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”

Can I Bequeath My Home to My Children without Taxes?

As part of your estate planning, you can pass your house tax-free to an heir. savingadvice.com’s recent article entitled “Use These Tips to Pass Your House to Your Heirs Tax-Free” reminds us that the most important thing is to look at the total value of your entire estate (not just your home). If the value is more than $11.58 million (the unified federal estate gift and estate tax exemption amount for 2020), then your estate will be subject to estate taxes. If it’s under that amount, there’s no worries, and you can pass a house tax-free through a will. However, you may also have state estate taxes on the inheritance.

Ask an experienced estate planning attorney about the potential capital gains taxes your heirs may have to pay, when they sell the property. If you owe any money to Medicaid upon your death, the state can place a lien on your property, which can affect your heirs. Let’s look at some options to discuss with your estate planning attorney:

Irrevocable Trust. If you have an estate that’s more than the $11.58 million amount, you might want to look at putting the house into an irrevocable trust, instead of just including it in your will. Ask your attorney about a qualified personal residence trust. When you die, the house will go to the heir(s) that you’ve designated with the trust. However, if you sell the house, the money goes into the trust and can’t be cashed out if the situation changes. It’s something to consider, if you have a high-value estate and want to pass a house tax-free to your children or other loved ones.

As a Gift. You can gift a house to your children, and there will be no taxes on that, if the value of your home is less than the $11.58 million. However, you must file a gift tax form when you do your annual taxes. As long as the value is below that amount, it should just be a matter of filing the form and not paying any fees.

Look at total value of your estate and your home. File a gift tax form with the IRS in the year that you gift the home and offset the total amount of the gift by first using your annual gift-tax exclusion of $15,000. This is per donee and per donor, so if you and your spouse jointly own the property and you gift it to multiple children, you can up the exclusion amount.

You shouldn’t apply for Medicaid within five years of gifting your home to your child, because there may be a transfer penalty if you gift assets just before applying for Medicaid benefits.

Can You Sell the House and Gift the Money? You can sell the home at current market value, then gift that money to your child. You can do this in a will or trust or give it to them directly. You could also sell the home to your child at a very low price. They’d get the house and can sell it themselves at a higher value when the time is right for them to do so. However, they may have to pay higher taxes when they do.

Selling your Home to Your Child for $1? OK, you’re technically selling the house, so it’s not a gift. However, the remainder of the value of the house is considered a gift, so the gift tax rules still apply. If your child sells the house, they must report the entire difference as a gain, which means capital gains taxes.

If you want to sell your house to your child, you should consider selling it to them with a small down payment as a seller-financed sale. You’ll carry the note for the balance, and your adult child will make affordable payments. You can even offset what they pay you, by gifting them up to $15,000 per year (which is low enough not to trigger the gift tax). Since you’ve sold the home, it’s no longer a part of your estate, so you don’t have to worry about taxes on your end.

Reference: savingadvice.com (July 29, 2020) “Use These Tips to Pass Your House to Your Heirs Tax-Free”

What’s the Difference Between an Inter Vivos Trust and a Testamentary Trust?

Trusts can be part of your estate planning to transfer assets to your heirs. A trust created while an individual is still alive is an inter vivos trust, while one established upon the death of the individual is a testamentary trust.

Investopedia’s recent article entitled “Inter Vivos Trust vs. Testamentary Trust: What’s the Difference?” explains that an inter vivos or living trust is drafted as either a revocable or irrevocable living trust and allows the individual for whom the document was established to access assets like money, investments and real estate property named in the title of the trust. Living trusts that are revocable have more flexibility than those that are irrevocable. However, assets titled in or made payable to both types of living trusts bypass the probate process, once the trust owner dies.

With an inter vivos trust, the assets are titled in the name of the trust by the owner and are used or spent down by him or her, while they’re alive. When the trust owner passes away, the remainder beneficiaries are granted access to the assets, which are then managed by a successor trustee.

A testamentary trust (or will trust) is created when a person dies, and the trust is set out in their last will and testament. Because the creation of a testamentary trust doesn’t occur until death, it’s irrevocable. The trust is a created by provisions in the will that instruct the executor of the estate to create the trust. After death, the will must go through probate to determine its authenticity before the testamentary trust can be created. After the trust is created, the executor follows the directions in the will to transfer property into the trust.

This type of trust doesn’t protect a person’s assets from the probate process. As a result, distribution of cash, investments, real estate, or other property may not conform to the trust owner’s specific desires. A testamentary trust is designed to accomplish specific planning goals like the following:

  • Preserving property for children from a previous marriage
  • Protecting a spouse’s financial future by giving them lifetime income
  • Leaving funds for a special needs beneficiary
  • Keeping minors from inheriting property outright at age 18 or 21
  • Skipping your surviving spouse as a beneficiary and
  • Making gifts to charities.

