FIVE ESTATE MISTAKES
Understanding key concepts can help you save you
from a bad estate plan
Every reader of this article has an estate plan, whether or not they know it. Some have taken a proactive approach and retained counsel to create a plan and draft appropriate documents that express their wishes. The rest — perhaps unknowingly — rely on the laws of the state in which they reside. The laws affecting seniors have become increasingly complex, and it is up to the client to seek appropriate advice at an early date.
Power of attorney
Some may be tempted to download a power of attorney form from the Internet. Anyone can search the Internet for the term “power of attorney” and find Web sites with standardized forms for sale or immediate download. This might sound like a simple solution, but don’t be misled.
The basic power of attorney documents found on the Internet often do not cover the very specific issues you may need addressed. Medical powers of attorney are not always included, nor are clauses about gifting, real estate transactions or the ability to make asset transfers to affect Medicaid eligibility. These are important parts of your estate plan that require case-by-case consideration.
Tax allocation clause
One of the most important provisions in a will is the tax allocation clause, which allocates a decedent’s estate or inheritance tax burden among the estate beneficiaries by specifying the source or fund from which the death taxes are to be paid. The allocation of taxes among beneficiaries of an estate is generally governed by the terms of a testator’s will, a nontestamentary instrument passing nonprobate property or the default rules under applicable state law.
Despite the importance of tax allocation clauses, which can dramatically alter the dispositive provisions of a client’s estate plan, many practitioners rely on general boilerplate tax clause provisions for all clients without fully examining the impact that such clauses have on the plan. Generally, a tax clause contained in a will charges the estate’s tax burden to the residuary estate or apportions the tax burden among the estate beneficiaries in proportion to their share of the estate tax liability. Often, a boilerplate tax allocation clause commonly found in wills charges the testator’s residuary estate under the will with the burden of all taxes imposed on both probate and nonprobate property. An example where a tax allocation clause resulted in a presumably unintended result involved the estate of Charles Kuralt. His 1994 will provided that all estate, inheritance and other death taxes imposed by reason of death would be paid, without apportionment, by his residuary estate. The residuary beneficiaries included his surviving spouse and two children. Shortly before his death, he prepared a handwritten codicil (which was ultimately admitted to probate) that devised his Montana ranch to his longtime companion. Since the terms of Kuralt’s will provided that the taxes were to be paid from the residuary estate, the residuary beneficiaries (his wife and kids) bore responsibility for payment of taxes attributable to the property that passed to the companion.
Special needs trust
Consider establishing a special needs trust if one of your potential beneficiaries is entitled to government benefits such as Supplemental Security Income or Medicaid. Direct receipt of funds will cause the individual to be disqualified, which means the funds will need to be spent down before requalifying for the benefits. This result is particularly harmful for those who incur substantial medical expenses each month.
Consider a situation in which Mom and Dad have three children, one who is disabled. The parents are killed together in an accident and don’t have wills. In most states, the children will be entitled to receive the inheritance in equal shares. Since the disabled child’s share is not diverted to a special needs trust, the result will be disqualification from the entitlement program that he or she may have been otherwise eligible until the funds are spent.
Another situation I handled involved a client in a nursing home, the costs of which are being covered by Medicaid. A family member dies, leaving the ill person an inheritance. Again, the ill person is disqualified from Medicaid. This means that he or she must pay the nursing home bill directly (at a rate of $5,000 to $9,000 per month, depending on the locale) until only $2,000 remains.
State estate tax
Since the state death tax credit was repealed at the federal level through the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), many states have imposed their own estate tax. (It’s important to know that an estate tax differs from an inheritance tax. Some states have both, and some states have neither.)
The planning focus is often on the federal estate tax, and many erroneously believe that tax planning is no longer necessary in light of the current federal estate tax exemption of $2 million. The state estate tax can be avoided in many cases; therefore, you need to take a proactive approach with respect to this issue. In New Jersey, the exemption is $675,000.
Updated documents
When important changes occur in our lives, we need to revisit our wills and beneficiary designations to make sure that our current intent is expressed. The following are major events that might motivate individuals to take a second look at their will:
• Marriage or new life partner
• Divorce
• Birth of a child
• Change of who will inherit your assets
• Change of who should handle your estate after your death
Many have failed to update their documents since the enactment of EGTRRA in 2001. This mistake has caused many surviving spouses to unnecessarily incur state estate tax liability at the death of the first spouse.
Don’t allow your estates to suffer unintended consequences. Become more familiar with the laws affecting you by seeking the advice of an attorney with expertise in this complex area of law.
Thursday, October 15, 2009
Wednesday, September 30, 2009
Laws May Cause Issues for Owners In Civil Unions
When civil unions became legal for same-sex couples in New Jersey last year, the lesbian, gay, bisexual and transgender community celebrated a hard-won victory. But conflicting laws for LGBT partners at the state and federal levels have some business owners who live with same-sex partners worried about how the conflict may affect their estate planning.
Kimberlee Williams and Tamara Fleming-Cooper are co-owners of Newark-based marketing firm Femworks LLC and are both in civil unions. If both owners were to die and their respective partners were each to receive half the business, it would become “difficult on the federal level to transfer our assets to them without an estate tax being paid,” says Williams.
Femworks, which has five part-time employees besides the owners, specializes in reaching African Americans in the LGBT community.
Neither Williams nor Fleming-Cooper have children, but both want to have everything figured out before they do because their business makes up a large portion of their personal assets.
Each member of a civil union must file separate federal tax returns because federal law doesn’t recognize civil unions. Williams says there is a burden on small business owners because of the time spent on all the paperwork.
Stephen Hyland, a Westmont attorney who specializes in LGBT couples law, says that under federal law one member of a civil union who gives the other more than $12,000 in one year as a gift will eat into a $1 million lifetime gift-tax exclusion.
“Let’s say a business owner [in New Jersey] in a same-sex civil union and his partner buy a house and the business owner puts down the entire down payment,” he says. “Later in the same year, the business owner gives his partner a $50,000 stake in the company. The business owner would have given his partner a reportable gift of half the down payment plus the $50,000 investment minus the $12,000 annual gift exclusion.”
Hyland notes that the $1 million lifetime federal gift-tax exclusion counts toward the federal estate-tax exemption, a tax levied upon death that is currently capped at $2 million but scheduled to jump to $3.5 million next year.
“So if I used up $500,000 of my gift-tax exclusion, I’ve really reduced the amount of my estate I can leave tax-free to $1.5 million” under the current cap.
Meanwhile, members of a traditional marriage can gift each other unlimited amounts of money without being federally taxed, and can take federal-tax deductions on all assets left to each after death, says Hyland. But gay and lesbian couples don’t have that right, notes Hyland.
For state taxes such as the inheritance-transfer tax and the estate tax, same-sex partners in civil unions get the same exemptions as married couples, he says.
In New Jersey, an estate in excess of $675,000 is subject to the state’s estate tax, however civil-union couples and married couples pay no tax on assets they leave to their spouse. Same-sex couples in domestic partnerships are exempt from the state’s inheritance-transfer tax but not from the estate tax.
“What it comes down to is that anytime an [LBGT] business owner is doing something that would be non-taxable federally if he were married, it has tax implications either as a gift or income,” Hyland says. “Unfortunately, that’s the effect of the federal law.”
Stephanie Canas Hunnell, a lawyer in Belmar, says same-sex partners in civil unions should create what is called a dummy form with the state when filing their federal estate taxes because the federal government doesn’t recognize same-sex unions.
“One form is a real form filed with the federal government to pay taxes, as if the estate was being left to a stranger,” she adds.
“The other is a dummy form filled out as if the estate was being left to a spouse. You would use dummy form in New Jersey to get the same tax benefits as a married couple,” says Canas Hunnell.
“Because the federal government doesn’t recognize same-sex marriages or civil unions as having the same rights and responsibilities as opposite-sex married couples, they’re not going to give any [tax] benefits,” she says. “So you’re not any kind of relation according to the [federal] government and you’re going to pay a higher tax.”
Both Hunnell and Hyland advise LGBT business owners in New Jersey to assemble a team comprised of a lawyer, an accountant and a financial adviser who are familiar with the laws surrounding same-sex couples.
