News, Events & Blog
Congress recently passed the Tax Cut and Jobs Act (“TCJA”) earlier this year, the largest revision to the tax code in thirty (30) years. Among the many changes are significant increases in the Estate, Gift, and Generation-Skipping Transfer (GST) tax exclusion amounts. In effect, this means that fewer families will be subject to such transfer taxes and that many estate plans will need to be updated to properly address the new law. The changes under the TCJA present an important opportunity for high net-worth individuals and families to review their current estate planning documents and ensure that their plan is properly tailored to achieve their goals.
Overview of Changes
The most significant change is the doubling of the unified Estate and Gift tax exclusion amount – the combined amount that individuals can give away during life or at death before paying transfer taxes – from $5.59 million to $11.18 million per person. The new tax law also preserves “portability,” a surviving spouse’s ability to retain any estate or gift exclusion unused by a deceased spouse, meaning that for married couples, the exclusion is effectively $22.36 million. This exclusion is inflation adjusted, but current law provides that this doubled exclusion sunsets December 31, 2025, after which estate taxes are slated to revert to current levels.
The new law also increases the amount each person can make exempt from the GST tax. As with the estate and gift tax exclusion, the new GST exclusion will increase from $5.59 million to $11.18 million per person (in 2018 as indexed for inflation). Unlike with the estate and gift tax, however, there is no “portability” for GST taxes. Thus, each spouse must use their own GST exclusion before they pass.
In addition to the changes made by the new tax bill, 2018 also brings a routine increase in the annual exclusion from the Gift tax to $15,000 per person, per year. This annual exclusion allows each individual to make a gift of $15,000 to any other individual (and in some cases trusts) without reducing their lifetime Estate and Gift tax exclusion amount.
Review of Your Estate Plan
The changes in the Estate, Gift and GST tax law mean that many estate plans should be revised to take advantage of tax changes, ensure existing tax formulas still achieve the intended results, or simplify complex planning that is no longer necessary and shift a focus towards income tax planning for beneficiaries. There are also certain planning opportunities that you may want to explore.
First, the increased exclusion amount may be an opportunity to unwind complex planning that may no longer be needed to minimize transfer taxes. For instance, many estate plans created under assumptions of prior law provide that at the death of the first spouse, the deceased spouse’s assets are divided into two (2) separate trust shares: a Marital Trust for the benefit of the surviving spouse and a Credit Shelter Trust that may benefit the surviving spouse, your children and/or grandchildren, or combinations of those people. For married couples with large estates, this technique defers payment of any Estate tax until the passing of the second spouse. The trade-off is that the Credit Shelter Trust may not benefit the surviving spouse solely and the income tax basis of the Credit Shelter Trust is locked into place upon the first spouse’s death. Many couples who used such techniques to minimize Estate tax prior to the new increased exclusion amounts will prefer for the surviving spouse to retain greater control of assets and plan for the remainder beneficiaries to receive a step-up in income tax basis for all of the assets upon the surviving spouse’s passing. ShuffieldLowman can assist you with weighing that control over the asset protection and the certainty of the Credit Shelter Trust to determine what is best for each family.
As mentioned above, another scenario involving Marital and Credit Shelter Trusts may play out in other plans containing “formula gifts.” Certain estate plans leave assets up to the Estate tax exclusion amount to a Credit Shelter Trust for the benefit of children or grandchildren and leave assets in excess of that amount to a Marital Trust for the benefit of the spouse. Because the Estate tax exclusion amount is now so large, this could mean unintentionally disinheriting the spouse and leaving all assets to the Family Trust or just leaving significantly less to the surviving spouse than intended.
Next, we do not know if the federal increased exclusion amounts will not be extended and will in fact expire in 2025, which is what the TCJA provides. Under a subsequent administration the exclusion amounts may even return to the lower levels of the past that existed for most of the 2000s. If either of these events does indeed occur, then the current increase in the exclusion amounts provides a temporary, “use it or lose it” opportunity to transfer assets outside your taxable estate, thereby “locking in” the current exclusion amount before it is reduced and freezing values from future appreciation. This estate tax planning might involve increased contributions to Irrevocable Trusts such as Irrevocable Life Insurance Trusts, Intentionally Defective Grantor Trusts (IDGTs), sales to these types of trusts, forgiveness of intra-family promissory notes, or other wealth transfer vehicles. You may want to consider further planning using the increased exemption amounts to remove assets from the estate.
