How Do I Sell a Home in an Irrevocable Trust?
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How Do I Sell a Home in an Irrevocable Trust?

A trustee who sells a home in irrevocable trust for a parent who died should know that generally, assets transferred to an irrevocable trust will be deemed a completed gift and will not be included in an estate for estate tax purposes.

Lehigh Valley Live’s recent article entitled “What happens to tax on a home sold from a trust?” explains that this means there wouldn’t be a step-up in basis to the fair market value upon the decedent’s death.

Remember that an irrevocable trust is a type of trust in which its terms can’t be modified, amended, or terminated without the permission of the grantor’s named beneficiary or beneficiaries.

Irrevocable trusts have tax-shelter benefits that revocable trusts to don’t.

However, an irrevocable trust can be created so that the settlor (the creator) of the trust keeps certain rights and powers, so that gifts to the trust are incomplete.

In that instance, the assets are included in the settlor’s estate upon death and obtain a step-up in basis upon the decedent’s death.

If the trust sells the asset in the trust, the trust may need to file Form 1041, U.S. Income Tax Return for Estates and Trusts, and the trust may be required to pay a tax.

If the trust distributes any income to the beneficiaries in the same tax year it receives that income, the income is passed through to the beneficiaries, and the beneficiaries must report it on the beneficiaries’ individual tax returns (Form 1040) and pay any tax due.

It’s generally a good idea to report and pay tax at the individual rate instead of at the trust or estate level.

That’s because the trust or estate will begin to pay tax at the highest rate at only $13,150. In comparison, an individual doesn’t pay tax at the highest rate until his or her income exceeds over $440,000.

Note that an irrevocable trust is a more complex legal arrangement than a revocable trust. As a result, there might be current income tax and future estate tax implications when using this type of trust. It’s wise to seek the assistance of an experienced estate planning attorney.

Reference: Lehigh Valley Live (Aug. 16, 2021) “What happens to tax on a home sold from a trust?”

What Does Tax Proposal Mean for Estate Planning?

The president’s tax plan proposes to nearly double the top tax rate on capital gains and eliminate a tax benefit on appreciated assets, known as the “step-up in basis.”

CNBC’s recent article entitled “Wealthy may face up to 61% tax rate on inherited wealth under Biden plan” reports that the combined tax rate would be the highest in nearly a century.

Some more well-off families could face combined tax rates of as much as 61% on inherited wealth under President Biden’s tax plan.

It is not known if President Biden’s plan can get through Congress, even with changes. Many moderate Democrats are likely to resist his proposal to raise the capital gains rate to 39.6%, as well as the plan to eliminate the step-up. Moreover, just a small number of the wealthiest taxpayers would ever see a rate of 61%. Most of us others would try to avoid this hike with tax and estate planning.

According to analysis by the Tax Foundation, families who own a business or a large amount of stock and want to transfer the assets to heirs could see a dramatic tax change.

For instance, you are an entrepreneur who started a business decades ago, that is now worth $100 million. Under the current tax law, the business would pass to the family without a capital gains tax—the value of the business would be “stepped-up,” or adjusted to its current value and the heirs would only pay a capital gain, if they later sold at a higher valuation. However, under President Biden’s plan, the family would immediately owe a capital gains tax of $42.96 million upon death (capital gains rate of 39.6%, plus the net investment income tax of 3.8%, minus the $1 million exemption).

If the estate tax remains unchanged, the family would also have an estate tax of 40% on the $57.04 million of remaining value of the assets. Including exemptions, the estate tax would amount to $18.13 million.

The combined estate tax and capital gains tax liability would total $61.10 million, reflecting a combined effective tax rate of just over 61% on the original $100 million asset. The rate rises, when including potential state capital gains and estate taxes.

However, experts say that if the step-up is eliminated, Congress would likely eliminate or overhaul the estate tax.

Reference: CNBC (May 3, 2021) “Wealthy may face up to 61% tax rate on inherited wealth under Biden plan”

What Is the Tax-Law Exception for 529 College Plans in 2021?

