Category: Capital Gains Tax

charitable options to reduce estate taxes

Charitable options to Reduce Estate Taxes

Increasing tax changes for the wealthy are coming, and motivation to find ways to protect the wealth is getting increased attention, according to a recent article from CNBC entitled “Here’s how to reduce exposure to tax increases with charitable contributions.” Charitable remainder trusts (CRTs) and Donor Advised Funds (DAFs) are options for people who are already charitably inclined to reduce estate taxes. The CRT is complicated, requiring estate planning attorneys to create them and accountants to maintain them. The DAF is simpler, less expensive and is growing in popularity.

Both enable income tax deductions, in the current year or carried forward for five years, on cash contributions of up to 60% of the donors’ AGI and up to 30% of AGI on contributed assets. These contributions also reduce the size of taxable estates.

CRTs funnel asset income into a tax-advantaged cash stream that goes to the donor or another designated non-charitable beneficiary. The income stream flows for a set term or, if desired, for the lifetime of the non-charitable beneficiary. The trusts must be designed, so that at the end of the term, at least 10% of the funds remain to be donated to a charity, which must be designated at the outset.

No tax is due on proceeds from the sale of trust assets, until the cash makes its way to the non-charitable beneficiary. When assets are held by individuals, their sale creates capital gains tax in the year they are sold.

CRT donors can fund the trusts with highly appreciated assets, then manage them for optimal returns while minimizing tax exposure by adjusting the income stream to spread the tax burden over an extended period of time. If capital gains tax rates are raised by Congress, this would be even better for high earners.

DAFs do not allow dispersals to non-charitable beneficiaries. All gains must ultimately be donated to charity. However, the DAF provides advantages. They are easy to create and can be set up with most large financial service companies. Their cost is lower than CRTs, which have recurring fees for handling required IRS filings and trust management. Charges from financial institutions typically range from 0.1% to 1% annually, depending upon the size, and a custodial fee for holding the account.

DAFs can be created and funded by individuals or a family and receive a deduction that very same year. There is no hurry to name the charitable beneficiaries or direct donations. With a CRT, donors must name a charitable beneficiary when the trust is created. These elections are difficult to change in the future, since the CRT is an irrevocable trust. The DAF allows ongoing review of giving goals.

Funding a DAF can be done with as little as $5,000. The DAF contribution can include shares of privately owned businesses, collectibles, even cryptocurrency, as long as the valuation methods used for the assets meet IRS rules. Donors can get tax deductions without having to use cash, since a wide range of assets may be used.

The DAF is a good way for less wealthy individuals and families to qualify for itemizing tax deductions, rather than taking the standard deduction. DAF donations are deductible the year they are made, so filers may consolidate what may be normally two years’ worth of donations into a single year for tax purposes. This is a way of meeting the IRS threshold to qualify for itemizing deductions.

Both charitable options are effective ways to reduce estate taxes. Which of these two works best depends upon your individual situation. With your estate planning attorney, you’ll want to determine how much of your wealth would benefit from this type of protection and how it would work with your overall estate plan.

If you would like to learn more about charitable contributions, please visit our previous posts. 

Reference: CNBC (April 20, 201) “Here’s how to reduce exposure to tax increases with charitable contributions.”

 

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talk about inheritance with your children

Talk about Inheritance with your Children

How do you talk about inheritance with your children? One strategy to get your children prepared to handle the assets they’ll eventually inherit, is to have them meet with your professional advisors. They can explain what you’ve been doing.

FedWeek’s recent article entitled “Preparing Your Heirs for Their Inheritance” suggests that your children should meet with your accountant for an explanation of any tax planning tactics that you have been implementing. That way those tactics can be continued after your death. If you have a broker or a financial planner, your heirs should meet with this adviser for a review of your portfolio strategies.

Know that if you hold investment property, it might pose special problems.

While your investment portfolio can be split between your children, who can follow their individual inclinations, it’s tough to divide physical property. Your kids might disagree on how the property should be managed.