Kimberlee Williams and Tamara Fleming-Cooper are co-owners of Newark-based marketing firm Femworks LLC and are both in civil unions. If both owners were to die and their respective partners were each to receive half the business, it would become “difficult on the federal level to transfer our assets to them without an estate tax being paid,” says Williams.
Femworks, which has five part-time employees besides the owners, specializes in reaching African Americans in the LGBT community.
Neither Williams nor Fleming-Cooper have children, but both want to have everything figured out before they do because their business makes up a large portion of their personal assets.
Each member of a civil union must file separate federal tax returns because federal law doesn’t recognize civil unions. Williams says there is a burden on small business owners because of the time spent on all the paperwork.
Stephen Hyland, a Westmont attorney who specializes in LGBT couples law, says that under federal law one member of a civil union who gives the other more than $12,000 in one year as a gift will eat into a $1 million lifetime gift-tax exclusion.
“Let’s say a business owner [in New Jersey] in a same-sex civil union and his partner buy a house and the business owner puts down the entire down payment,” he says. “Later in the same year, the business owner gives his partner a $50,000 stake in the company. The business owner would have given his partner a reportable gift of half the down payment plus the $50,000 investment minus the $12,000 annual gift exclusion.”
Hyland notes that the $1 million lifetime federal gift-tax exclusion counts toward the federal estate-tax exemption, a tax levied upon death that is currently capped at $2 million but scheduled to jump to $3.5 million next year.
“So if I used up $500,000 of my gift-tax exclusion, I’ve really reduced the amount of my estate I can leave tax-free to $1.5 million” under the current cap.
Meanwhile, members of a traditional marriage can gift each other unlimited amounts of money without being federally taxed, and can take federal-tax deductions on all assets left to each after death, says Hyland. But gay and lesbian couples don’t have that right, notes Hyland.
For state taxes such as the inheritance-transfer tax and the estate tax, same-sex partners in civil unions get the same exemptions as married couples, he says.
In New Jersey, an estate in excess of $675,000 is subject to the state’s estate tax, however civil-union couples and married couples pay no tax on assets they leave to their spouse. Same-sex couples in domestic partnerships are exempt from the state’s inheritance-transfer tax but not from the estate tax.
“What it comes down to is that anytime an [LBGT] business owner is doing something that would be non-taxable federally if he were married, it has tax implications either as a gift or income,” Hyland says. “Unfortunately, that’s the effect of the federal law.”
Stephanie Canas Hunnell, a lawyer in Belmar, says same-sex partners in civil unions should create what is called a dummy form with the state when filing their federal estate taxes because the federal government doesn’t recognize same-sex unions.
“One form is a real form filed with the federal government to pay taxes, as if the estate was being left to a stranger,” she adds.
“The other is a dummy form filled out as if the estate was being left to a spouse. You would use dummy form in New Jersey to get the same tax benefits as a married couple,” says Canas Hunnell.
“Because the federal government doesn’t recognize same-sex marriages or civil unions as having the same rights and responsibilities as opposite-sex married couples, they’re not going to give any [tax] benefits,” she says. “So you’re not any kind of relation according to the [federal] government and you’re going to pay a higher tax.”
Both Hunnell and Hyland advise LGBT business owners in New Jersey to assemble a team comprised of a lawyer, an accountant and a financial adviser who are familiar with the laws surrounding same-sex couples.
Monday, August 17, 2009
BUSINESS SUCCESSION LEGAL PLANNING
By Parag Patel, Esq.
If the U.S. Government is your favorite charity, rest assured, it will find a way to use your donation. But wouldn't it be better to give your money to your children?
Studies show that 60% to 70% of all family-owned businesses, including hotels, have no business succession plan in place or no one to take over the reins. This leaves third-party sales, family limited partnerships and buy-sell agreements as the most likely methods of transfer if a business is to continue.
Proper business succession planning will protect you from a potential liquidity shortfall and intervention by the IRS, and will ensure your successor (i.e., your son, daughter, nephew, etc.) receives the maximum value upon transfer of your business.
Gifting and Family Limited Partnerships:
A substantial portion of the estimated $6 trillion to $8 trillion of personal wealth that will transfer over the next 10 years consists of family business interests, including hotel properties. Unlike publicly traded securities, no ready market exists for closely held private interests. Each business therefore represents a unique and challenging valuation problem to the IRS with respect to estate and gift taxes. One way to deal with this problem is gifting. With a new IRS ruling allowing for gifts of minority shares to family members at a discount, individuals considering a transfer of shares of a family business should gift the shares now. The formation of a family limited partnership holding all shares of your business interests is a common and popular way to maximize gifts and still maintain control of your businesses until you are ready for your successor to takeover the business.
Valuation of Your Business:
Disputes over business value are a leading cause of tax challenge between the IRS and business owners. The transfer must be well-documented by an independent expert. The valuation process has been around since 1959 and has been well-treated by the courts. It carries stiff penalties for over-under valuation, hence strict adherence is mandatory.
Buy-Sell Agreements:
A family business should have a buy-sell agreement in place that specifies terms of ownership and price of transferred shares between family members in the event one of the them retires, leaves the business, becomes disabled or dies. Of course, the lower the specified share price, the lower the estate and gift tax value of the shares. The specific mechanism for setting the price of the shares in the agreement has been a subject of controversy for many decades.
Regardless of your method of planning, you have worked too hard to build up your business to have it lose value or fall apart when you can no longer run the business. I have had too many clients that simply fail to do any business succession planning and ultimately give the U.S. Government more in taxes. The time is now to think about tomorrow.
If the U.S. Government is your favorite charity, rest assured, it will find a way to use your donation. But wouldn't it be better to give your money to your children?
Studies show that 60% to 70% of all family-owned businesses, including hotels, have no business succession plan in place or no one to take over the reins. This leaves third-party sales, family limited partnerships and buy-sell agreements as the most likely methods of transfer if a business is to continue.
Proper business succession planning will protect you from a potential liquidity shortfall and intervention by the IRS, and will ensure your successor (i.e., your son, daughter, nephew, etc.) receives the maximum value upon transfer of your business.
Gifting and Family Limited Partnerships:
A substantial portion of the estimated $6 trillion to $8 trillion of personal wealth that will transfer over the next 10 years consists of family business interests, including hotel properties. Unlike publicly traded securities, no ready market exists for closely held private interests. Each business therefore represents a unique and challenging valuation problem to the IRS with respect to estate and gift taxes. One way to deal with this problem is gifting. With a new IRS ruling allowing for gifts of minority shares to family members at a discount, individuals considering a transfer of shares of a family business should gift the shares now. The formation of a family limited partnership holding all shares of your business interests is a common and popular way to maximize gifts and still maintain control of your businesses until you are ready for your successor to takeover the business.
Valuation of Your Business:
Disputes over business value are a leading cause of tax challenge between the IRS and business owners. The transfer must be well-documented by an independent expert. The valuation process has been around since 1959 and has been well-treated by the courts. It carries stiff penalties for over-under valuation, hence strict adherence is mandatory.
Buy-Sell Agreements:
A family business should have a buy-sell agreement in place that specifies terms of ownership and price of transferred shares between family members in the event one of the them retires, leaves the business, becomes disabled or dies. Of course, the lower the specified share price, the lower the estate and gift tax value of the shares. The specific mechanism for setting the price of the shares in the agreement has been a subject of controversy for many decades.
Regardless of your method of planning, you have worked too hard to build up your business to have it lose value or fall apart when you can no longer run the business. I have had too many clients that simply fail to do any business succession planning and ultimately give the U.S. Government more in taxes. The time is now to think about tomorrow.
Friday, July 17, 2009
15 IRS Audit Tips
1. In an audit, you must convince the IRS that you reported all of your income and were entitled to any credits, deductions and exemptions that are questioned.
2. Delaying the audit usually works to your advantage. Request more time whenever you need it to get your records in order or for any other reason.
3. Keep the IRS from holding the audit at your business or home. Instead, go to the IRS or have your tax attorney handle it.
4. Give the auditor no more information than she is entitled to, and do not talk any more during the audit than is absolutely necessary.