Through trust planning, married couples may use of their opportunity for estate tax reduction through the Unified Federal Estate and Gift Tax Exemption. That’s the maximum amount of assets the IRS allows you to transfer tax-free during life or at death. It can be a substantial part of the estate, making this a very good choice for financial planning.

Reference: Investopedia (Aug. 30, 2019) “Inter Vivos Trust vs. Testamentary Trust: What’s the Difference?”

What Exactly Is the Estate Tax?

In the U.S., we treat the estate tax and gift tax as a single tax system with unified limits and tax rates—but it is not very well understood by many people. The Motley Fool’s recent article entitled “What Is the Estate Tax in the United States?” gives us an overview of the U.S. estate and gift tax, including what assets are included, tax rates and exemptions in 2020.

The U.S. estate tax only impacts the wealthiest households. Let’s look at why that’s the case. Americans can exempt a certain amount of assets from their taxable estate—the lifetime exemption. This amount is modified every year to keep pace with inflation and according to policy modifications. This year, the lifetime exemption is $11.58 million per person. Therefore, if you’re married, you and your spouse can collectively exclude twice this amount from taxation ($23.16 million). To say it another way, if you’re single and die in 2020 with assets worth a total of $13 million, just $1.42 million of your estate would be taxable.

However, most Americans don’t have more than $11.58 million worth of assets when they pass away. This is why the estate tax only impacts the wealthiest households in the country. It is estimated that less than 0.1% of all estates are taxable. Therefore, 99.9% of us don’t owe any federal estate taxes whatsoever at death. You should also be aware that the lifetime exemption includes taxable gifts as well. If you give $1 million to your children, for example, that counts toward your lifetime exemption. As a result, the amount of assets that could be excluded from estate taxes would be then decreased by this amount at your death.

You don’t have to pay any estate or gift tax until after your death, or until you’ve used up your entire lifetime exemption. However, if you give any major gifts throughout the year, you might have to file a gift tax return with the IRS to monitor your giving. There’s also an annual gift exclusion that lets you give up to $15,000 in gifts each year without touching your lifetime exemption. There are two key points to remember:

  • The exclusion amount is per recipient. Therefore, you can give $15,000 to as many people as you want every year, and they don’t even need to be a relative; and
  • The exclusion is per donor. This means that you and your spouse (if applicable) can give $15,000 apiece to as many people as you want. If you give $30,000 to your child to help her buy their first home and you’re married, you can consider half of the gift from each spouse.

The annual gift exclusion is an effective way for you to reduce or even eliminate estate tax liability. The estate tax rate is effectively 40% on all taxable estate assets.

Finally, the following kinds of assets aren’t considered part of your taxable estate:

  • Anything left to a surviving spouse, called “the unlimited marital deduction”;
  • Any amount of money or property you leave to a charity;
  • Gifts you’ve given that are less than the annual exclusion for the year in which they were given; and
  • Some types of trust assets.

Reference: The Motley Fool (Jan. 25, 2020) “What Is the Estate Tax in the United States?”

What Should I Know about Estate and Inheritance Taxes with Property in Two States?

If you’re set to receive your full Social Security benefits next year, you may want to make sure you understand the estate and inheritances taxes of owning property, especially if it’s in more than one state.

Let’s say you own two co-ops in Manhattan and a home in New Jersey. All are all mortgage-free but you have a $69,000 home equity loan on the house. You may wonder if it’s better to continue to live in New Jersey with assets in New York or to move back to New York—or even somewhere else. This decision should be based at least in part on how your assets will be taxed, when you pass away. You also want to think about the beneficiaries of your property.

nj.com’s recent article asks, “Are estate and inheritances taxes worse in New York or New Jersey?” The article explains that estate and inheritance taxes are two different things, and it’s important to understand them.

An estate tax is levied on the estate of the decedent. An inheritance tax is paid by the beneficiary who gets the distribution from the estate. Few states have inheritances taxes. New Jersey abandoned their estate tax effective Jan. 1, 2018. However, New Jersey still has an inheritance tax. It is only applicable to non-Class A beneficiaries, which typically are heirs who are not lineal descendants. Children or grandchildren are Class A beneficiaries, so the inheritance tax would not apply to them.

There’s no inheritance tax in New York. However, the estate tax is imposed on taxable estates in excess of the state exemption. That’s $5.49 million in 2019 and will go up to $5.85 million in 2020. New York estate tax rates begin at 3.06% and increase to 16.0% for taxable estates in excess of $10.1 million.

An estate of a New York non-resident is required to file a New York State estate tax return, if the estate includes any real or tangible property in New York State and the amount of the non-resident’s federal gross estate, plus the amount of any “includable gifts,” is more than the state’s exclusion amount at the time of death. “Includable gifts” are gifts made while the decedent was a New York resident during the preceding three-year period ending on the date of death. These aren’t included in the decedent’s federal gross estate.

In the example above, it looks like New Jersey would be the better domicile in which to claim residency, because no estate or inheritance tax would be due. Depending on the value of the two co-ops in New York, he may owe New York estate tax, if the value exceeds the New York State estate exclusion amount. That’s true whether he’s a New York or New Jersey resident.