With any assets—but especially rental property—you have to be realistic. Ask yourself if your children can work together to manage the real estate.

If they cannot, you may be better off leaving your investment property to the one child who really can manage real estate and leave your other children non-real estate assets instead. You might also provide that some of your children can buy out the others at a price set by an independent appraisal.

Another way you can help is by proper handling of appreciated assets, such as stocks.

If you purchased $20,000 worth of XYZ Corp. shares many years ago, those shares are worth $50,000. If you sell those shares to raise $50,000 in cash for retirement spending, you’ll have a $30,000 long-term capital gain.

You might raise retirement cash, by selling other securities where there’s been little or no appreciation.

That will allow you to keep the shares and leave them to your children. At your death, your shares may be worth $50,000, and that value becomes the new basis (cost for tax purposes) in those shares. If your children sell them for $50,000, they won‘t owe capital gains tax.

All of the appreciation in those shares during your lifetime will not be taxed. So take the time to talk about inheritance with your children. It will avoid a great deal of head and heartache for everyone. If you are interested in learning more about discussing difficult estate planning topics with your children, please visit our previous posts. 

Reference: FedWeek (March 31, 2021) “Preparing Your Heirs for Their Inheritance”

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Roth IRAs are an ideal planning tool

Potential Changes to the Estate Tax

Potential changes to the estate tax that are now being considered by President Biden may expand the number of Americans who will need to pay the federal estate tax in one of two ways: raising rates and lowering qualifying thresholds on estates and increasing the liability for inheriting and selling assets. It is likely that these changes will raise revenues from the truly wealthy, while also imposing estate taxes on Americans with more modest assets, according to a recent article “It May Be Time to Start Worrying About the Estate Tax” from The New York Times.

Inheritance taxes are paid by the estate of a person who died. Some states have estate taxes of their own, with lower asset thresholds. As of this writing, a married couple would need to have assets of more than $23.4 million before they had to plan for federal estate taxes. This historically high exemption may be ending sooner than originally anticipated.

One of the changes being considered is a common tax shelter. Known as the “step-up in basis at death,” this values the assets in an estate at the date of death and disregards any capital gains in a deceased person’s portfolio. Eliminating the step-up in basis would require inheritors to pay capital gains whenever they sold assets, including everything from the family home to stock portfolios.

If you’re lucky enough to inherit wealth, this little item has been an accounting gift for many years. A person who inherits stock doesn’t have to think twice about what their parents or grandparents paid decades ago. All of the capital gains in those shares or any other inherited investment are effectively erased, when the owner dies. There are no capital gains to calculate or taxes to pay.

However, those capital gains taxes are lost revenue to the federal government. Eliminating the step-up rules could potentially generate billions in taxes from the very wealthy but is likely to create financial pain for people who have lower levels of wealth. A family that inherited a home, for instance, would have a much bigger tax burden, even if the home was not a multi-million-dollar property but simply one that gained in value over time.

Reducing the estate tax exemption could lead to wealthy people having to revise their estate plans sooner rather than later. Twenty years ago, the exemption was $675,000 per person and the tax rate was 55%. Over the next two decades, the exemption grew and the rates fell. The exemption is now $11.7 million per person and the tax rate above that amount is 40%.

Lowering the exemption, possibly back to the 2009 level, would dramatically increase tax revenue.

What is likely to occur and when, remains unknown, but what is certain is that potential changes to the estate tax will require your attention. Stay up to date on proposed changes and be prepared to update your estate plan accordingly. If you are interested in learning more about the estate tax, please visit our previous posts.

Reference: The New York Times (March 12, 2021) “It May Be Time to Start Worrying About the Estate Tax”

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Charitable Contribution Deductions from an Estate

The interest in charitable giving increased in 2020 for two reasons. One was a dramatic increase in need as a result of the COVID pandemic, reports The Tax Advisor’s article “Income tax deductions for trusts and estates.” The other was more pragmatic from a tax planning perspective. The CARES Act increased the amounts of charitable contributions that may be deducted from taxes by individuals and corporations. What if a person wishes to make a donation from the assets that are held in trust? Is that still an income tax deduction? It depends. The rules for charitable contribution deductions from an estate are substantially different than those for individuals and corporations.

