All Nerd's Eye View Articles On Estate Planning Strategies

IRS Will Now Require Executors To Report Cost Basis To Beneficiaries For Inherited Assets

March 30, 2016 07:01 am 3 Comments CATEGORY: Estate Planning

When a beneficiary inherits property from a decedent, the asset receives a step-up in basis to its value on the date of death – which is both a tax perk for inheritors, and a form of tax simplification (as beneficiaries otherwise may not know what the decedent’s original cost basis was anyway).

However, with hard-to-value assets, there may be a disagreement between the valuation for estate tax purposes, and the value used by the beneficiary for cost basis reporting. After all, the estate prefers a small value (to minimize estate taxes) while the beneficiary ideally wants the highest possible value reported (to get a higher basis step up). And in the past, it was even possible for the executor and beneficiary to report different amounts, each to their own benefit (and the detriment of the IRS!).

To close this perceived “loophole”, in 2015 Congress created the new IRC Section 1014(f) that requires beneficiaries to use a date-of-death valuation for cost basis purposes that is no larger than the amount reported on the estate tax return, curbing the abuse. In addition, Congress also established the new IRC Section 6035, which requires executors to file a new Form 8971 to notify the IRS who the beneficiaries are, along with a Schedule A that informs both the IRS and the beneficiaries what their inherited cost basis will be.

The good news of the new reporting form is that it should actually ease the burden for beneficiaries who need to determine cost basis for their inherited assets. However, the requirement is a new burden for executors, who may struggle to follow the 30-days-after-Form-706 deadline for filing the new Form 8971 and supporting Schedule A, especially in situations where it takes a long time to identify all the beneficiaries and determine which property will be distributed to them. In fact, ironically the rules have been so complex to roll out, that the IRS has had to repeatedly delay its implementation as well, though the new Form 8971 reporting requirements are now scheduled to take effect by June 30 of 2016, and will apply retroactively back to any estate tax returns filed since last July 31 of 2015!

Using A NING Domestic Asset Protection Trust To Reduce State Income Tax Liabilities

December 30, 2015 07:01 am 7 Comments CATEGORY: Estate Planning

While most income tax planning is focused on minimizing Federal tax liabilities, the reality is that with state income tax rates as high as 13.3%, strategies that reduce state income tax liabilities are increasingly popular as well.

A recently popular strategy is the so-called “NING” trust, an extension of the DING trust where portfolio assets that may generate significant income are contributed into a Nevada trust to shift the tax exposure to Nevada’s 0% state tax rates, rather than the settlor’s high-tax-rate home state. The end result can be a significant state income tax savings, while avoiding any unfavorable gift tax ramifications (and for higher income individuals already pegged to top Federal tax brackets, no adverse Federal tax consequences). And as an added benefit, the trust itself qualifies as a Nevada asset protection trust (indirectly necessary for the favorable tax treatment!).

Unfortunately, the non-trivial costs to create and manage a NING trust, along with the potentially unfavorable Federal income tax treatment (for those not already at top tax rates) limit the appeal of the strategy for most. Nonetheless, for those who do have significant assets and income, and investments with significant tax exposure, a Nevada trust structured as a NING can generate substantial state income tax savings… at least, until the remaining high-tax-rate states follow the recent actions of New York and crack down on the strategy altogether!

New IRS Change Will Require Estates To Request An Estate Closing Letter

September 30, 2015 07:01 am 14 Comments CATEGORY: Estate Planning

For those who are subject to Federal estate taxes, the estate closing letter is a small but essential step in the process of administering an estate. It affirms that the IRS has reviewed and agreed on the Form 706 estate tax return as filed, and is often the last step for an executor to actually close an estate with the probate court.

However, in recent years the IRS has been forced to issue a rapidly growing number of estate closing letters, not to close out the estates of those who actually have an estate tax liability, but nontaxable estate tax returns that were filed solely for the purpose of claiming portability of a deceased spouse’s unused exemption.