5. Do not expect to come out of the audit without owing something, the odds are against you.
6. Do not give copies of other years' tax returns to the auditor; if you do and she sees something she does not like she will make adjustments in these years too.
7. The IRS must complete an audit within three years of the time the tax return is filed, unless the IRS finds tax fraud or a significant underreporting of income.
8. If the audit is not going well, demand a recess to consult a tax attorney.
9. If you are still unclear about the tax law or how to present your documents to an auditor, consult a tax attorney before the audit.
10. If you are missing receipts or other documents, you are allowed to reconstruct records.
11. Do not bring to an audit any documents that do not pertain to the year under audit or were not specifically requested by the audit notice.
12. If the subject of tax fraud comes up during an audit, do not try to handle it yourself.
13. Field audits are more intensive than office audits. They are used mainly when there is business income; consult a tax attorney before a field audit.
14. When you get the examination report, call the auditor if you do not understand or agree with it. Meet with her or her manager to see if you can reach a compromise.
15. If you ca not live with an audit result, you may appeal within the IRS or go on to Tax Court.
2. Delaying the audit usually works to your advantage. Request more time whenever you need it to get your records in order or for any other reason.
3. Keep the IRS from holding the audit at your business or home. Instead, go to the IRS or have your tax attorney handle it.
4. Give the auditor no more information than she is entitled to, and do not talk any more during the audit than is absolutely necessary.
5. Do not expect to come out of the audit without owing something, the odds are against you.
6. Do not give copies of other years' tax returns to the auditor; if you do and she sees something she does not like she will make adjustments in these years too.
7. The IRS must complete an audit within three years of the time the tax return is filed, unless the IRS finds tax fraud or a significant underreporting of income.
8. If the audit is not going well, demand a recess to consult a tax attorney.
9. If you are still unclear about the tax law or how to present your documents to an auditor, consult a tax attorney before the audit.
10. If you are missing receipts or other documents, you are allowed to reconstruct records.
11. Do not bring to an audit any documents that do not pertain to the year under audit or were not specifically requested by the audit notice.
12. If the subject of tax fraud comes up during an audit, do not try to handle it yourself.
13. Field audits are more intensive than office audits. They are used mainly when there is business income; consult a tax attorney before a field audit.
14. When you get the examination report, call the auditor if you do not understand or agree with it. Meet with her or her manager to see if you can reach a compromise.
15. If you ca not live with an audit result, you may appeal within the IRS or go on to Tax Court.
Wednesday, June 17, 2009
Top 7 Costly Estate Planning Mistakes and How To Avoid Them
1. Where There Is A “Will” Is There Is A Way? The biggest mistake is the failure to plan, having the wrong plan or even having an outdated plan. Everyone can benefit from a will or some other form of estate planning. Avoiding or reducing estate taxes, saving estate administrative costs, specifying who will receive your estate and protecting your family are just a few of the benefits a will can achieve.
2. Understanding the Death Tax System. If you are married, with proper planning you and your spouse can shield double the state and federal exemption amount ($3.5 million federal and $675,000 for New Jersey) from estate tax. The mistake occurs when the first spouse dies and leaves their entire estate to the surviving spouse thereby in effect losing the deceased spouses individual exemption amount. Instead, it is often beneficial for the spouse to leave all or a portion of their estate to a simple trust called an exemption trust (also know as a credit shelter trust).
3. Should Assets be Jointly Titled? Joint assets often have a right of survivorship which transfers ownership at death to the joint owner by operation of law. This bypasses the will. Since probate in New Jersey is relatively straightforward, instead of being an advantage, joint ownership can interfere with an estate plan.
4. What Are The Benefits Of Beneficiary Designations? IRA And Retirement Plan Distributions. A well thought out estate plan can be undermined by an incorrect beneficiary designation. The most common error is naming minor or irresponsible beneficiaries. A trust may be a better designation. Also consider a “Stretch IRA”.
5. Can Life Insurance Be Improperly-Owned? Life insurance death benefits are not subject to income tax. However, they are subject to estate taxes if the policies are owned by the insured at death. A way to avoid this is to have life insurance owned by an irrevocable life insurance trust.
6. Gifting When You Shouldn't And Not Gifting When You Should. When properly applied, gifting can be an extremely effective way to reduce estate taxes. However, many individuals incorrectly assume that gifting is simple and fail to obtain competent advice.
7. Hiring A Generalist. When hiring a doctor, attorney, mechanic or any type of service profession, I strongly recommend hiring a specialist. Almost without exception, the specialist will have more experience and skill in their area of specialty than will a generalist. This usually translates into higher quality services provided in the most cost effective manner possible.
2. Understanding the Death Tax System. If you are married, with proper planning you and your spouse can shield double the state and federal exemption amount ($3.5 million federal and $675,000 for New Jersey) from estate tax. The mistake occurs when the first spouse dies and leaves their entire estate to the surviving spouse thereby in effect losing the deceased spouses individual exemption amount. Instead, it is often beneficial for the spouse to leave all or a portion of their estate to a simple trust called an exemption trust (also know as a credit shelter trust).
3. Should Assets be Jointly Titled? Joint assets often have a right of survivorship which transfers ownership at death to the joint owner by operation of law. This bypasses the will. Since probate in New Jersey is relatively straightforward, instead of being an advantage, joint ownership can interfere with an estate plan.
4. What Are The Benefits Of Beneficiary Designations? IRA And Retirement Plan Distributions. A well thought out estate plan can be undermined by an incorrect beneficiary designation. The most common error is naming minor or irresponsible beneficiaries. A trust may be a better designation. Also consider a “Stretch IRA”.
5. Can Life Insurance Be Improperly-Owned? Life insurance death benefits are not subject to income tax. However, they are subject to estate taxes if the policies are owned by the insured at death. A way to avoid this is to have life insurance owned by an irrevocable life insurance trust.
6. Gifting When You Shouldn't And Not Gifting When You Should. When properly applied, gifting can be an extremely effective way to reduce estate taxes. However, many individuals incorrectly assume that gifting is simple and fail to obtain competent advice.
7. Hiring A Generalist. When hiring a doctor, attorney, mechanic or any type of service profession, I strongly recommend hiring a specialist. Almost without exception, the specialist will have more experience and skill in their area of specialty than will a generalist. This usually translates into higher quality services provided in the most cost effective manner possible.
Thursday, May 28, 2009
Six Estate Planning Myths
The most time-consuming aspect of estate planning is educating clients and dispelling common misconceptions that most people have regarding Wills, Trusts, Estate Taxes and Probate. Over the years, we have identified six recurring misconceptions which many of our clients carry with them into our first conference:
MYTH #1 - "I DON'T HAVE A WILL"
New Jersey law provides a Will for people who die without one. "New Jersey's Will" provides for the following:
The manner in which your property will be distributed among your surviving relatives.
The designation of an administrator who will be responsible for settling the estate.
Guardians for minor children.
MYTH #2 - "I DON'T NEED A WILL"
See Myth #1; do you want the state to dictate:
The manner in which your property is distributed?
Who will be responsible for administering your estate?
Who will be guardians for your minor children?
A Will may also be necessary to minimize Death Taxes. (See Myth #3.)
MYTH #3 - "I HAVE NO FEDERAL ESTATE & GIFT EXPOSURE"
Federal Estate & Gift Tax is generally a concern only where assets (including the face value of life insurance) exceed the "Applicable Exclusion Amount". The Applicable Exclusion Amount is $1,500,000 for 2004 and 2005; $2,000,000 for 2006-2008; and $3,500,000 in 2009. The Federal Estate Tax is repealed in 2010 under current law, but scheduled to be reinstated in 2011 absent further Congressional Action. The Applicable Exclusion Amount in 2011 would only be $1,000,000.
For married couples, there is no Federal Estate Tax exposure at the first death, regardless of the amount of their assets, as long as everything passes to the surrvivor. However, Estate Tax will be due at the second death to the extent assets exceed the survivor's Applicable Exclusion Amount (discussed above). For Example, if Ricky and Lucy have assets valued at $3,000,000, the Federal Estate Tax and New Jersey Estate Tax (discussed below) due when neither is surviving could exceed $840,000. This is the case even though Ricky and Lucy each have a $1,500,000 Applicable Exclusion Amount ($3,000,000 combined).