Finally, some clients may even wish to use the increased exclusion amount to unwind prior planning and bring assets back into their gross estate to obtain a step-up in basis in those assets to fair market value at the time of their death. This type of planning is geared toward reducing income tax liability of your beneficiaries upon the sale of the inherited assets.
These are just a few examples of the many ways in which the TCJA may affect your estate plan. The TCJA makes significant changes to the Estate, Gift and GST tax regimes. If your estate plan was implemented under previous law, it would be beneficial to review your plan to ensure it accomplishes your current goals in light of these changes. If you would like a comprehensive review of your estate plan, contact ShuffieldLowman today.
This year will be the first to see the implementation of new filing deadlines for many forms. The first new deadline, that will occur shortly, is for filing W-2’s, which is now January 31 instead of the previous February deadlines. March 15 is the new deadline for Form 1065 (partnership returns) and Form 1120 (S-corporation returns). This includes the K-1s. Each is extendable to September 15.
Next comes April 15. Forms 1040 continue to be due on this date, but FINCEN 114 (Report of Foreign Bank Account) is now due at the same time instead of June 30, as in the past. Form 1041 (Income Tax Return for Estates and Trusts) and Form 1120 (Corporate Tax Return) are due on April 15 and are extendable to September 30 and September 15, respectively.
Other forms, such as Form 5471 (Report of Foreign –Owned Corporations), that are due at the same time as some of the income tax returns, will change their due dates to correspond to the new due dates of these returns. Caution is advised in checking all deadlines and not simply relying on past experience.
As you know, the Internal Revenue Service closely scrutinizes transfers between family members of stock, units, and partnership interests (“Stock”) in any corporation, limited liability company, or partnership that is family-owned (a “Family Business”). The Service has announced proposed regulations that eliminates the use of valuation discounts that would otherwise decrease the estate and gift tax value of such Stock when transferred by sale or gift to family members. If you are considering a gift or sale of Stock in a Family Business, you may want to consider taking action right away to implement your planning.
When Stock in a Family Business is transferred between family members, valuation discounts are commonly applied for, among other things, lack of marketability and lack of control. The lack of marketability discount is based on the fact that a Family Business cannot easily be sold on the open market and is not publicly traded; so, the true value of the Stock is actually worth less than a pro rata portion of the total value of the underlying assets. The lack of control discount is based on the fact that a non-voting interest or a minority interest that does entitle the owner to a vote (but not unilateral control of the entity) is worth less to an arm’s length purchaser than if they could control the entity. These discounts are designed to reflect the true economics of a Family Business from the view point of a third party purchaser.
Valuation discounts have been an effective tool to reduce or eliminate federal estate and gift taxes on transfers of Stock in Family Businesses for many years. The Service, however, has long sought to limit the benefit of this tool. This has been especially true when the Service determines that the Family Business in question has no legitimate “business purposes.” The proposed regulations address the Service’s concerns by eliminating all discounts. We expect attorneys, accountants, appraisal experts, and other planners to comment in the next ninety (90) days about the validity and public policy implications of the proposed regulations. However, the very real possibility is that the proposed regulations will be effective when the final version is published, which might occur in as little as one hundred and twenty (120) days.
The new regulations do basically two (2) things. First, when valuing Stock in a Family Business certain restrictions on liquidation rights are disregarded when such rights lapse after a transfer (for instance if the General Partner of a partnership dies) or if after a transfer the restrictions may later be removed by the transferor or the transferor’s family. Second, any lapse of voting or liquidation rights is deemed to be a transfer to the other family member/owners in the Family Business. Both rules only apply if one (1) or more members of the family has control of the Family Business both before and after the transfer or lapse. Control may occur when certain voting or equity thresholds are met; furthermore, ownership by a particular family member will be attributed to related family members, making it hard not to pass the threshold of control. In plain English, this means that valuation discounts will no longer be available for transfers of Stock in a Family Business to family members.
