Federal Estate Tax Is No Longer The Biggest Concern

Focus of Estate Planning Shifts

As many of you have heard, recent tax law changes are turning traditional estate planning on its head – causing a shift in attention from an estate tax focus to an income tax focus.   Planning techniques long considered wise – e.g., shifting wealth to younger generations while senior family members are still alive or automatically leaving assets to a bypass “credit shelter” trust – may no longer be necessary to save estate tax and could now leave many families paying income tax they would not otherwise owe.  Chances are, if you have accumulated modest wealth, your existing estate planning documents drafted prior to 2013 contains planning techniques that are out of date.

The New Law Changing Estate Tax

The legislative deal Congress passed in January 2013 set the top estate and gift tax rate at 40% and raised the exemption to $5 million per person, adjusted for inflation. It now stands at $5.43 million and will rise to $5.45 million in 2016. That means an individual can leave $5.45 million to heirs and pay no federal estate or gift tax. Not only will this exemption rise with inflation, but spouses can now share–and effectively inherit through a portability election–each other’s exclusions.  In other words, a married couple will be able to shield $10.9 million from federal estate and gift taxes before the 40% rate will kick in.

As a result, the federal estate tax is no longer the biggest concern for most Americans who want to avoid taxes on wealth they leave to heirs.  In fact, according to the Tax Policy Center, only about 4,000 estates, or approximately .14% of the total, are expected to owe federal estate tax this year.  To provide perspective, 2.3% of estates were subject to tax in 1999 and 7.65% in 1976, according to the Tax Policy Center.

Income Tax Focused Planning

Although the legislative deal Congress passed in January of 2013 provided a generous estate and gift tax exemption, it also raised the top income tax rate on long-term capital gains to 20% – its highest level since 1997.  With the new 3.8% net investment income tax that took effect as a part of the Affordable Care Act, the top rate on long-term capital gains from investments is now 23.8%, up from 15% in 2012.  As a result, a main focus of current estate planning is what some practitioners refer to as “freebasing” – or utilizing planning techniques so that it frees survivors to get the most income tax savings from the step-up in basis of the decedent’s property.   In other words, while historical planning techniques oftentimes arranged for assets to be excluded from a loved one’s estate, under the new law, the greatest tax savings is now most often achieved through planning for estate inclusion, and minimizing capital gains.

For example, when you sell an asset such as stock, you owe capital gains tax on the difference between what you paid for it (its basis) and the sales price.  If you inherit certain assets you can “step up” the decedent’s tax basis to whatever the asset is worth at death.  Thus, highly appreciated inherited property can be sold immediately with no capital gains (or later, with all the gains before you inherited it disregarded).  On the other hand, if you receive property from a living donor, or receive a remainder interest from a standard “credit-shelter” trust, you do not get the stepped up basis and can result in significant capital gains tax.

Bottom Line

Do not fall victim to the trap that estate planning is just about reducing estate taxes.  Just because you do not have a taxable estate, does not mean that your existing estate documents still suit you.  While the true meaning of estate planning is more about people and relationships than about cold, hard numbers, if you are not diligent with your estate planning, you could be losing a stepped up basis in appreciated assets.  These new rules are complex, but they present tax-saving opportunities that many people planning estates remain unaware of.

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Tax Strategies Beyond Year End Giving

In the first part of this series, we discussed year-end charitable giving and tax strategies that can accomplish both clients’ charitable goals and provide some significant tax benefits.  The focus of that article was immediate gifts given and received that provide current support to charitable organizations.

But what if clients want to be more strategic with timing and how they give?

Other Tax Strategies: Planned or Deferred Gifts

Planned or deferred gifts play an increasingly important role in providing a foundation for future ongoing support to a charitable institution.  Just ask any university president how much time is spent in seeking planned gifts and you will find that it is a substantial portion of their job.

Simple Tax Strategy

As in current gifts, the simplest way to make a planned gift is a bequest of cash or property through an individual’s estate planning documents, either a Will or a Trust.  The bequest can be a specific dollar amount or a percentage of one’s estate.  The donor continues to own the asset until the time of death or trust termination at which time the Trustee or Personal Representative/Executor fulfills the commitment under the terms of the governing document.