Grandparents might use this tactic to dramatically reduce their estate, without using any of their lifetime exemption if they meet some conditions, explains Financial Advisor’s recent article entitled “Tax Break Adds Perk To 529 College Plans.” That’s five years’ worth of the standard $15,000 annual exclusion that normally applies to 2021 gifts. Your spouse can also make the same gift.

You could give a five-year gift of $150,000 per couple and report it on a gift tax return. This uses none of your exemption. You should fund the educations of grandchildren or children, while they are young. If they end up being academic stars or athletes, scholarships can be adjusted against the 529 plan. If they choose not to go to college, you can select a new beneficiary. It is a smart way to frontload the 529 and take advantage of the tax-free growth.

Income earned in any qualified distributions from a 529 are typically not taxed, except under some states’ special rules. Non-qualified distributions are taxed and subject to a 10% penalty. Note that a 529 withdrawal to pay for health insurance or other medical expenses is a non-qualified distribution.

Many people get befuddled by filing a gift tax return. They think a tax is due. However, in fact, it is just a letter to the IRS informing them that you are using some of your lifetime exemption now.

The Tax Cuts and Jobs Act of 2017 also permitted 529 money to be used for tuition for grades K-12. Therefore, frontloading the contribution makes for potentially faster accumulation of assets in the plan, which could be helpful due to the shorter timeframe between funding and use.

There are some conditions to note in the current political climate. If a donor funds a plan with $75,000 for the benefit of an individual, that donor could not give that person any additional gifts over the five years without using their lifetime exemption (now $11.7 million per person). If that exemption amount were to be reduced, it is possible that a person will have used up their lifetime exemption and would not be able to give additional gifts above the annual exclusion without paying gift tax.

This tax break comes with another catch: if the donor dies within the five years, the balance reverts back to the deceased donor’s estate.

You should know that the downside is limited investment options. Plans are generally conservative, so you do not lose your principal. There also may be high fees and costs. The plans often impede students who apply for financial aid, though not as much as some other investment holdings.

Reference: Financial Advisor (May 3, 2021) “Tax Break Adds Perk To 529 College Plans”

How to Avoid Probate

Avoiding probate and minimizing estate taxes are sound estate planning goals, but they shouldn’t be the only focus of an estate plan.

Nj.com’s recent article entitled “How can we avoid probate and avoid taxes for our children?” says that proper estate planning is a much broader discussion you should have with a qualified estate attorney. However, the article offers some topics to discuss with an attorney, who can review all the specifics of your situation.

Probate is the legal process for settling the debts, taxes and last expenses of a deceased person and distributing the remaining assets to his or her heirs. The costs and time needed to settle an estate can be burdensome in some states. However, steps can be taken to significantly limit probate.

Without any special planning, there are a few types of assets that can be transferred outside of probate. Items owned jointly with rights of survivorship (JTWROS) automatically become the sole property of the survivor at the first joint owner’s death. This property doesn’t go through probate.

Accounts with beneficiary designations, like retirement accounts, annuities, and life insurance policies also pass outside probate. There is a payable on death (POD) feature that provides for a beneficiary designation on non-retirement accounts (like a bank account), so POD accounts can also be transferred outside of probate.

You can also create a living trust and transfer assets into the trust during your lifetime to avoid probate. Since the trust document dictates the way in which assets are distributed upon the death of the grantor rather than the will, probate is not needed here either.

In addition, ancillary probate is a second, simultaneous process that is needed when real estate is owned in a state outside the decedent’s state of residence.

Placing out-of-state real estate in a living trust is a useful way to avoid ancillary probate. You can also place the out-of-state real estate in a Limited Liability Company (LLC), so the estate owns an interest in an LLC rather than real property. That way, the entire probate process can be handled in the decedent’s state of residence. However, talk to an experienced estate planning attorney to review which of these options — or perhaps another option — would be best for your unique situation and goals.

Other types of trusts, whether created during your lifetime or at your death, can provide creditor protection and ensure that an inheritance stays in the family, as well as help minimize estate taxes.

Under current law, federal estate tax is only due if your estate is worth more than $11.7 million (double that if you are married). A few states also have an estate tax. Other states also have an inheritance tax, but in many instances it does not apply to amounts left to the decedent’s closest relatives, including their children.