Existing Family Businesses would not be “grandfathered” under the proposed regulations. Only gifts or sales completed prior to thirty (30) days after the effective date of the final regulations would be exempt from the new rules. It is also very likely that regardless of how broad or narrow the final regulations may be, the ultimate validity of the regulations will be determined through taxpayers litigating this issue in the Tax and Federal Courts. Therefore, once the new regulations are made final, we may not have any certainty in this area for the next several years while legal battles are fought with the Service.
Because of the uncertainty of the new proposed regulations, we recommend that our clients who may be inclined to transfer Stock in a Family Business, whether by gift, sale, or both, consider all of their planning options as soon as possible to determine if they should go ahead with some transfers prior to the issuance of the final regulations. We would be happy to sit down with you and discuss all of your planning options.
There is an inherent risk of liability that goes along with property ownership. You as a property owner could potentially be subject to tort claims stemming from activities that occur on the land. If the property were held in your individual name or in the name of your Revocable Trust at the time a tort claim was made and the claim resulted in a judgment against you or your trust, your personal assets, or the assets of your Revocable Trust, could be attached to satisfy the judgment. However, if the property is held in a separate LLC, only the property held in the LLC can be used to satisfy the judgment. This restructuring is advantageous to you because it would give you maximum protection for your personal assets.
This structure maximizes the asset protection for Corporations as well, because any judgment against one piece of real estate could only be satisfied by that piece of real estate and not the assets of corporation or the other pieces of real estate since they are in separate LLC’s.
Having each piece of real property in a separate LLC has advantages from a business standpoint in that it makes it simpler to bring in a developer as an owner of the real estate. Bringing in a developer as an owner when the real estate is held by an S corporation is difficult because an S corporation can only be owned by certain individuals and trusts, whereas most developers will be some form of business entity. However, any business entity can be a member in an LLC, and by having each piece of real estate in a separate LLC, you can bring in a developer as a member for just the one piece of property. Also, if you do bring a developer in on a joint venture, by the real estate being in an LLC, you have the flexibility to provide different allocations of distributions and taxes between you and the joint venture partner. This flexibility would not be available if the real estate was held in an S Corporation. Finally, when you decide to sell the real property you can sell the entity rather than selling the actual real property.
Each piece of real property in a separate LLC has advantages from an Estate Planning standpoint in that it makes it simple to transfer ownership. The ownership of real estate held by an LLC is represented proportionately by a member’s shares of an LLC. Rather than filing a new deed, members can transfer ownership of the property to their children by simply issuing them membership interest in the LLC. This makes gifting away interest in the real estate very simple to do. Also, it is easier to gift interest in an LLC than it is to gift away stock in an S Corporation, because an LLC has no restrictions on who can be an interest holder whereas there are limits who can be a holder of stock in an S Corporation. Therefore, each gift of stock out of the S Corporation would have to be analyzed to ensure it was going to an eligible S Corporation shareholder.
For Real Property currently held in your individual name or in your Revocable Trust, we suggest creating a single member limited liability company (LLC) for each parcel of real estate you currently hold. A LLC holding company should be created to be the single member of each of the LLC’s holding the real estate. You or your trust would be the sole member of the LLC holding company. You would still maintain control of each LLC holding the real estate because the holding company is the sole member of each LLC and you would be the manager of the holding company.
For Real Property currently being held in the name of a Corporation, we recommend creating a single member LLC for each piece of real estate and then having the Corporation contribute the real estate to the individual LLC in exchange for ownership interest in the LLC.
Any real estate that you acquire in the future should be held in a separate LLC with the LLC holding company as its sole member. Because of the business and estate planning advantages a LLC has over a S corporation, it is best to never acquire any real estate in a S corporation.