To relieve its own administrative burden, the IRS informally “announced” in a recent update to its Estate Tax FAQ that it will no longer automatically issue an estate tax closing letter at all, and instead will require estate administrators to proactively request the closing letter instead.

For those who merely filed the Form 706 estate tax return to claim portability, this change isn’t necessarily a problem, as few in such situations would have requested (or had any need) for a closing letter anyway. However, for those who do face an estate tax, the new process adds yet another step for the estate administrator to manage. And because the estate closing letter can’t even be requested until four months after the Form 706 is filed, the new rules may force taxable estates to remain open even longer – delaying distributions for beneficiaries and racking up administrative costs – before the estate can finally be closed!

How The 691(c) IRD Deduction Can Eliminate The Need For Deathbed Roth Conversions To Avoid (Federal) Estate Taxes

July 15, 2015 07:01 am 10 Comments CATEGORY: Estate Planning

For those in poor health who face potential estate taxes and have a large IRA, a popular tax strategy is the so-called “deathbed Roth conversion” where the IRA owner converts to a Roth before death as a means to pay the income taxes up front and reduce the size of his/her estate. For large estates (and large IRAs), the tax savings can be significant.

However, the caveat of the deathbed Roth conversion strategy is that in most cases it is unnecessary, thanks to the availability of the so-called “IRD” (Income in Respect of a Decedent) tax, which provides IRA beneficiaries an income tax deduction for any estate taxes paid by the original IRA owner. In fact, the whole purpose of the IRD deduction is to eliminate any need for deathbed conversions (or liquidations) of pre-tax assets, by aligning the tax deductions to ensure that the beneficiaries will be no worse off (nor any better).

On the other hand, it’s notable that while the IRD deduction does shelter against Federal estate taxes, deathbed Roth conversions can still be relevant to protect against state estate taxes. Though in either case, the greatest driver of the outcome is not actually the IRD deduction or minimizing state estate taxes at all, but trying to shift the timing of when the IRA is recognized for tax purposes, so that the income taxes are paid at whichever rate is lower – either the IRA owner now, or the rate the beneficiaries would pay by simply inheriting the pre-tax IRA and stretching it out in the future!

When A Roth IRA May Actually Be A Terrible Asset To Inherit

January 21, 2015 07:01 am 29 Comments CATEGORY: Estate Planning

The tax-free nature of growth on a Roth IRA makes it a highly appealing investment account to hold, and a similarly appealing type of account to inherit. All else being equal, it’s clearly better to be the beneficiary of an account that will never be taxed, than one that will be taxed over time.

However, the caveat to leaving a Roth IRA as an asset to inherit is that doing so implicitly means that the original IRA owner will have paid taxes to get money into the account, either through systematic contributions spanning many years, or possibly through a large Roth conversion (or a series of partial Roth conversions over time). Which means the benefit of inheriting a Roth IRA is actually more nuanced – if the IRA owner pays “too much” in taxes to create the Roth, the beneficiary may have been better off to simply inherit a traditional IRA and pay the taxes themselves instead!

In fact, ultimately the decision of whether to bequest a Roth or traditional IRA should be driven by a comparison of the original IRA owner’s marginal tax rate, and the expected marginal tax rate of the beneficiary in the future. If the beneficiary’s tax rates are higher, it’s clearly beneficial for the current IRA owner to go ahead and convert the IRA, paying the taxes now at current rates, and leaving the (high income) beneficiary a tax-free account. However, if the reality is that the beneficiary’s tax rates are actually lower – perhaps because the original IRA owner’s wealth is being spread across multiple beneficiaries, because the beneficiary simply has less income and assets, or maybe just due to the fact that the beneficiary lives in a different state that has a lower tax rate – then the best thing a (higher-income) IRA owner can do is simply to leave a traditional IRA to the beneficiary and let the beneficiary pay the taxes at his/her own lower tax rates!

Qualifying A “See-Through” Trust As An IRA Designated Beneficiary – Conduit Or Accumulation?