The IRS code allows an estate or nongrantor trust to make a deduction which, if pursuant to the terms of the governing instrument, is paid for a purpose specified in Section 170(c). For trusts created on or before October 9, 1969, the IRS code expands the scope of the deduction to allow for a deduction of the gross income set aside permanently for charitable purposes.

If the trust or estate allows for payments to be made for charity, then donations from a trust are allowed and may be tax deductions. Otherwise, they cannot be deducted.

If the trust or estate allows distributions for charity, the type of asset contributed and how it was acquired by the trust or estate determines whether a tax deduction for a charitable donation is permitted. Here are some basic rules, but every situation is different and requires the guidance of an experienced estate planning attorney.

Cash donations. A trust or estate making cash donations may deduct to the extent of the lesser of the taxable income for the year or the amount of the contribution.

Noncash assets purchased by the trust/estate: If the trust or estate purchased marketable securities with income, the cost basis of the asset is considered the amount contributed from gross income. The trust or estate cannot avoid recognizing capital gain on a noncash asset that is donated, while also deducting the full value of the asset contributed. The trust or estate’s deduction is limited to the asset’s cost basis.

Noncash assets contributed to the trust/estate: If the trust or estate acquired an asset it wants to donate to charity as part of the funding of the fiduciary arrangement, no charity deduction is permitted. The asset that is part of the trust or estate’s corpus, the principal of the estate, is not gross income.

The order of charitable deductions, compared to distribution deductions, can cause a great deal of complexity in tax planning and reporting. Required distributions to noncharitable beneficiaries must be accounted for first, and the charitable deduction is not taken into account in calculating distributable net income. The recipients of the distributions do not get the benefit of the deduction. The trust or the estate does.

Charitable distributions are considered next, which may offset any remaining taxable income. Last are discretionary distributions to noncharitable beneficiaries, so these beneficiaries may receive the largest benefit from any charitable deduction.

If there are charitable contribution deductions from an estate, it must file form 1041A for the relevant tax year, unless it meets any of the exceptions noted in the instructions in the form.

These are complex estate and tax matters, requiring the guidance of an experienced estate planning attorney for optimal results. If you would like to learn more about charitable giving in your estate planning, please visit our previous posts. 

Reference: The Tax Advisor (March 1, 2021) “Income tax deductions for trusts and estates”

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Donor Advised Fund is a Win-Win for All Concerned

Many Americans are feeling charitable these days, and with good reasons. It’s a hard time for many, and if you are financially able, making donations may help you feel you are making a difference for others during uncertain times. There are many options when making donations, and the recent article “Choosing Charity: How Donor-Advised Funds Benefit Your Contributions” from Fort Worth Magazine explains your choices. A Donor Advised Fund is a win-win situation for all concerned.

Donor Advised Funds (DAFs) can be opened for varying amounts, that are set by the sponsoring organizations. Smaller community foundations would welcome a DAF for $5,000, for instance. DAFs can be funded with cash or other assets, but once the donation is made, the asset no longer belongs to you. However, you may be able to decide when donations are distributed, and which charities receive funding. There are no required distribution dates, so the funds could go unused for a long time, while you receive the tax write-off right away.

You may also determine the investments within the fund, level of risk and overall investment strategy.

Another good reason to use DAFs: the sponsoring organization becomes the donor of record. Therefore, DAFs are an excellent way to make anonymous contributions.

There are also DAFs that involve active involvement from an advisor, if that is of value to you.

Why is now a great time to use a Donor-Advised Fund?

Some investors have highly appreciated assets that could lead to a significant tax liability, if they were sold right now. DAF offers an alternative—rather than sell the assets and pay taxes, putting them into a DAF can achieve the following:

  • You receive a tax deduction,
  • There are no capital gains taxes, and
  • Your chosen the charity that fully benefits from the funds.