With summer having just ended, now is the time to discuss the importance of saving for retirement with your children and grandchildren. Many parents and grandparents will have wanted their children and grandchildren to work over the summer so that they appreciate the effort it takes to earn an income. Therefore, many will have worked a summer job; that is by itself an important step to understanding the value of the dollar and the rewarding feeling of earning one’s own income. The money they have earned is usually spent (or saved) however they would like. While there is nothing wrong with this, the savvy parent or grandparent will take this opportunity to shift their focus to their future. By creating a custodial Individual Retirement Account (an “IRA”), the child or grandchild that is a minor may begin to learn about saving money, investing assets, publicly traded markets, the benefits of income tax deferral, retirement matching programs, and the time value of money.
So long as the minor has earned income for the year, they may create and/or contribute to their own IRA (either a Traditional IRA or a Roth IRA). Legal title to the account will rest in their legal or natural guardian as custodian of the IRA that is held for their benefit. The amount that may be contributed to the custodial IRA is limited by the lesser of the usual annual contribution limits for IRAs (i.e., Five Thousand Five Hundred Dollars ($5,500) in 2015), or the total amount of the minor’s earned income in that year. Also keep in mind that most financial institutions have a minimum account balance requirement. Often this could be One Thousand Five-Hundred Dollars ($1,500) or more, which may be less than what the minor earned during their summer job. There are however financial institutions that only require a One Hundred Dollar minimum balance ($100).
For example, let’s say a grandchild earned Two Thousand Dollars ($2,000) this summer. The grandchild has several options, such as: (1) keep the Two Thousand Dollars ($2,000) and do with it what they will, (2) contribute all or a portion of it to their custodial IRA, (3) keep all of it, while a parent or grandparent makes a gift to the minor that may be used as a contribution to their custodial IRA, or (4) a combination of the second and third options.
To illustrate these options, we will describe the second, third, and fourth scenarios. The second scenario will not be very appealing to the minor. That is natural, as they just worked very hard for their income (perhaps for the first time in their life) and the thought of saving the money for retirement is a foreign concept to them. Most minors will need some encouragement to get excited about retirement savings. The third scenario is the “have your cake and eat it too” option. There is nothing wrong with that in this context. The parent or grandparent may just wish to help start their retirement savings process and hope that it will engage the minor and turn on a light bulb for them. However, the fourth scenario is the most likely to cause the minor to become actively engaged in the discussion about saving and investing for their future, since they have skin in the game now. Their grandparent could talk with them and explain that if they agree to set aside One Thousand Dollars ($1,000) of their own money for their future by creating an IRA, then the grandparent will also give the grandchild One Thousand Dollars ($1,000) for that purpose. The grandchild has One Thousand Dollars ($1,000) of spending money and Two Thousand Dollars ($2,000) for their retirement.
The next big decision is whether to create a Traditional IRA or Roth IRA. If the minor is being claimed as a dependent on an adult’s income tax return, then you should first check with the CPA preparing that adult’s income tax return. It is likely that the minor would not be able to claim an income tax deduction for contributions to a Traditional IRA. Therefore, a Roth IRA is usually the preferred choice. Moreover, once the minor begins taking their Required Minimum Distributions (in the distant future), the withdrawals will be income tax free and will have had forty (40) or more years to grow tax free. For instance, assuming an average rate of return of six percent (6%), that Two Thousand Dollar ($2,000) contribution would become Twenty Thousand Five Hundred Seventy One Dollars ($20,571) forty (40) years later. If the minor continues to make annual contributions to their IRA, this growth only compounds over time.
It is also important to remember to fill out the beneficiary designation for the custodial IRA. Think through who is the likely choice as primary and contingent beneficiaries for the minor. If you feel the minor is mature enough to take part in this discussion, then ask them their opinion and desires on the matter. After all, the minor will eventually become owner of the IRA once the custodianship ends.
Assuming that the parent or grandparent does make a gift to the minor, then what are the tax consequences to the donor? Because the donor would be making a cash gift to the natural or legal guardian of the minor, for that minor’s benefit, it will qualify for the Gift Tax Annual Exclusion since it is a present interest. That means that the donor may give up to the maximum contribution for the custodial IRA ($5,500) (assuming that the minor earned at least that much income) and because that amount is less than the Gift Tax Annual Exclusion amount i.e. Fourteen Thousand Dollars ($14,000) in 2015, it will be excluded from being a taxable gift, will not reduce the donor’s Estate or Gift Tax Exemption Amount, and no Gift Tax Return (Form 709) will be required to be filed (assuming the donor made no other taxable gifts).
