this writing, though, such changes are only proposals, so it’s wise to plan using the laws and regulations we have. And here’s what we have right now, for tax year 2017.

COLA increase in the lifetime exclusion amount for estate and gift taxes

Our current federal Internal Revenue Code”unifies” the estate tax and the gift tax, providing for a combined tax credit that allows people both to make taxable gifts during their lifetimes and to transfer estate property to heirs at their deaths free of federal taxes up to a certain total amount. That amount increases each year to adjust for inflation, and for persons dying in 2017, the new exclusion amount will be $5.49 million. (Call it a round 5-1/2 million if you like. That’s a $40,000 increase over 2016.)

You might think this amount is high enough to prevent you from having to think about federal estate taxes. However, keep in mind that this amount includes not just the value of financial assets and real estate that you own, but also the payout values of your retirement plans and any life insurance that you own at your death. When calculating how close you are to taxability, be sure to include the value of any death benefits and group life insurance that your employer might provide.

No increase in the annual exclusion amount for gifts

The Code’s gift tax provisions are written to apply to even small gifts. However, Congress in its beneficence has provide for an “annual exclusion” that exempts from gift taxation and reporting gifts up to a specified amount. That amount is also adjusted for inflation, but only when thousand-dollar increments are exceeded. For 2017, the annual exclusion remains at $14,000, the same as it has been since 2013.

A few reminders about the annual gift tax exclusion. First, you can give up to $14,000 to as many different people as you want. So if your estate is at, above, or near the lifetime exclusion amount mentioned above, making annual gifts to your children, grandchildren, nieces and nephews might be a good way to make sure they come to visit you often (as well as keeping your family’s money out of Uncle Sam’s wallet).

Also, there are several categories of gifts that can exceed this amount without incurring gift taxes or using up your lifetime exemption. Most people can make unlimited tax-free gifts to their spouses (except for noncitizen spouses – tax-free gifts to them are limited to $149,000 in 2017). Moreover, money you spend on medical care or education for someone else isn’t treated as a taxable gift so long as you pay the school, college, or medical care provider directly. (Directly means you write the check or incur the credit charge. Reimbursements of others don’t qualify.)

As always, contact me if you have any questions about maximizing or using your lifetime or annual exclusions from estate and gift taxes.

Consider “Front-Loading” Your Life Insurance Trust Contributions

December 7, 2012 By Doug Welty

A proposal that first appeared in the Obama administration’s failed 2012 budget proposal seeks to override existing state laws and limit the terms of cascading or “dynasty” trusts to 90 years. This proposal didn’t make it into the “Fiscal Cliff” legislation, but might resurface again in 2013.

Frontload your irrecovable life insurance trust Although there can be no guarantees, any new federal law along those lines probably would treat existing dynasty trusts as grandfathered, and so exempt from this term limitation. However, if gifts were made to such trusts after the effective date of a trust term limitation law, a result might be that the trust would lose its grandfathered status. This already happens with certain grandfathered trusts (those settled before September 25, 1985) with respect to the generation-skipping transfer (GST) tax.

Or, a contribution after the effective date might cause the trust to be divided into a “dynasty share” and a “limited-term share.”

Many of my clients (and many, many people who aren’t my clients yet) have already-existing life insurance trusts (ILITs) to which they contribute annually. Many of these trusts are 100% exempt from the generation-skipping transfer tax. Those folks, to the extent possible and practicable, should consider using some of their lifetime exemption to “front-loading” their gifts to such GST exempt ILITs. Just in case.

7 Major Errors in Estate Planning – A Financial Advisor’s View

May 18, 2012 By Doug Welty

These days, access to estate planning counsel and financial advisors is no longer restricted to the very rich.

(Well, there was never actually an exclusive club of rich folks who kept the secret rituals secret, but it used to cost a lot more than it does today. And in the good old days, only the very rich had to concern themselves with income taxes and death taxes.)

These can burn you. But even with the increasing democratization of trust and estate planning, there continues to be a large group who, somehow, just don’t get the word. Forbes Online contributor Rob Clarfeld posted an article in April entitled “7 Major Errors In Estate Planning.” His top seven aren’t necessarily the same seven I’d pick (I’ll put up my own short list one of these days) but they’re awfully common nevertheless. Here are the bullet points in Rob’s list – his comments are at the link.

Not having a plan at all (aside from the “plan” that legislators have written for you).
Trying to do everything yourself.
Failing to consider how IRA and life insurance beneficiary designations and improper titling of assets can affect your planning.
Failure to understand the interplay between gift taxes, death taxes, and life insurance.
Allowing your annual gift tax exemptions to go to waste.
Failing to take advantage of the $5 million 2012 gift tax exemption amount scheduled to sunset on December 31. (Update – it’s back for 2013.)
Leaving assets outright, rather than in well-designed “spendthrift” trusts, to adult children.

Are you guilty of any of these planning sins? If you know you are (or even think you are), contact me for more information. You can use the form in the sidebar.