Reference: nj.com (March 24, 2021) “How can we avoid probate and avoid taxes for our children?”

Does Your State Have an Estate or Inheritance Tax?

Did you know that Hawaii and the State of Washington have the highest estate tax rates in the nation at 20%? There are 8 states and DC that are next with a top rate of 16%. Massachusetts and Oregon have the lowest exemption levels at $1 million, and Connecticut has the highest exemption level at $7.1 million.

The Tax Foundation’s recent article entitled “Does Your State Have an Estate or Inheritance Tax?” says that of the six states with inheritance taxes, Nebraska has the highest top rate at 18%, and Maryland has the lowest top rate at 10%. All six of these states exempt spouses, and some fully or partially exempt immediate relatives.

Estate taxes are paid by the decedent’s estate, prior to asset distribution to the heirs. The tax is imposed on the overall value of the estate. Inheritance taxes are due from the recipient of a bequest and are based on the amount distributed to each beneficiary.

Most states have been steering away from estate or inheritance taxes or have upped their exemption levels because estate taxes without the federal exemption hurt a state’s competitiveness. Delaware repealed its estate tax at the start of 2018, and New Jersey finished its phase out of its estate tax at the same time. The Garden State now only imposes an inheritance tax.

Connecticut still is phasing in an increase to its estate exemption. They plan to mirror the federal exemption by 2023. However, as the exemption increases, the minimum tax rate also increases. In 2020, rates started at 10%, while the lowest rate in 2021 is 10.8%. Connecticut’s estate tax will have a flat rate of 12% by 2023.

In Vermont, they’re still phasing in an estate exemption increase. They are upping the exemption to $5 million on January 1, compared to $4.5 million in 2020.

DC has gone in the opposite direction. The District has dropped its estate tax exemption from $5.8 million to $4 million in 2021, but at the same time decreased its bottom rate from 12% to 11.2%.

Remember that the Tax Cuts and Jobs Act of 2017 raised the estate tax exclusion from $5.49 million to $11.2 million per person. This expires December 31, 2025, unless reduced sooner!

Talk to an experienced estate planning attorney about estate and inheritance taxes, and see if you need to know about either, in your state.

Reference: The Tax Foundation (Feb. 24, 2021) “Does Your State Have an Estate or Inheritance Tax?”

How Does the Generation-Skipping Transfer Tax Work in Estate Planning?

The generation-skipping transfer tax, also called the generation-skipping tax, can apply when a grandparent leaves assets to a grandchild—skipping over their parents in the line of inheritance. It can also be triggered, when leaving assets to someone who’s at least 37½ years younger than you. If you are thinking about “skipping” any of your heirs when passing on assets, it is important to know what that may mean tax-wise and how to fill out the requisite form. An experienced estate planning attorney can help you and counsel you on the best way to pass along your estate to your beneficiaries.

KAKE.com’s recent article entitled “What Is the Generation-Skipping Transfer Tax?” says the tax code imposes both gift and estate taxes on transfers of assets above certain limits. For 2020, you can exclude gifts of up to $15,000 per person from the gift tax, with the limit twice as much for married couples who file a joint return. Estate tax applies to estates larger than $11,580,000 for 2020, increased to $11,700,000 in 2021.

The gift tax rate can be as high as 40%, and the estate tax is also 40% at the top end. The IRS uses the generation-skipping transfer tax to collect its portion of any wealth that is transferred across families, when not passed directly from parent to child. Assets subject to the generation-skipping tax are taxed at a flat 40% rate.

Note that the GSTT can apply to both direct transfers of assets to your beneficiaries and to assets passing through a trust. A trust can be subject to the GSTT, if all trust beneficiaries are considered to be skip persons who have a direct interest in the trust.

The generation-skipping tax is a separate tax from the estate tax, but it applies alongside it. Similar to the estate tax, this tax begins when an estate’s value exceeds the annual exemption limits. The 40% GSTT would be applied to any transfers of assets above the exempt amount, in addition to the regular 40% estate tax.