October 8, 2014 07:01 am 7 Comments CATEGORY: Estate Planning

An IRA owner has the right to name whoever they wish to be the beneficiary of their retirement account. However, because Congress did not want to allow IRAs (and other retirement accounts) to continue indefinitely, after the original IRA owner passes away there are required minimum distributions (RMDs) that must be taken by the beneficiary, forcing the account to be liquidated over time.

Fortunately, though, Congress does allow those post-death RMDs to be drawn out slowly over the life expectancy of the beneficiary, at least where the beneficiary is a “designated” beneficiary that is a human being with a life expectancy to be stretched across in the first place. But a significant problem arises in the case of trusts named as beneficiary of an IRA – it’s impossible to stretch out RMDs over the life expectancy of an entity that is just “a piece of paper” and isn’t alive in the first place! As a result, leaving a retirement account to a trust potentially loses the ability to stretch the distributions out after the death of the original owner.

The good news, however, is that the Treasury Regulations actually do allow an IRA inheritance trust in certain circumstances to be treated as designated beneficiaries eligible to stretch post-death RMDs over life expectancy, by looking through the named trust to the underlying beneficiaries and using their life expectancies instead. The caveat, though, is that qualifying for “see-through” trust treatment requires the trust to be drafted properly, consider crucial decisions like whether to be structured as a “conduit” or “accumulation” trust, and at best may still entail the trade-off of less favorable income tax treatment to achieve other financial and estate planning goals!

IRS Opens Temporary Window For Retroactive Portability Of Estate Tax Exemption In Rev Proc 2014-18

February 12, 2014 07:01 am 3 Comments CATEGORY: Estate Planning

The potential for portability of a deceased spouse's unused exemption amount (DSUEA) to a surviving spouse was a significant change that emerged from the fiscal cliff legislation in 2010. However, early adoption of portability was limited, due both to a lack of awareness of the rule by many of those who needed it, and the fact that the portability rules were just "temporary" and faced future sunset in the fiscal cliff of 2012 until subsequently made permanent under the Taxpayer Relief Act of 2012... and by that time, it was already too late for many who might have wished to claim portability.

To provide relief for this unfortunate situation, the IRS has issued Revenue Procedure 2014-18, which will allow any decedent who passed away in 2011, 2012, or 2013 to have an extension to file an estate tax return and claim DSUEA portability for the surviving spouse. However, the relief provision reopening portability for anyone who died in the past 3 years is temporary; the Form 706 estate tax return must be filed by the end of 2014 to claim this "retroactive" portability, or the window will once again be closed for good.

For many surviving spouses, this opportunity for retroactive portability is an appealing relief provision to get a "free" second chance to claim portability and carry over a decedent's unused estate tax exemption amount; the only requirement is that a Form 706 estate tax return now be filed. In situations where the surviving spouse has also since passed away, the potential for retroactive portability could actually result in an immediate and significant estate tax refund. And notably, for same-sex spouses - who couldn't file for portability in 2011, 2012, or most of 2013 because the marriage wasn't recognized in the first place - the new relief provisions of Rev. Proc. 2014-18 offers the opportunity to go back and claim portability for a same-sex surviving spouse who never had the opportunity in the first place!

The Untenable State Of State Estate Taxes – Recouple, Repeal, Or Enact Gift Taxes

January 15, 2014 07:01 am 6 Comments CATEGORY: Estate Planning

The past decade has been a tumultuous one for the world of state estate taxes. What had been a rather stable structure for decades, with the Federal credit for state estate taxes paid that allowed states to create a "sponge tax" to absorb the maximum Federal credit, was brought to an end with the Economic Growth and Tax Relief Reconciliation Act of 2001, and in the years that followed the system was phased out and replaced with a state estate tax deduction instead. As a result, states faced the possibility that their estate tax revenue would drop to zero, which is in fact what happened for all states by 2005 that did not "decouple" from the Federal system to create their own state estate tax, often with their own exemptions.