The pandemic has left many people facing uncertainty. Therefore, now isn’t the right time for everyone to open their wallets and a DAF. However, if you are charitably-minded and in a financial position to benefit, a Donor Advised Fund is a win-win for all concerned. If you would like to learn more about charitable giving, please visit our previous posts. 

Reference: Fort Worth Magazine (Feb. 3, 2021) “Choosing Charity: How Donor-Advised Funds Benefit Your Contributions”

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Probate can affect Real Estate Transactions

Probate can affect real estate transactions. For a family whose 91-year-old mother lives in her home, has a will and has appointed two sisters as Power of Attorney and executors of her estate, the question of handling the transfer of the home is explored in a recent article from the Herald Tribune, “Transfer title now or go through probate in the future?”

The family wasn’t sure if it made more sense to transfer the title to her two daughters and son while she was still living, or let the children handle the transfer as part of the estate. The brother may wish to purchase the home after the mother passes, as he lives with his mother.

If nothing is done, the house will be part of the probated estate. A case will have to be opened, a representative will be appointed by the court (usually the executor of the will) and then the executor can sell assets in the estate, close accounts and deal with the IRS and the Social Security Administration. The probate process can be time-consuming and expensive, depending on where the mother lives.

There are a number of steps that could be taken to simplify things. The mom’s assets can be held jointly, so they pass to the surviving owner, or a trust can be created, and her assets be titled to the trust, so they pass automatically to beneficiaries.

The issue of the house becomes a little more complicated because there are so many options. This is where probate can affect real estate transactions. If the house has appreciated significantly over the years, keeping it in the estate will minimize taxes that have to be paid if and when it is sold.

For example, let’s say the house has increased in value by $250,000. Under current tax law, the mother can exclude up to $250,000 in profits from the sale of the home. This is the exclusion before the sale of a primary residence where the owner has lived in the home for two out of the last five years.

If she signs a quitclaim deed now to give the home to her three children, the IRS will consider this a gift to the three children. Her cost basis in the property (what she paid for the home, plus the cost of any material or structural improvements) will be transferred to the children. However, when the children go to sell the property, they won’t have that same $250,000 exclusion. The three siblings will have to pay federal income or capital gains tax on the same of the home.

However, if the home remains in the mother’s estate when she passes, the siblings inherit the home at the stepped-up basis. In other words, the value of the house (for estate tax purposes) will rise to the current market value at the time of her death, and not the value when she paid for the house. If the children decide to sell the house immediately, there won’t be any profit and there won’t be any taxes.

Depending on the state’s probate laws, the children might be able to use a transfer on death deed that would let the property transfer automatically to heirs upon the mother’s death. The siblings then inherit the property at the stepped-up value.

Here’s another question to consider: how does the cost of setting up trusts and transfer on death deeds compare to the estimated cost of probating the estate?

This family, and others in the same situation, should speak with an estate planning attorney to evaluate their options. The siblings in this case need to clarify whether their brother wants to buy the house and if he is able to do so. The mom then needs to make a decision, while she is still able to do so, because after all, it’s still her home.

If you would like to learn more about how to protect the family home for future generations, please visit our previous posts.

Reference: Herald-Tribune (Nov. 7, 2020) “Transfer title now or go through probate in the future?”

 

when mom refuses to get an Estate Plan

Passing the Vacation Home to the Family

If this winter-like weather plus pandemic have left you wondering about how to get started on passing the vacation home to the family or preparing to sell it in the future, you’ll need to understand how property is transferred. The details are shared in a useful article titled “Exit strategy for keeping the cabin in the family” from The Spokesman Review.

Two options to consider: an outright sale to the adult children or placing the cabin in a qualified personal residence trust. Selling the vacation home and renting it back from the children, is one way that parents can keep it in the family, enjoy it without owning it, and help the children out with rental income.

One thing to bear in mind: the sale of the vacation home will not escape a capital gains tax. It’s likely that the vacation home has appreciated in value, especially if you’ve owned it for a long time. If you have made capital improvements over that time period, you may be able to offset the capital gains.