Married couples need Wills to implement a "Bypass Trust" for the benefit of the survivor in order to preserve the decedent's (i.e., the first person to die) Applicable Exclusion Amount. A Bypass Trust is a trust established under the decedent's Will for the benefit of the survivor. Notwithstanding the survivor's enjoyment of the Bypass Trust assets, none of those assets are exposed to Estate Tax in the survivor's estate. In Ricky and Lucy's case, a Bypass Trust would have eliminated all Federal Estate Taxes, saving the family almost $660,000. However, as a result of recent changes to the New Jersey Estate Tax, fully funding the Bypass Trust would generate a New Jersey Estate tax upon Ricky's Passing.
Effective January 1, 2002, the State of New Jersey will impose an Estate Tax on assets which exceed the New Jersey "Applicable Exclusion Amount". Under old law, the New Jersey Applicable Exclusion Amount was the same as under Federal Law. However, the New Jersey Exclusion is now fixed at $675,000. Accordingly, New Jersey Estate Tax can be due even where no Federal Estate Tax is due. For example, if an individual dies in 2004 with a taxable estate of $1,500,000, there would be no Federal Estate Tax due, but the New Jersey Estate Tax would be $64,400. Moreover, the extent to which Bypass Trusts (discussed above) are funded when one spouse dies must be reassessed in light of the new law. In the example set forth above relating to Ricky and Lucy, setting aside $1,500,000 in a Bypass Trust for Lucy's benefit would be the most advantageous planning technique for Federal Estate Tax purposes, but could potentially generate a New Jersey Estate Tax of $64,400 upon Ricky's passing. Accordingly, the new law greatly affects both estate planning documents and decisions made during the estate administration process.
MYTH #4 - "I HAVE NO NEW JERSEY INHERITANCE TAX EXPOSURE"
Even if there is no Federal Estate & Gift Tax exposure or New Jersey Estate Tax exposure, there may be New Jersey Inheritance Tax exposure. This tax applies to property transferred at death to the following individuals: brothers, sisters, nephews, nieces, cousins and friends. It does not apply to property transferred to children, grandchildren, step-children and parents.
Example: Ricky dies with assets valued at $1,000,000. His Will provides that all of his property will pass to his friend, Ethel. Federal Estate Tax - $0; New Jersey Inheritance Tax - $153,000.
The New Jersey Estate Tax would be $33,200, but Ricky's estate would only be liable for the higher of the Inheritance Tax or Estate Tax. The two taxes are not combined.
MYTH #5 - "I MUST AVOID PROBATE"
In New Jersey, Probate is neither an expensive, nor a time consuming process.
"Probate" is simply the legal process by which an individual's Will is proven as a valid legal document to dispose of that individual's property. This "process" usually consists of a thirty minute meeting at the County Surrogate's office.
Once the Will is "probated", or proven as valid, the decedent's (the person that has died) property can be distributed in accordance with the directions set forth in the Will.
MYTH #6 - "TRUSTS ARE JUST FOR THE WEALTHY"
A Trust is simply a vehicle for separating the legal title and beneficial ownership of property.
A "Trustee" is designated as the person or entity who has legal title to the property placed in that person or entity's "trust".
The "Trustee" must manage the trust property in accordance with the directions set forth in the trust document, for the benefit of the trust's "beneficiary".
Even the simplest Will should contain provisions for a trust to be established to hold property for the benefit of minors.
MYTH #1 - "I DON'T HAVE A WILL"
New Jersey law provides a Will for people who die without one. "New Jersey's Will" provides for the following:
The manner in which your property will be distributed among your surviving relatives.
The designation of an administrator who will be responsible for settling the estate.
Guardians for minor children.
MYTH #2 - "I DON'T NEED A WILL"
See Myth #1; do you want the state to dictate:
The manner in which your property is distributed?
Who will be responsible for administering your estate?
Who will be guardians for your minor children?
A Will may also be necessary to minimize Death Taxes. (See Myth #3.)
MYTH #3 - "I HAVE NO FEDERAL ESTATE & GIFT EXPOSURE"
Federal Estate & Gift Tax is generally a concern only where assets (including the face value of life insurance) exceed the "Applicable Exclusion Amount". The Applicable Exclusion Amount is $1,500,000 for 2004 and 2005; $2,000,000 for 2006-2008; and $3,500,000 in 2009. The Federal Estate Tax is repealed in 2010 under current law, but scheduled to be reinstated in 2011 absent further Congressional Action. The Applicable Exclusion Amount in 2011 would only be $1,000,000.
For married couples, there is no Federal Estate Tax exposure at the first death, regardless of the amount of their assets, as long as everything passes to the surrvivor. However, Estate Tax will be due at the second death to the extent assets exceed the survivor's Applicable Exclusion Amount (discussed above). For Example, if Ricky and Lucy have assets valued at $3,000,000, the Federal Estate Tax and New Jersey Estate Tax (discussed below) due when neither is surviving could exceed $840,000. This is the case even though Ricky and Lucy each have a $1,500,000 Applicable Exclusion Amount ($3,000,000 combined).
Married couples need Wills to implement a "Bypass Trust" for the benefit of the survivor in order to preserve the decedent's (i.e., the first person to die) Applicable Exclusion Amount. A Bypass Trust is a trust established under the decedent's Will for the benefit of the survivor. Notwithstanding the survivor's enjoyment of the Bypass Trust assets, none of those assets are exposed to Estate Tax in the survivor's estate. In Ricky and Lucy's case, a Bypass Trust would have eliminated all Federal Estate Taxes, saving the family almost $660,000. However, as a result of recent changes to the New Jersey Estate Tax, fully funding the Bypass Trust would generate a New Jersey Estate tax upon Ricky's Passing.
Effective January 1, 2002, the State of New Jersey will impose an Estate Tax on assets which exceed the New Jersey "Applicable Exclusion Amount". Under old law, the New Jersey Applicable Exclusion Amount was the same as under Federal Law. However, the New Jersey Exclusion is now fixed at $675,000. Accordingly, New Jersey Estate Tax can be due even where no Federal Estate Tax is due. For example, if an individual dies in 2004 with a taxable estate of $1,500,000, there would be no Federal Estate Tax due, but the New Jersey Estate Tax would be $64,400. Moreover, the extent to which Bypass Trusts (discussed above) are funded when one spouse dies must be reassessed in light of the new law. In the example set forth above relating to Ricky and Lucy, setting aside $1,500,000 in a Bypass Trust for Lucy's benefit would be the most advantageous planning technique for Federal Estate Tax purposes, but could potentially generate a New Jersey Estate Tax of $64,400 upon Ricky's passing. Accordingly, the new law greatly affects both estate planning documents and decisions made during the estate administration process.
MYTH #4 - "I HAVE NO NEW JERSEY INHERITANCE TAX EXPOSURE"
Even if there is no Federal Estate & Gift Tax exposure or New Jersey Estate Tax exposure, there may be New Jersey Inheritance Tax exposure. This tax applies to property transferred at death to the following individuals: brothers, sisters, nephews, nieces, cousins and friends. It does not apply to property transferred to children, grandchildren, step-children and parents.
Example: Ricky dies with assets valued at $1,000,000. His Will provides that all of his property will pass to his friend, Ethel. Federal Estate Tax - $0; New Jersey Inheritance Tax - $153,000.
The New Jersey Estate Tax would be $33,200, but Ricky's estate would only be liable for the higher of the Inheritance Tax or Estate Tax. The two taxes are not combined.
MYTH #5 - "I MUST AVOID PROBATE"
In New Jersey, Probate is neither an expensive, nor a time consuming process.
"Probate" is simply the legal process by which an individual's Will is proven as a valid legal document to dispose of that individual's property. This "process" usually consists of a thirty minute meeting at the County Surrogate's office.
Once the Will is "probated", or proven as valid, the decedent's (the person that has died) property can be distributed in accordance with the directions set forth in the Will.