That is the way the IRS gets its money on wealth, as it moves from one person to another. If you passed your estate to your child, who then passes it to their child then no GSTT would apply. The IRS would just collect estate taxes from each successive generation. However, if you skip your child and leave assets to your grandchild, it eliminates a link from the taxation chain, and the GSTT lets the IRS replace that link.

You can use your lifetime estate and gift tax exemption limits, which can help to offset how much is owed for the generation-skipping tax. However, any unused portion of the exemption counted toward the generation-skipping tax is lost when you pass away.

If you’d like to minimize estate and gift taxes as much as possible, there are several options. Your experienced estate planning attorney might suggest giving assets to your grandchildren or another generation-skipping person annually, rather than at the end of your life. That’s because you can give up to $15,000 per person each year without incurring gift tax, or up to $30,000 per person if you’re married and file a joint return. Just keep the lifetime exemption limits in mind when planning gifts.

You could also make payments on behalf of a beneficiary to avoid tax. For instance, to help your granddaughter with college costs, any direct payments you make to the school to cover tuition would generally be tax-free. The same is true for direct payments made to healthcare providers, if you’re paying medical expenses on behalf of another.

Another option may be a generation-skipping trust that lets you transfer assets to the trust and pay estate taxes at the time of the transfer. The assets you put into the trust must stay there during the skipped generation’s lifetime. Once they die, the trust assets can be passed on tax-free to the next generation.

There’s also a dynasty trust. This trust can let you pass assets to future generations without triggering estate, gift, or generation-skipping taxes. However, they are meant to be long-term trusts. You can name your children, grandchildren, great-grandchildren and subsequent generations as beneficiaries and the transfer of assets to the trust is irrevocable. Therefore, when you place the assets in the trust, you will not be able to take them back out again. You can see why it’s so important to understand the implications, before creating this type of trust.

The generation-skipping tax can make a big impact on the assets you’re able to leave to heirs. If you’re considering using this type of trust to pass on assets or you’re interested in exploring other ways to transfer assets while minimizing taxes, speak to an experienced estate planning attorney.

Reference: KAKE.com (Feb. 6, 2021) “What Is the Generation-Skipping Transfer Tax?”

What Do I Need to Know about Gift-Giving with the Biden Administration?

After the election, many people are wondering what will happen to the federal gift and estate tax exemption. Kiplinger’s recent article entitled “Making a Gift This Year? Some Key Questions to Consider,” explains that the Tax Cuts and Jobs Act dramatically upped the lifetime gift, estate and generation-skipping tax exemption to $11.58 million per individual ($23.16 million per couple). This exemption, however, is set to expire at the end of 2025. Some observers say that Democrats could significantly shorten the time frame, ending it as early as 2021.

Some families may face the possibility of losing an opportunity to transfer wealth out of their estate and save on future estate taxes sooner than anticipated. No matter when the gift is made, here are some important issues to consider.

Can I afford to give? For couples who have a significant taxable estate, gifting assets and removing future appreciation could result in some substantial tax savings for their heirs. However, just because someone has the means to make a large gift, doesn’t necessarily mean it’s the right move. Some are so eager to take advantage of the tax benefits that they underestimate their own cost of living down the road. Look at whether the grantor has enough assets to maintain their desired lifestyle. Then, think about what can be transferred without negatively impacting goals and lifestyle choices.

How Do I Structure a Gift? There are many ways of distributing assets. Remember that any transfer is gift tax-free up to the annual exclusion amount ($15,000 per person per donor for 2020). Any gift over this will count against the donor’s lifetime exemption amount. Once that’s exhausted, the gift will be subject to gift tax.

Outright Cash Gifts. This may be the most uncomplicated way of gifting, but for families with significant wealth, this could have some drawbacks. Some recipients may not be prepared to manage money, and it may demotivate them to live off their inheritance rather than becoming productive on their own.

Trusts. These are frequently used for bigger gifts to provide for beneficiaries, while using some restrictions by the grantor to protect the assets from being squandered. One plan is to distribute the trust assets in stages, when the beneficiary reaches a certain age or achieves a specific goal. Another option is to leave assets in a discretionary lifetime trust, which would maintain the assets in a trust for the beneficiary’s entire lifetime. Drafted properly by an experienced estate planning attorney, this offers a high level of protection from divorcing spouses, lawsuits, bad decisions and outside influences. It also lets grantors create a lasting family legacy for many generations.