The actual gain is the difference between the adjusted sales price (that is, the selling price minus selling expenses) and their adjusted basis. What is the adjusted basis? That is the original cost, plus capital improvements. These are the improvements to the property with a useful life of more than one year and that increase the value of the property or extend its life. A new roof, a new deck, a remodeled kitchen or basement or finished basement are examples of what are considered capital improvements. New curtains or furniture are not.

Distinguishing the difference between a capital improvement and a maintenance cost is not always easy. An estate planning attorney can help you clarify this, as you plan for the transfer of the property.

Another way to transfer the property is with the use of a qualified personal residence trust (QPRT). In this situation, the vacation home is considered a second residence, and is placed within the trust for a specific time period. You decide what the amount of time would be and continue to enjoy the vacation home during that time. Typical time periods are ten or fifteen years. If you live beyond the time of the trust, then the vacation home passes to the children and your estate is reduced by the value of the vacation home. If you should die during the term of the trust, the vacation home reverts back to your estate, as if no trust had been set up.

A QPRT works for families who want to reduce the size of their estate and have a property they pass along to the next generation, but the hard part is determining the parent’s life expectancy. The longer the terms of the trust, the more estate taxes are saved. However, if the parents die earlier than anticipated, benefits are minimized.

The question for families considering the sale of their vacation home to the children, is whether the children can afford to maintain the property. One option for the children might be to rent out the property, until they are able to carry it on their own. However, that opens a lot of different issues. They should do so for period of one year at a time, so they receive the tax benefits of rental property, including depreciation.

If you are serious about passing the vacation home to the family, talk with a qualified estate planning attorney about what solution works best for your estate plan and your family’s future. There are other means of conveying the property, in addition to the two mentioned above, and every situation is different.

If you would like to learn more about family property and estate planning, please visit our previous posts. 

Reference: The Spokesman Review (April 19, 2020) “Exit strategy for keeping the cabin in the family”

 

why you need an estate plan

Why You Need an Estate Plan

Here’s why you need an estate plan. It’s always the right time to do your estate planning, but it’s most critical when you have beneficiaries who are minors or with special needs, says the Capital Press in the recent article, “Ag Finance: Why you need to do estate planning.”

While it’s likely that most adult children can work things out, even if it’s costly and time-consuming in probate, minor young children must have protections in place. Wills are frequently written, so the estate goes to the child when he reaches age 18. However, few teens can manage big property at that age. A trust can help, by directing that the property will be held for him by a trustee or executor until a set age, like 25 or 30.

Probate is the default process to administer an estate after someone’s death, when a will or other documents are presented in court and an executor is appointed to manage it. It also gives creditors a chance to present claims for money owed to them. Distribution of assets will occur only after all proper notices have been issued, and all outstanding bills have been paid.

Probate can be expensive. However, wise estate planning can help most families avoid this and ensure the transition of wealth and property in a smooth manner. Talk to an experienced estate planning attorney about establishing a trust. Farmers can name themselves as the beneficiaries during their lifetime, and instruct to whom it will pass after their death. A living trust can be amended or revoked at any time, if circumstances change.

The title of the farm is transferred to the trust with the farm’s former owner as trustee. With a trust, it makes it easier to avoid probate because nothing’s in his name, and the property can transition to the beneficiaries without having to go to court. Living trusts also help in the event of incapacity or a disease, like Alzheimer’s, to avoid conservatorship (guardianship of an adult who loses capacity). It can also help to decrease capital gains taxes, since the property transfers before their death.

If you have several children, but only two work with you on the farm, an attorney can help you with how to divide an estate that is land rich and cash poor.

If you are interested in learning more about estate planning, please visit our previous posts. 

Reference: Capital Press (December 20, 2018) “Ag Finance: Why you need to do estate planning”

Information in our blogs is very general in nature and should not be acted upon without first consulting with an attorney. Please feel free to contact The Wiewel Law Firm to schedule a complimentary consultation.
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