MYTH #6 - "TRUSTS ARE JUST FOR THE WEALTHY"
A Trust is simply a vehicle for separating the legal title and beneficial ownership of property.
A "Trustee" is designated as the person or entity who has legal title to the property placed in that person or entity's "trust".
The "Trustee" must manage the trust property in accordance with the directions set forth in the trust document, for the benefit of the trust's "beneficiary".
Even the simplest Will should contain provisions for a trust to be established to hold property for the benefit of minors.
Thursday, May 7, 2009
Estate Planning for Non-US citizens
Estate Planning for Non-US citizens
By Parag Patel Esq.
Non-US citizens (greencard holders or H-1 visaholders) are severely discriminated against by US estate tax laws.
Since estate taxes are based on the size of your estate. It is estimated that without proper planning, you will lose 15 percent to 75 percent of your estate, because the government will take it. Estate taxes alone are 49 percent of an estate worth over $3 million.
For both US citizen spouses, a $2,000,000 exemption is available. If the estate plan is properly structured, a $2 million exemption is available per couple. H-1 visaholders have a smaller $60,000 exemption and a $120,000 exemption per couple.
Furthermore, a large number of people have non-US citizen spouses (either greencard holders or H-1 visaholders) and these couples are adversely affected by discriminatory tax laws.
US citizens distribute unlimited amounts of property to their spouses (through lifetime gifts and/or transfers at death) by reason of the unlimited marital deduction. The theory behind the unlimited marital deduction is one of tax deferral, not tax avoidance. This is because the marital deduction only postpones collection of the estate tax, with the assumption that property received by a spouse under the marital deduction will ultimately be included in the gross estate of the surviving spouse.
To prevent the loss of tax revenue from a non-US citizen, who may decide to "take-the-money-and-run" back to a foreign country and beyond the reach of the IRS after the death of their spouse, the tax law denies any estate tax marital deduction for property passing to non-US citizen spouses.
Thus, there are only three choices available:
- set up a Qualified Domestic Trust (QDOT), a trust that provides the non-US citizen surviving spouse with distributions of income from the trust assets.
- to pay estate taxes on first death
- to become a US citizen
In light of all of the above, sophisticated estate planning for non-US citizens is strongly recommended and a competent tax attorney should consulted.
By Parag Patel Esq.
Non-US citizens (greencard holders or H-1 visaholders) are severely discriminated against by US estate tax laws.
Since estate taxes are based on the size of your estate. It is estimated that without proper planning, you will lose 15 percent to 75 percent of your estate, because the government will take it. Estate taxes alone are 49 percent of an estate worth over $3 million.
For both US citizen spouses, a $2,000,000 exemption is available. If the estate plan is properly structured, a $2 million exemption is available per couple. H-1 visaholders have a smaller $60,000 exemption and a $120,000 exemption per couple.
Furthermore, a large number of people have non-US citizen spouses (either greencard holders or H-1 visaholders) and these couples are adversely affected by discriminatory tax laws.
US citizens distribute unlimited amounts of property to their spouses (through lifetime gifts and/or transfers at death) by reason of the unlimited marital deduction. The theory behind the unlimited marital deduction is one of tax deferral, not tax avoidance. This is because the marital deduction only postpones collection of the estate tax, with the assumption that property received by a spouse under the marital deduction will ultimately be included in the gross estate of the surviving spouse.
To prevent the loss of tax revenue from a non-US citizen, who may decide to "take-the-money-and-run" back to a foreign country and beyond the reach of the IRS after the death of their spouse, the tax law denies any estate tax marital deduction for property passing to non-US citizen spouses.
Thus, there are only three choices available:
- set up a Qualified Domestic Trust (QDOT), a trust that provides the non-US citizen surviving spouse with distributions of income from the trust assets.
- to pay estate taxes on first death
- to become a US citizen
In light of all of the above, sophisticated estate planning for non-US citizens is strongly recommended and a competent tax attorney should consulted.
Thursday, April 23, 2009
Introduction to Estate Planning
Estate planning is concerned with the use, conservation and disposition of a person's property and wealth. This involves two elements: (1) minimizing the gift or estate tax consequences that occur when a person's property is passed to another either during life or at death; and (2) provisions for taking care of the decedent's spouse and family.
Both elements can be enormously complex, interrelated and often operate inversely. For instance, the goal of providing more for one's children or grandchildren and less for a surviving spouse may cause adverse estate tax consequences. This summary describes the fundamentals of estate planning.
I. DEFINITIONS
There are four main methods by which property is transferred at death:
1. Will
A will is a written document that takes effect at the death of the person signing it (the "testator"). A will covers all property owned by the testator at death. A state court proceeding ("probate") is instituted and the provisions of the will are implemented under supervision of the probate court. Both the tax and family estate planning objectives of the decedent can be accomplished with a will.
2. Living Trust
A living trust (sometimes called an "inter-vivos" trust) is a document that is revocable at any time by the person signing it ("grantor"). Living trusts have become quite popular as a method to avoid probate. To avoid probate, the trust must be funded; this means that title to the assets which the grantor owns personally must be actually transferred to the trust -- real property is deeded to the trust; bank accounts are switched to the trust; and stocks, bonds, partnership interests and other holdings are assigned or transferred to the trust.
NOTE : The grantor is usually the trustee and beneficiary of the trust during his or her lifetime.
Use of a Will vs. a Living Trust : Generally, with either a will or a trust the same estate tax consequences occur, and the same opportunities for tax and family planning are available. The debate over the value of each often centers around the savings of the costs incurred in a probate proceeding which typically run between 2 to 4 percent of the value of the probate estate. While a living trust which is fully funded with the grantor's assets prior to his or her death will eliminate probate, there may be advantages to probate which are also lost. In addition, the initial cost and maintenance of the living trust must be considered.
A realistic assessment of the net savings in using a living trust would be approximately 1 to 2 percent of the gross estate; an estate of $1,000,000 should save between $10,000 and $20,000 by using a living trust instead of a will.
The savings must be counter-balanced by the administrative burden of maintaining the assets in the trust over the period of one's life. There are other, non-economic advantages for using a trust which merit consideration such as privacy (a trust is not probated in open court) and upon the incapacity or death of the grantor, the trust continues to operate without court intervention.
3. Joint Tenancy
Joint tenancy is a method of holding title to property when two or more people own property together, but the last survivor will own the property outright. When a joint tenant dies, his or her interest goes automatically to the survivor; there is no probate and a will or living trust has absolutely no effect on joint tenancy property.
There may be adverse tax consequences to the joint tenant who dies first. There is a presumption that the entire fair market value of the property is part of the decedent's estate for estate tax purposes, unless the surviving joint tenant can prove (through financial records) the amount of his or her share of the payments made towards the purchase, improvement or upkeep of the jointly held property. For instance, if the surviving tenant can prove he or she made a 30 percent contribution towards the purchase, improvement or upkeep of the property, then 70 percent of the property will be included in the deceased tenant's estate for estate tax purposes.
4. Community Property
California is a community property state which means that any earnings and assets acquired during the marriage belong equally to both spouses, regardless of who actually earned the income. Property acquired before marriage, or gifts and inheritances received by one spouse during a marriage, are generally the separate property of that spouse.
Upon the death of either spouse, the community property is split equally and the surviving spouse receives his or her share of community property outright. The deceased spouse's 50 percent share of community property is part of his or her estate and is subject to his or her will or living trust.
II. The Gift and Estate Tax Aspect To Estate Planning
There are five basic tax concepts to estate planning:
1. Gift Tax
A person may make a gift of $10,000 per year per recipient ("donee") without incurring a federal gift tax. There is no longer a California gift tax. For a husband and wife, the amount is $20,000 per year, per donee. In order to qualify, the gift must be completed presently; the gift cannot be placed in trust unless the beneficiary has the right to withdraw it within a reasonable period after the gift is made. In most circumstances, it is the person making the gift ("donor") who is taxed, not the donee.
2. Estate Tax
The federal estate tax is a tax levied on the property owned by the decedent at death. The tax is paid by the estate for the privilege of passing property to the donee(s). The tax is based on the fair market value of the property at the date of death or on the alternate valuation date (discussed below). California has eliminated a separate estate tax on the decedent's property.