Under current New Jersey law, moving to another non-estate tax state, like Florida, won’t help him with any additional estate tax benefit. As always, talk with an estate planning attorney regarding the above specifics and to make certain that your estate plan is complete and follows your goals.

Reference: nj.com (December 4, 2019) “Are estate and inheritances taxes worse in New York or New Jersey?”

What Does Portability Mean, and How Do I Use It?

WMUR’s recent article, “Money Matters: Portability and estates,” explains that each taxpayer is typically permitted what is called an applicable exclusion amount. This is the amount of assets that, at your death, you can bequeath to others tax-free for estate tax purposes. Prior to the law change, spouses couldn’t share their exclusions. However, the Tax Cuts and Jobs Act increased this exclusion significantly. In 2019, the exclusion is $11.4 million per person.

The portion that’s not used by the deceased spouse can be transferred to the surviving spouse. The exclusion is indexed for inflation. However, this exemption level is only in effect until 2025. It will then again lower, probably to around half of its current level.

Before this tax law change, the most frequent way to maximize the exclusion was to set up a trust for each spouse—sometimes known an A/B trust. When the first spouse passes away, an amount equal to the exclusion would go to the B trust (also called a credit-shelter bypass trust).

The assets in this trust would be outside the surviving spouse’s estate and, because the exclusion was applied, were not subject to estate taxes. Anything remaining in the estate of the first to die, would be given to the survivor or could be placed in another trust. This trust is often called an A trust (or marital trust). Transfers to spouses aren’t usually subject to estate tax, so assets passing to the A marital trust would have no estate tax liability. At the surviving spouse’s death, his exclusion would be applied to the assets in the A trust. That way, both spouses would get the benefit of their exclusion.  However, this changed with the new tax law. The first spouse to die now uses the exclusion against assets in his estate. Any unused exclusion amounts can then be used by the surviving spouse with their own, at her death.

This would appear to simplify estate planning, for some, the use of two separate trusts will no longer be needed. However, remember these thoughts: (i) the unused applicable exclusion amount from an earlier marriage usually isn’t available, and you can use the amounts only from your last deceased spouse in your estate planning; (ii) these unused exclusion amounts aren’t indexed for inflation, so the property your spouse receives at your death may increase in value in the future, and its value could ultimately be greater than the unused exclusion; and (iii) to use portability, an estate tax return must be filed, so the estate executor must make an election to do so, by filing a return—even if the estate wouldn’t usually be required to do so.

Because of the tax law changes, estate documents drafted before 2010 may not accurately reflect your desire,s because portability and the increase in the exclusion amount can have an effect. Review the changes with your estate planning attorney.

Reference: WMUR (November 21, 2019) “Money Matters: Portability and estates”

Can You Explain the Concept of Step-Up Basis?

If you inherit assets—especially real property—you need to understand the step-up in basis rules. These rules can save you a lot of amount of money on capital gains and depreciation recapture taxes.

Motley Fool’s recent article on this subject asks “What is a Step-Up in Basis?” The article explains that step-up in basis has significant implications for inherited property. When an asset is inherited because the original owner has passed away, in many cases, it’s worth more than when it was first purchased. To avoid a huge capital gains tax bill when the inherited property is sold, the cost basis of the asset is modified to its value at the time of its owner’s death. This is called a step-up in basis. Note that this only applies to property transferred after death. If a property was gifted or transferred before the original owner dies, the original cost basis would transfer to the recipient.

This is a gigantic tax benefit for estate planning, regardless of whether you go ahead and sell the inherited asset immediately or hold on to it for a time. While a step-up in basis can let heirs avoid capital gains taxes, it doesn’t allow heirs to avoid estate taxes that apply to big inheritances.

The estate tax this year is imposed on property in excess of $11.4 million per individual and $22.8 million per married couple. Therefore, if you and your spouse leave a $25 million estate to your heirs, $2.2 million of this will still be taxable, even though your heirs’ cost basis in assets they inherited will be stepped up for capital gains tax purposes.

There are many strategies that a qualified estate planning attorney can advise you on to avoid estate taxes, but step-up in basis doesn’t exclude the value of inherited property from a taxable estate all by itself.

There are two significant ramifications of stepped-up cost basis regarding inherited real estate assets. First, like with other assets, you don’t have to pay capital gains on any appreciation that occurred before you inherited the property. Selling an investment property after years of holding it, can mean a massive capital gains tax bill. Therefore, a stepped-up cost basis can be a very valuable benefit. A step-up in basis can also give you a larger depreciation tax benefit. The cost basis of residential real estate can be depreciated (deducted) over 27½ years: a higher number divided by 27½ years is a greater annual depreciation deduction than a smaller number would produce.

Estate transfers are pretty complicated, so work with a qualified estate planning attorney.

Reference: Motley Fool (November 21, 2019) “What is a Step-Up in Basis?”