Gifts for Education Expenses. You can also make direct payments for education or for medical expenses with no gift tax consequences.

Uniform Trust to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA). These custodial accounts are usually less restrictive than trusts and allow minor beneficiaries access to funds at age a specific age, depending on state law.

Reference: Kiplinger (Oct. 30, 2020) “Making a Gift This Year? Some Key Questions to Consider”

What’s the Estate Tax Exemption for 2021?

The amount of the federal estate tax exemption is adjusted annually for inflation. Yahoo Sports’ recent article “Estate Tax Exemption Amount Goes Up for 2021” says that when you die your estate isn’t usually subject to the federal estate tax, if the value of your estate is less than the exemption amount. The 2021 exemption amount will be $11.7 million (up from $11.58 million for 2020). It is twice that amount for a married couple.

Just a small percentage of Americans die with an estate worth $11.7 million or more. However, for estates that do, the federal tax bill is can be taxed at a 40% rate. As the table below shows, the first $1 million is taxed at lower rates – from 18% to 39%. That results in a total tax of $345,800 on the first $1 million, which is $54,200 less than what the tax would be if the entire estate were taxed at the top rate. However, when you are beyond the first $1 million, everything else is taxed at the 40% rate.

Rate | Taxable Amount (Value of Estate Exceeding Exemption)

18% | $0 to $10,000

20% | $10,001 to $20,000

22% | $20,001 to $40,000

24% | $40,001 to $60,000

26% | $60,001 to $80,000

28% | $80,001 to $100,000

30% | $100,001 to $150,000

32% | $150,001 to $250,000

34% | $250,001 to $500,000

37% | $500,001 to $750,000

39% | $750,001 to $1 million

40% | Over $1 million

Note that the 2018 increase is temporary. The base exemption amount is set to drop back down to $5 million (adjusted for inflation) in 2026. There’s also a chance if Joe Biden is president, the federal estate tax exemption might go back down sooner. This is because he has called for a reduction of the exemption amount to pre-2018 levels.

Don’t Forget State Estate Taxes. While an estate isn’t subject to federal estate tax, the estate might be subject to a state estate tax. In fact, 12 states and DC impose their own estate tax. The state exemption amounts are also often much lower than the federal estate tax exemption. Six states also levy an inheritance tax, which is paid by the heirs. Maryland has both an estate tax and an inheritance tax.

Reference: Yahoo Sports (Oct. 27, 2020) “Estate Tax Exemption Amount Goes Up for 2021”

How Do I Keep Money in the Family?

That seems like an awfully large amount of money. You might think only the super wealthy need to worry about estate planning, but you’d be wrong to think planning is only necessary for the 1%.

US News and World Report’s recent article entitled “5 Estate Planning Tips to Keep Your Money in the Family” reminds us that estate taxes may be only part of it. In many cases, there are income tax ramifications.

Your heirs may have to pay federal income taxes on retirement accounts. Some states also have their own estate taxes. You also want to make certain that your assets are transferred to the right people. Speaking with an experienced estate planning attorney is the best way to sort through complex issues surrounding estate planning. Here are some things you should cover:

Create a Will. This is a basic first step. However, 68% of Americans don’t take it. Many of those who don’t have a will (about a third) say it’s because they don’t have enough assets to make it worthwhile. This is not true. Without a will, your estate is governed by state law and will be divided in probate court. Ask an experienced estate planning attorney to help you draft a will.  You should also review it on a regular basis because laws and family situations can change.

Review Your Beneficiaries. There are specific types of accounts, like retirement funds and life insurance in which the owners designate the beneficiaries, rather than this asset passing via the will. The named beneficiaries will also supersede any directions for the accounts in your will. Like your will, review your account beneficiaries after any major life change.

Consider a Trust. Ask an experienced estate planning attorney about a trust for possible tax benefits and the ability to control when a beneficiary gets their money (after they graduate college or only for a first home, for example). If money is put in an irrevocable trust, the assets no longer belong to you. Instead, they belong to the trust. That money can’t be subject to estate taxes. In addition, a trust isn’t subject to probate, which keeps it private.