3. Stepped-up Basis at Death
When a person dies, all assets owned by the decedent are valued at their fair market value, usually by appraisal, by the person (the executor of the will or trustee of the living trust) filing the federal estate tax return. The determination of fair market value is generally made as of the date of death, however, there is an alternative valuation date of 6 months after death available for estates that have decreased in value.
As a corollary to this rule, the tax basis of the decedent's property is "stepped-up" to the estate tax valuation amount. Tax basis refers to the value of the property for computing gain or loss. It is usually the cost of the property plus improvements and less any depreciation.
For example, if the decedent dies owning stock which he or she purchased for $5, but has a current value of $100, the full $100 value is used to determine the estate tax. The stock then receives a stepped-up basis of $100 in the hands of the donee. No income tax will be paid by the donee on the subsequent sale of stock for $100 or less; income tax will only be paid on the sale of stock for an amount in excess of $100 and only for that excess amount.
With community property, even though 50 percent passes outright to the surviving spouse, both portions of the community property receive a stepped-up basis at the death of the first spouse. If a married couple owns a house worth $500,000 which has a tax basis of $45,000, the tax basis for the entire house (both community property shares) is stepped-up to $500,000 upon the death of the first spouse, and a later sale of the house for $560,000 will result in only $60,000 in gain. A sale of the house for the same amount prior to the death of the first spouse would have caused a $515,000 gain.
The stepped-up basis rule does not apply to certain income the decedent earned prior to his or her death. This income is considered income in respect to a decedent ("IRD"). IRD includes income from property sold prior to death, unpaid compensation and retirement benefits.
4. The Unified Estate and Gift Tax Credit and the Credit Exemption Trust
Each person is entitled to a lifetime credit of $600,000 for gift and estate taxes called the "unified credit." This credit applies to gifts made over and above the $10,000 annual gift tax exclusion discussed previously. If a person makes an annual gift to a single donee of $50,000, then the additional $40,000 - which does not qualify for the annual gift tax exclusion - will reduce the unified credit from $600,000 to $560,000. The unified credit is phased out for estates over $10 million.
The unified credit may be used for property left to any donee, either outright or in trust. In a typical estate plan the unified credit amount is used by creating a trust for that amount for the surviving spouse during his or her lifetime. Upon the surviving spouse's death, the children would then become the beneficiaries of the trust. This trust is sometimes called an "exemption trust" or a "by-pass" trust since it is exempt from estate taxes and by-passes the surviving spouse's estate. The exemption trust may provide the surviving spouse with the following rights during his or her life without causing the trust to become part of the surviving spouse's estate for estate tax purposes: (1) all the trust's net income may be payable to the surviving spouse; (2) the trust's principal may be applied to the surviving spouse for his or her health, support, maintenance and education ("ascertainable standards"); and (3) the surviving spouse may have the noncumulative right to withdraw the greater of 5 percent or $5,000 of trust principal per calendar year for any reason ("5&5 power").
The unified credit plays a major role in estate planning because there is no estate tax for estates that are less than or equal to the unified credit. In most circumstances, there is no estate tax on estates of $600,000 or less.
5. The Marital Deduction and the Marital Deduction Q-TIP Trust
The decedent's gross estate is entitled to deduct all amounts passing to a surviving spouse which qualify for the marital deduction. The marital deduction can become extremely complicated, but it represents the most important deduction available to married couples. Property which passes to the surviving spouse under the marital deduction escapes taxation on the death of the first spouse, but that property then becomes part of the surviving spouse's estate for estate tax purposes. Oftentimes, because the surviving spouse is in a higher tax bracket, property passing under a marital deduction is taxed at a higher rate at the death of the surviving spouse.
The marital deduction applies to property that is left: (1) outright to a spouse; (2) in trust in which the spouse has the right to withdraw any or all of the property during his or her lifetime; and (3) property which is left in trust for the spouse's life under a Q-TIP ("qualified terminable interest property") trust.
A Q-TIP trust is an exception to the general rule that to qualify for a marital deduction, property must be left outright to the spouse or in trust in which all the principal may be withdrawn by the spouse. A Q-TIP trust may qualify for a marital deduction if the spouse is entitled to receive all the trust's income at least annually and during the spouse's lifetime, no person, including the spouse, is permitted to appoint any trust property to anyone other than the spouse. The person filing the estate tax return must properly elect to take a marital deduction for the Q-TIP trust.
The advantage of the Q-TIP trust is that the desires of the decedent spouse will control the ultimate disposition of the trust's assets, and the decedent's estate retains the benefit of the marital deduction. On the death of the surviving spouse, the assets in the Q-TIP trust are taxed in the surviving spouse's estate, but any increase in estate tax resulting from this inclusion is generally taken directly from the Q-TIP assets, not from the surviving spouse's other assets.
By prudently combining the unified credit with the marital deduction, the estate of the first spouse will pay no estate tax. The surviving spouse also has a unified credit that can be applied to any estate tax owing at his or her death. Therefore, for estates under $1,200,000 (2 x $600,000), assuming no increase in value during the time between the death of the first spouse and second spouse and assuming no reduction of the unified credit for either spouse, a properly structured estate plan eliminates taxation on both spouses' estates through the maximum use of the unified credit.
III. Using the Unified Credit in Estate Planning
Assume that:
1. a married couple has all their assets as community property;
2. the value of that community property is $1,000,000;
3. the husband is the first to die and the wife lives another 8 years;
4. the couple has two children; and
5. no gifts were ever made that exceeded the annual gift tax exclusion.
Upon the death of the husband, the husband's estate (50% ofthe community property) is worth $500,000 and his wife retains her 50% share of the community property ($500,000). The husband's estate will pay no estate tax since his unified credit is worth $600,000.
Example 1 : If the husband leaves all his property outright to this wife, then his wife will have an estate totaling $1,000,000. On the death of his wife, assuming no growth in her estate, she will now have a $1,000,000 estate subject to estate tax, but a unified credit worth only $600,000. This means her estate will be subject to estate tax on the balance of $400,000. The tax will be $153,000 according to the current tax rate schedule.
Example 2 : Same facts as Example 1 except husband left his property to an exemption trust, which permitted his wife the right to receive all the income from the trust during her life and certain other powers (such as the power to invade the principal under an ascertainable standard and the 5&5 power discussed previously). Upon her death the trust assets could then be divided between the couple's two children and the exemption trust would not be part of the wife's estate for estate tax purposes. Upon her death, her estate would be worth $500,000 and her unified credit worth $600,000 would eliminate any estate taxes.
If we assume a 4% growth rate during the 8 years she outlives her husband, then under Example 1, her estate will appreciate from $1,000,000 to $1,368,600 and the estate tax will be $255,000.
Under Example 2, her estate consists of her share of community property valued at $500,000 which will appreciate to $684,285 and the estate tax will be $19,400, a reduction of $236,150.
IV. Non-tax Aspects of Estate Planning
Couples with minor children need to carefully plan their estates, although the focus is usually on taking care of the children rather than saving estate taxes. The major assets are usually life insurance and the family home. In case of the deaths of both parents, provisions for the guardian(s) for the children and trustee(s) for the property must be carefully considered. While the funding of these trusts might follow the exemption trust and marital deduction trust pattern, the exemption trust is geared for the care and support of the children.
Also, decisions must be made such as: Should the trustee(s) save and conserve the trust estate for the college education of the children? At what ages should the children receive the trust principal and what amounts and when? All at 21? Half at 25 and the remaining principal at 35? What happens if the children die without having any children? Who then receives the property? The decedent's family, a specified charity or charities?
A carefully planned estate will cover a variety of remote contingencies, provide for the continuing personal and financial care and support of the decedent's spouse and family, and reduce or eliminate estate taxes.
Both elements can be enormously complex, interrelated and often operate inversely. For instance, the goal of providing more for one's children or grandchildren and less for a surviving spouse may cause adverse estate tax consequences. This summary describes the fundamentals of estate planning.
I. DEFINITIONS
There are four main methods by which property is transferred at death:
1. Will
A will is a written document that takes effect at the death of the person signing it (the "testator"). A will covers all property owned by the testator at death. A state court proceeding ("probate") is instituted and the provisions of the will are implemented under supervision of the probate court. Both the tax and family estate planning objectives of the decedent can be accomplished with a will.