If you would like to discuss this, or any other gifting strategy for the benefit of minors, please feel free to contact us and we will be happy to go over your options with you.
While all of our loved ones are important to us, when establishing a comprehensive estate plan we need to give extra attention to those individuals who have special needs. Not only must we consider the value and types of assets that these individuals will receive, but we also need to pay close attention to how these assets will be administered for their benefit and how the government assistance that such individuals receive will be affected by this new financial resource. In many cases, a Special Needs Trust may be an appropriate tool to supplement the care of such individuals while preserving their inheritance over their lifetime.
How does a Special Needs Trust work?
Whether or not the inheritance is considered a “resource” for purposes of determining if an individual can receive certain means-based government benefits is extremely important when planning for a beneficiary with special needs. If the individual’s resources exceed a certain threshold (generally a very low level) then the individual is not eligible to receive such benefits. In general, a sum of money that is devised to an individual under a will or standard trust agreement would be counted as a resource of that individual for purposes of determining if they can receive certain means-based government benefits. However, if the devise is left to such individual in a properly drafted Special Needs Trust, that money will not be counted as an available resource for that beneficiary, and they can continue to receive government benefits despite the money that is held for their benefit in the Special Needs Trust. The Special Needs Trust contains language that the funds in the trust are not to supplement government benefits, but to supplement them. In practical terms, this means that your gift to that beneficiary can be used to supplement their care while they continue to receive government benefits to provide for their support.
Why would I consider a Special Needs Trust if I have significant wealth?
Often clients are initially resistant to planning options that are designed to protect means based government benefits simply because they feel that the inheritance they are leaving the individual with special needs will be enough to provide for that individual without the need for government assistance. However, when you begin to consider the high cost of health care for individuals with special needs, even a large inheritance can be exhausted in a short period of time.
Consider, for example, if you leave a gift of $500,000 to your mentally handicapped niece as part of your Revocable Trust who currently receives SSI and Medicaid benefits. If this gift is left to her under a standard trust or as an outright devise under your Will, it will be counted as a resource for her and she will become ineligible for the means based benefits she is currently receiving. If her care costs are $100,000 per year, then depending on the rate of growth of her inheritance, this gift will only pay for approximately 5 years of care. After that time, your niece will again have no financial resources and will have to apply for public benefits to provide for her care.
If instead, the gift of $500,000 is left to your niece in a properly drafted Special Needs Trust, managed by an individual or corporate trustee, that inheritance will not be considered a resource for purposes of means based benefits eligibility. Since that gift will not disqualify her for the benefits she is receiving, she will continue to get those benefits to pay for her care and support. The money in her Special Needs Trust can be used to supplement that care by paying for extra therapies, entertainment, comfort items and other goods and services to enhance her quality of life. The inheritance can continue to grow and provide benefits to the beneficiary for decades instead of being immediately exhausted. Also, with a testamentary Special Needs Trust, there is no required payback to the state for Medicaid benefits paid on behalf of an individual during his lifetime. If the special needs individual passes, the funds in the Special Needs Trust can go to other beneficiaries as provided in the trust.
Who is going to manage the Special Needs Trust?
One of the challenges of planning for a beneficiary with special needs is that often the person putting together the estate plan is the person who has been caring for this individual throughout their lifetime. There are frequently concerns about who will care for the beneficiary and who will ensure that the money that is left will be properly managed and administered for the benefit of the special needs beneficiary. While a Special Needs Trust is a great planning tool, the administration of such Trust should be handled with special care to ensure that the Trustee is not doing anything that adversely affects the beneficiary’s government benefits. For this reason, consider a corporate or professional Trustee who has experience in managing these types of Special Needs Trusts.
If you would like to further discuss how Special Needs Trusts work or discuss whether this planning tool may be appropriate to incorporate into your estate plan, please contact one of our attorneys to discuss any questions you may have.