Rather than a bequest in a document, donors should also consider making a charity the sole or partial beneficiary of a life insurance policy such that the charity receives the proceeds of the policy at the time of the insured’s death.  A particularly attractive source of charitable gifting can come from an IRA or other tax-deferred account where the payment to a qualified charity eliminates the ultimate income tax liability that must otherwise be paid when distributions are taken by an individual.

Sophisticated Tax Strategy

An area that should be explored by a potential donor involves more sophisticated techniques that provide for ultimate charitable gifts to an organization while maintaining a current income stream for the donor until their death.  Charitable gift annuities and charitable remainder trusts can enhance the value of a planned gift to one or more favorite institutions while continuing to provide the donor with a flow of income through their remaining lifetime.  There are many variables involved that ultimately affect the amount of the income tax and estate tax deductions available to a donor, including the age of the donor, whether it is for only the donor’s lifetime or also includes the lifetime of a surviving spouse, and the payout rate for the ongoing lifetime income payments.  These annuities and trusts represent the merger of two core concepts – satisfying the desire of donors to support the mission of a favorite charity while providing for continuing financial security for their remaining lifetime.  Your favorite charity will normally be able to provide you with illustrations without cost or obligation that can show you the benefits of establishing a charitable gift annuity or charitable remainder trust including the amount of lifetime income benefits you would be receiving as well as the value of the ultimate gift to the organization.

Tailored Tax Planning

As stated in my previous column, your tax and legal advisors are important partners in making sure that the gifts meet both the intent of the donor and the expectations of the recipient.  A plan can be tailored to meet your specific charitable goals and lifetime income needs.  We welcome the opportunity to explore how planned giving can accomplish multiple goals for you and your family.

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Gearing Up For Year End Tax Planning

This is Part I in a two part series that discusses charitable giving in conjunction with taxes and estate planning.

Tax Planning to Decrease Income Tax Liability

As we approach the end of the calendar year, many people begin thinking about year-end tax strategies and tax planning that can reduce the income tax bite when filing their tax returns next spring. Those individuals who are inclined to support their favorite charities may find it advantageous to make year-end gifts that not only provide vital support to the organization but help reduce the donor’s income tax liability.

Traditional Giving Patterns

Past giving patterns suggest that religious and educational institutions are the primary recipients of support from donors but other types of organizations, including animal welfare, conservation, and health and medical research, are frequent beneficiaries of tax planning donations. Cash is the easiest way to make a gift and will be welcomed by any organization relying on gifts to keep it operating.

Other Methods of Giving

The gifting of appreciated securities can be very advantageous to both donor and recipient as the donor receives a charitable income tax deduction based on the current fair market value of the assets being donated and escapes the capital gains tax that would otherwise be levied if the assets were sold and the cash proceeds from the sale donated to the charity. The charity can elect to keep the securities or can immediately sell them at current market value and realize the cash proceeds for the organization. Occasionally, more unusual types of gifts are offered to a charity, such as a parcel of real estate. However, a donor cannot expect a charitable organization to blindly accept such a gift without exercising due diligence to determine whether there are environmental issues or whether the real estate is easily marketable for the organization to obtain the cash proceeds from an eventual sale.

Communication with Charitable Organization

Donors are well advised to communicate with their intended charity about their intended gift, especially if a non-cash donation, and work through any issues which may cause the charity to politely decline the opportunity to receive the gift. Charities also like to know about the donor’s intended use of the gift when received by the charity, such as a particular department or program within the organization. As a donor, please engage in a dialogue with the charitable beneficiary if your gift is anything more than a nominal annual donation in support of the charity’s operations.

Making Sure Your Charitable Contribution is Advantageous for Tax Planning Purposes

Your tax, financial and legal advisers are important partners in making sure that the gifts meet both the intent of the donor and the expectations of the recipient. Making both sides of the gifting process satisfied is one of the most rewarding aspects of our practice. We welcome the opportunity to discuss your charitable gifting ideas and provide counsel and advice on the best approach for you and your family.

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Will Defense & Contesting

Building wealth is a lifelong endeavor and protecting and growing assets as well as managing their transfer and distribution can be anything but simple. Most executors and trustees ensure their legacy lives on through their succession planning and generally their wills or trusts go through probate without a hitch. However, if you suspect your loved one’s will is not what he or she intended, there are several things that you can do legally to correct the situation. You also can defend the validity of the will if you feel it was written correctly.

If you have questions regarding defending the probate of a will or contesting it, contact us.