Convert to Roth’s. If you have a traditional 401(k) or IRA account, it might unintentionally create a hefty tax bill for your heirs. When your children inherit an IRA, they inherit the income tax liability that goes with it. Regular income tax must be paid on distributions from all traditional retirement accounts. In the past, non-spousal heirs, such as children could “stretch” those distributions over their lifetime to reduce the total amount of taxes due. However, now the account must be completely liquidated within 10 years after the death of the owner. If the account balance is substantial, it could necessitate major distributions that may be taxed at a higher rate. To avoid leaving beneficiaries with a large tax bill, you can gradually convert traditional accounts to Roth accounts that have tax-free distributions. The amount converted will be taxable on your income taxes, so the objective is to limit each year’s conversion, so it doesn’t move you into a higher tax bracket.

Make Gifts While You’re Alive. A great way to make certain that your money stays in the family, is to just give it to your heirs while you’re alive. The IRS allows individuals to give up to $15,000 per person per year in gifts. If you’re concerned about your estate being taxable, these gifts can decrease its value, and the money is tax-free for recipients.

Charitable Donations. You can also reduce your estate value, by making charitable donations. Ask an experienced estate planning attorney about setting up a donor-advised fund, instead of making a one-time gift. This would give you an immediate tax deduction for money deposited in the fund and then let you make charitable grants over time. You could designate a child or grandchild as a successor in managing the fund.

Complicated strategies and a constantly changing tax code can make estate planning feel intimidating. However, ignoring it can be a costly mistake for your heirs. Talk to an estate planning attorney.

Reference:  US News and World Report (Sep. 30, 2020) “5 Estate Planning Tips to Keep Your Money in the Family”

Protecting Inheritance from the Taxman
Illustration of businessman with small income running away from tax paper monster

Protecting Inheritance from the Taxman

Wealth Advisor’s recent article entitled “4 Ways to Protect Your Inheritance from Taxes” explains that inheritances aren’t considered income for federal tax purposes—whether it’s cash, investments or property. However, any subsequent earnings on the inherited assets are taxable, unless it comes from a tax-free source. You must report the interest income on your taxes. Any gains when you sell inherited investments or property are also taxable (but you can usually also claim losses on these sales). Remember that state taxes on inheritances vary, so ask an experienced estate planning attorney for details. Let’s look at fours steps you can take to protect your inheritance:

Look at the alternate valuation date. The basis of property in a decedent’s estate is the fair market value (FMV) of the property on the date of death, but the executor might use the alternate valuation date, which is six months after the date of death. This is only available, if it will decrease both the gross amount of the estate and the estate tax liability, typically resulting in a larger inheritance to the beneficiaries. If the estate isn’t subject to estate tax, then the valuation date is the date of death.

Use a trust. If you know you’re getting an inheritance, ask that they create a trust for the assets. A trust lets you to pass assets to beneficiaries after your death without probate.

Minimize retirement account distributions. Inherited retirement assets aren’t taxable, until they’re distributed. There are rules as to when the distributions must happen. If one spouse dies, the surviving spouse usually can take over the IRA as his or her own. Required minimum distributions (RMDs) would begin at age 72, just as they would for the surviving spouse’s own IRA. However, if you inherit a retirement account from someone not your spouse, you can transfer the funds to an inherited IRA in your name. You have to start taking minimum distributions the year of or the year after the inheritance, even if you’re not yet 72.

Make some gifts. It may be wise to give some of your inheritance to others. It will be a benefit to them, but it could also potentially offset the taxable gains on your inheritance with the tax deduction you get for donating to a charitable organization. If want to leave money to people when you die, you can give annual gifts to your beneficiaries while you’re still living up to a certain amount—$15,000 for to each person without being subject to gift taxes. Gifting also reduces the size of your estate, which can be important if you’re close to the taxable amount. Talk with an experienced estate planning attorney to be certain that you’re staying current with the frequent changes to estate tax laws.

Wealth Advisor (Sep. 15, 2020) “4 Ways to Protect Your Inheritance from Taxes”