2. Living Trust
A living trust (sometimes called an "inter-vivos" trust) is a document that is revocable at any time by the person signing it ("grantor"). Living trusts have become quite popular as a method to avoid probate. To avoid probate, the trust must be funded; this means that title to the assets which the grantor owns personally must be actually transferred to the trust -- real property is deeded to the trust; bank accounts are switched to the trust; and stocks, bonds, partnership interests and other holdings are assigned or transferred to the trust.
NOTE : The grantor is usually the trustee and beneficiary of the trust during his or her lifetime.
Use of a Will vs. a Living Trust : Generally, with either a will or a trust the same estate tax consequences occur, and the same opportunities for tax and family planning are available. The debate over the value of each often centers around the savings of the costs incurred in a probate proceeding which typically run between 2 to 4 percent of the value of the probate estate. While a living trust which is fully funded with the grantor's assets prior to his or her death will eliminate probate, there may be advantages to probate which are also lost. In addition, the initial cost and maintenance of the living trust must be considered.
A realistic assessment of the net savings in using a living trust would be approximately 1 to 2 percent of the gross estate; an estate of $1,000,000 should save between $10,000 and $20,000 by using a living trust instead of a will.
The savings must be counter-balanced by the administrative burden of maintaining the assets in the trust over the period of one's life. There are other, non-economic advantages for using a trust which merit consideration such as privacy (a trust is not probated in open court) and upon the incapacity or death of the grantor, the trust continues to operate without court intervention.
3. Joint Tenancy
Joint tenancy is a method of holding title to property when two or more people own property together, but the last survivor will own the property outright. When a joint tenant dies, his or her interest goes automatically to the survivor; there is no probate and a will or living trust has absolutely no effect on joint tenancy property.
There may be adverse tax consequences to the joint tenant who dies first. There is a presumption that the entire fair market value of the property is part of the decedent's estate for estate tax purposes, unless the surviving joint tenant can prove (through financial records) the amount of his or her share of the payments made towards the purchase, improvement or upkeep of the jointly held property. For instance, if the surviving tenant can prove he or she made a 30 percent contribution towards the purchase, improvement or upkeep of the property, then 70 percent of the property will be included in the deceased tenant's estate for estate tax purposes.
4. Community Property
California is a community property state which means that any earnings and assets acquired during the marriage belong equally to both spouses, regardless of who actually earned the income. Property acquired before marriage, or gifts and inheritances received by one spouse during a marriage, are generally the separate property of that spouse.
Upon the death of either spouse, the community property is split equally and the surviving spouse receives his or her share of community property outright. The deceased spouse's 50 percent share of community property is part of his or her estate and is subject to his or her will or living trust.
II. The Gift and Estate Tax Aspect To Estate Planning
There are five basic tax concepts to estate planning:
1. Gift Tax
A person may make a gift of $10,000 per year per recipient ("donee") without incurring a federal gift tax. There is no longer a California gift tax. For a husband and wife, the amount is $20,000 per year, per donee. In order to qualify, the gift must be completed presently; the gift cannot be placed in trust unless the beneficiary has the right to withdraw it within a reasonable period after the gift is made. In most circumstances, it is the person making the gift ("donor") who is taxed, not the donee.
2. Estate Tax
The federal estate tax is a tax levied on the property owned by the decedent at death. The tax is paid by the estate for the privilege of passing property to the donee(s). The tax is based on the fair market value of the property at the date of death or on the alternate valuation date (discussed below). California has eliminated a separate estate tax on the decedent's property.
3. Stepped-up Basis at Death
When a person dies, all assets owned by the decedent are valued at their fair market value, usually by appraisal, by the person (the executor of the will or trustee of the living trust) filing the federal estate tax return. The determination of fair market value is generally made as of the date of death, however, there is an alternative valuation date of 6 months after death available for estates that have decreased in value.
As a corollary to this rule, the tax basis of the decedent's property is "stepped-up" to the estate tax valuation amount. Tax basis refers to the value of the property for computing gain or loss. It is usually the cost of the property plus improvements and less any depreciation.
For example, if the decedent dies owning stock which he or she purchased for $5, but has a current value of $100, the full $100 value is used to determine the estate tax. The stock then receives a stepped-up basis of $100 in the hands of the donee. No income tax will be paid by the donee on the subsequent sale of stock for $100 or less; income tax will only be paid on the sale of stock for an amount in excess of $100 and only for that excess amount.
With community property, even though 50 percent passes outright to the surviving spouse, both portions of the community property receive a stepped-up basis at the death of the first spouse. If a married couple owns a house worth $500,000 which has a tax basis of $45,000, the tax basis for the entire house (both community property shares) is stepped-up to $500,000 upon the death of the first spouse, and a later sale of the house for $560,000 will result in only $60,000 in gain. A sale of the house for the same amount prior to the death of the first spouse would have caused a $515,000 gain.
The stepped-up basis rule does not apply to certain income the decedent earned prior to his or her death. This income is considered income in respect to a decedent ("IRD"). IRD includes income from property sold prior to death, unpaid compensation and retirement benefits.
4. The Unified Estate and Gift Tax Credit and the Credit Exemption Trust
Each person is entitled to a lifetime credit of $600,000 for gift and estate taxes called the "unified credit." This credit applies to gifts made over and above the $10,000 annual gift tax exclusion discussed previously. If a person makes an annual gift to a single donee of $50,000, then the additional $40,000 - which does not qualify for the annual gift tax exclusion - will reduce the unified credit from $600,000 to $560,000. The unified credit is phased out for estates over $10 million.
The unified credit may be used for property left to any donee, either outright or in trust. In a typical estate plan the unified credit amount is used by creating a trust for that amount for the surviving spouse during his or her lifetime. Upon the surviving spouse's death, the children would then become the beneficiaries of the trust. This trust is sometimes called an "exemption trust" or a "by-pass" trust since it is exempt from estate taxes and by-passes the surviving spouse's estate. The exemption trust may provide the surviving spouse with the following rights during his or her life without causing the trust to become part of the surviving spouse's estate for estate tax purposes: (1) all the trust's net income may be payable to the surviving spouse; (2) the trust's principal may be applied to the surviving spouse for his or her health, support, maintenance and education ("ascertainable standards"); and (3) the surviving spouse may have the noncumulative right to withdraw the greater of 5 percent or $5,000 of trust principal per calendar year for any reason ("5&5 power").
The unified credit plays a major role in estate planning because there is no estate tax for estates that are less than or equal to the unified credit. In most circumstances, there is no estate tax on estates of $600,000 or less.
5. The Marital Deduction and the Marital Deduction Q-TIP Trust
The decedent's gross estate is entitled to deduct all amounts passing to a surviving spouse which qualify for the marital deduction. The marital deduction can become extremely complicated, but it represents the most important deduction available to married couples. Property which passes to the surviving spouse under the marital deduction escapes taxation on the death of the first spouse, but that property then becomes part of the surviving spouse's estate for estate tax purposes. Oftentimes, because the surviving spouse is in a higher tax bracket, property passing under a marital deduction is taxed at a higher rate at the death of the surviving spouse.
The marital deduction applies to property that is left: (1) outright to a spouse; (2) in trust in which the spouse has the right to withdraw any or all of the property during his or her lifetime; and (3) property which is left in trust for the spouse's life under a Q-TIP ("qualified terminable interest property") trust.
A Q-TIP trust is an exception to the general rule that to qualify for a marital deduction, property must be left outright to the spouse or in trust in which all the principal may be withdrawn by the spouse. A Q-TIP trust may qualify for a marital deduction if the spouse is entitled to receive all the trust's income at least annually and during the spouse's lifetime, no person, including the spouse, is permitted to appoint any trust property to anyone other than the spouse. The person filing the estate tax return must properly elect to take a marital deduction for the Q-TIP trust.