Yet the reality is that for the remainder of that decade, states had continued to rely upon the Federal $1,000,000 gift tax exemption threshold to effectively "backstop" their state estate tax systems; after all, without any gift tax system, the estate tax doesn't really work, as people simply gift the money away before they die to avoid paying the tax at death. In turn, a new wave of state estate tax "disruption" occurred at the end of 2010 when the fiscal cliff legislation "reunified" the Federal gift and estate tax systems, bringing up the Federal gift tax exemption from $1,000,000 to an inflation-indexed $5M+ level, removing in the process the Federal gift tax support structure for the states that still had a gift tax.

As a result, in today's environment the states remaining with a state estate tax find themselves in an untenable position; most have an estate tax but no gift tax, which just invites citizens to either give away the money before they pass away, or relocate and change their residency to another state to another the tax (which causes the state loses income, property, and other tax revenue as well!). To fix the problem, states are increasingly compelled to come up with a solution: either enact gift taxes themselves to backstop the system (and then hire auditors to oversee and enforce the system); repeal the estate tax; or "recouple" the state back to the Federal system, to once again rely on the Federal tax structure and the IRS to backstop the states. Ultimately, it remains to be seen which path the states will pursue, but the likelihood for legislation is increasing - some states are considering proposals already - which means the time window is quickly closing for anyone who actually wishes to take advantage of the state estate tax "loophole" that still exists today!

Helping Financial Planning Clients With Their Digital Estate Planning

September 24, 2013 06:14 am 7 Comments CATEGORY: Estate Planning

Helping clients through their estate planning is a core part of the financial planning process - and of course, the reality is that the orderly resolution of an individual's affairs after they pass away is an issue that long predates financial planning itself. Though the rules have changed significantly over the years and decades, the courts have long played a role in ensuring that property is distributed properly, albeit with some cases a bit more orderly than others.

Yet in today's world, a unique new type of property is being introduced for the first time: digital assets. In this guest post, financial planner William Bissett shares an example of a potentially problematic client scenario, where it's necessary to help a client through not only the traditional estate planning process for their "traditional" assets, but also to recognize that the matter has grown significantly more complex as clients must also resolve everything from online billpay to recovering photos from social media accounts.

Going forward, helping clients plan for their digital assets may become increasingly important as more and more of our lives are move (or at least are captured) online. Though the laws themselves are still a bit murky on how to handle such situations - and perhaps, because of that fact - it is crucial to at least help ensure that clients have an inventory of their various digital accounts and digital assets, to help surviving spouses and heirs to get through the process as smoothly as possible.

The Rise Of The Spousal Lifetime Access Trust (SLAT)

May 22, 2013 11:06 am 2 Comments CATEGORY: Estate Planning

In late 2012, a new estate planning strategy emerged - the so-called "Spousal Lifetime Access Trust" (or SLAT for short). The basic concept of the SLAT was relatively straightforward: it would function like a bypass trust, but be funded during life instead of at death, with the intention of using it to take advantage of the then-current $5.12M estate tax exemption before it dropped back to $1M as was scheduled for 2013.

Ultimately, the estate tax fiscal cliff didn't happen, but the SLAT remains valid in 2013 and beyond for a new purpose: planning around state estate taxes, and the mismatch between the numerous states that have only a $1M state estate tax exemption and no gift tax, while the Federal gift and estate tax exemptions are at $5.25M. Given this "decoupling" of the state estate tax from its Federal gift tax - and the lack of any state gift tax backstop - couples have a unique opportunity to manage or avoid state estate taxes by creating "supercharged bypass trusts" in the form of SLATs funded during life.

The caveat to the strategy is the "reciprocal trust" doctrine, which can cause SLATs to become "uncrossed" and taxable in the original donor's estate. Fortunately, reciprocal trust treatment can be avoided. Unfortunately, though, the rules to avoid reciprocal trust treatment are based on the facts and circumstances of the situation, and consequently a focus for the IRS and estate planning attorneys in the coming years may be figuring out how best to avoid the reciprocal trust doctrine without actually ruining the client's financial and estate planning goals.

Nonetheless, though, the reality remains that the SLAT may be increasingly popular in the coming years, at least until states implement a gift tax, recouple to the Federal gift and estate tax system, or just repeal their state estate taxes entirely.