The advantage of the Q-TIP trust is that the desires of the decedent spouse will control the ultimate disposition of the trust's assets, and the decedent's estate retains the benefit of the marital deduction. On the death of the surviving spouse, the assets in the Q-TIP trust are taxed in the surviving spouse's estate, but any increase in estate tax resulting from this inclusion is generally taken directly from the Q-TIP assets, not from the surviving spouse's other assets.
By prudently combining the unified credit with the marital deduction, the estate of the first spouse will pay no estate tax. The surviving spouse also has a unified credit that can be applied to any estate tax owing at his or her death. Therefore, for estates under $1,200,000 (2 x $600,000), assuming no increase in value during the time between the death of the first spouse and second spouse and assuming no reduction of the unified credit for either spouse, a properly structured estate plan eliminates taxation on both spouses' estates through the maximum use of the unified credit.
III. Using the Unified Credit in Estate Planning
Assume that:
1. a married couple has all their assets as community property;
2. the value of that community property is $1,000,000;
3. the husband is the first to die and the wife lives another 8 years;
4. the couple has two children; and
5. no gifts were ever made that exceeded the annual gift tax exclusion.
Upon the death of the husband, the husband's estate (50% ofthe community property) is worth $500,000 and his wife retains her 50% share of the community property ($500,000). The husband's estate will pay no estate tax since his unified credit is worth $600,000.
Example 1 : If the husband leaves all his property outright to this wife, then his wife will have an estate totaling $1,000,000. On the death of his wife, assuming no growth in her estate, she will now have a $1,000,000 estate subject to estate tax, but a unified credit worth only $600,000. This means her estate will be subject to estate tax on the balance of $400,000. The tax will be $153,000 according to the current tax rate schedule.
Example 2 : Same facts as Example 1 except husband left his property to an exemption trust, which permitted his wife the right to receive all the income from the trust during her life and certain other powers (such as the power to invade the principal under an ascertainable standard and the 5&5 power discussed previously). Upon her death the trust assets could then be divided between the couple's two children and the exemption trust would not be part of the wife's estate for estate tax purposes. Upon her death, her estate would be worth $500,000 and her unified credit worth $600,000 would eliminate any estate taxes.
If we assume a 4% growth rate during the 8 years she outlives her husband, then under Example 1, her estate will appreciate from $1,000,000 to $1,368,600 and the estate tax will be $255,000.
Under Example 2, her estate consists of her share of community property valued at $500,000 which will appreciate to $684,285 and the estate tax will be $19,400, a reduction of $236,150.
IV. Non-tax Aspects of Estate Planning
Couples with minor children need to carefully plan their estates, although the focus is usually on taking care of the children rather than saving estate taxes. The major assets are usually life insurance and the family home. In case of the deaths of both parents, provisions for the guardian(s) for the children and trustee(s) for the property must be carefully considered. While the funding of these trusts might follow the exemption trust and marital deduction trust pattern, the exemption trust is geared for the care and support of the children.
Also, decisions must be made such as: Should the trustee(s) save and conserve the trust estate for the college education of the children? At what ages should the children receive the trust principal and what amounts and when? All at 21? Half at 25 and the remaining principal at 35? What happens if the children die without having any children? Who then receives the property? The decedent's family, a specified charity or charities?
A carefully planned estate will cover a variety of remote contingencies, provide for the continuing personal and financial care and support of the decedent's spouse and family, and reduce or eliminate estate taxes.
Friday, April 17, 2009
ESTATE PLANNING: MORE THAN A WILL
By Parag P. Patel, Esq.
During our lifetime, most of us strive to create and build upon our net worth. We generate savings, purchase a home, and eventually invest in stocks, bonds, mutual funds, IRAs and retirement plans. Unfortunately, most of us risk losing an unnecessarily large amount of these assets by failing to plan to protect them.
Recent surveys have revealed that over 40% of our population does not have a will. For those individuals, their death often creates a scenario whereby their family must needlessly waste money to petition the court for an individual to administer the estate. In many instances, this insult is compounded by the assets being subject to taxes, which could easily have been avoided. Thus, an integral part of anyone's financial planning must be an estate plan.
Traditionally, an estate plan was simply a will. However, with the growing medical needs of an aging population, as well as the ever-present threat of the Internal Revenue Service, prudent estate planning requires additional protections for all of us. Even the best written will has little value if one's assets are depleted in later years by health care costs which can be mitigated or borne by someone else.
Any prudent estate plan should address four questions:
(1) Where do I want my money to go after I am dead?
(2) How can I minimize any taxes as a result of my death?
(3) How can I protect my estate and myself if I become disabled?
(4) Do I want my life to be extended by life support even though a medical event has left me in critical condition without any hope of recovery?
The basic documents, which are necessary to answer these questions, are a will, living will and power of attorney. A will declares who shall inherit an individual's assets (the beneficiaries) and who shall be responsible for distributing them to such beneficiaries (the executor). For young parents, a will can also be used to appoint a guardian for their children and a trustee to manage a child's money until they are old enough to handle it themselves.
Often, individuals wish to care for their spouse first, then their children. Often, this intention is reflected in a will. If you die without a will, though, your spouse is only entitled to the first $50,000.00 outright. In New Jersey, he or she must split the rest of your assets with your children, no matter how young or old they are. If you have no children, your parents step into their place.
Even if you have a will, your assets are not completely protected. It is necessary to execute a Power of Attorney to provide to appoint someone to care for you and your assets if you are disabled. Individuals, who become disabled mentally and do not have a power of attorney, can only be protected by an expensive and humiliating procedure known as a guardianship, whereby they are judged to be "incompetent" in the public forum of a court.
Finally, a living will should be executed to announce your intentions in the event an accident, stroke or other serious medical event leaves you brain dead or physically depleted of any possible quality of life. A living will protects your assets from being used for unnecessary and costly life support. Without a living will, there is no authority, outside of a court proceeding, to allow a doctor to discontinue this treatment.
During our lifetime, most of us strive to create and build upon our net worth. We generate savings, purchase a home, and eventually invest in stocks, bonds, mutual funds, IRAs and retirement plans. Unfortunately, most of us risk losing an unnecessarily large amount of these assets by failing to plan to protect them.
Recent surveys have revealed that over 40% of our population does not have a will. For those individuals, their death often creates a scenario whereby their family must needlessly waste money to petition the court for an individual to administer the estate. In many instances, this insult is compounded by the assets being subject to taxes, which could easily have been avoided. Thus, an integral part of anyone's financial planning must be an estate plan.
Traditionally, an estate plan was simply a will. However, with the growing medical needs of an aging population, as well as the ever-present threat of the Internal Revenue Service, prudent estate planning requires additional protections for all of us. Even the best written will has little value if one's assets are depleted in later years by health care costs which can be mitigated or borne by someone else.
Any prudent estate plan should address four questions:
(1) Where do I want my money to go after I am dead?
(2) How can I minimize any taxes as a result of my death?
(3) How can I protect my estate and myself if I become disabled?
(4) Do I want my life to be extended by life support even though a medical event has left me in critical condition without any hope of recovery?
The basic documents, which are necessary to answer these questions, are a will, living will and power of attorney. A will declares who shall inherit an individual's assets (the beneficiaries) and who shall be responsible for distributing them to such beneficiaries (the executor). For young parents, a will can also be used to appoint a guardian for their children and a trustee to manage a child's money until they are old enough to handle it themselves.
Often, individuals wish to care for their spouse first, then their children. Often, this intention is reflected in a will. If you die without a will, though, your spouse is only entitled to the first $50,000.00 outright. In New Jersey, he or she must split the rest of your assets with your children, no matter how young or old they are. If you have no children, your parents step into their place.
Even if you have a will, your assets are not completely protected. It is necessary to execute a Power of Attorney to provide to appoint someone to care for you and your assets if you are disabled. Individuals, who become disabled mentally and do not have a power of attorney, can only be protected by an expensive and humiliating procedure known as a guardianship, whereby they are judged to be "incompetent" in the public forum of a court.
Finally, a living will should be executed to announce your intentions in the event an accident, stroke or other serious medical event leaves you brain dead or physically depleted of any possible quality of life. A living will protects your assets from being used for unnecessary and costly life support. Without a living will, there is no authority, outside of a court proceeding, to allow a doctor to discontinue this treatment.
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