Articles Posted in Estate Taxes

STATE SPECIFIC PROTECTIONS

        The current aggregate value of retirement assets in America is roughly $21 trillion, with individual retirement accounts (IRAs) amounting to the largest single investment asset.  While many, if not most, types of retirement assets and accounts are protected against creditors, the IRA is not necessarily one of them.  The various protections for IRA are dependent on the amount, how long ago you put the money into your account and the state or jurisdiction you live in.  Employer sponsored plans are covered by protections found in federal law, so it is much easier to talk about what protections exist for such plans.  The Employer Retirement Income Security Act of 1974 (ERISA) created a large host of protections for employees, including protections against creditors, except when the creditor is the Internal Revenue Service (IRS) or a spouse or former spouse for debt incurred through domestic relations.  

The protections found under ERISA have expanded over time through both Congressional action and judicial interpretation of the law.  ERISA plans must provide periodic updates to the employees, information about the plan features, creates fiduciary responsibilities for the plan administrators as well as things such as an appeal process for certain decisions that the employee disagrees with.  One large collective group of accounts that are not protected, however, are IRAs.  IRAs, as the name implies, are owned by an individual and thus do not fall under the protections of ERISA.  Most protections for IRAs are found in state law.  

VERY SIMPLE CONCEPT

This blog examined the dynasty trust in the past but it is time to reexamine certain aspects of the dynasty trust.  The dynasty trust is a trust designed primarily to avoid the generation skipping transfer tax when a person wants to leave money to their grandchildren or great grandchildren (or even generations beyond that).  Before getting into the nuts and bolts of what a dynasty trust is, it is best to outline some of the basic tax issues inherent in the generation skipping transfer tax.  

Grandfather wants to leave an asset to his son, with the intention that he will leave it to his son and for him to leave it to his son and so on.  Just to make the dollar figures simple, let us assume that it worth $10 million.  For further simplicity, let us also assume that grandfather’s estate already went through the federal (and state) estate tax exemption.  That means that son has to pay the current top estate tax rate of 40%, which means that the asset is no longer worth $10 million.  Instead it is only worth $6 million.  For further simplicity, father’s estate also passed through all of his estate tax exemption, so instead of the asset being worth $6 million when it passes to the grandson, it is now worth $3.6 million in light of the 40% estate tax.  And the process goes on and on.  

FURTHER CHANGES MAY BE NEEDED

When a person receives an asset via the probate process, the transaction must be reported to the IRS, even if it does not trigger any tax liability as to the estate or the recipient.  This is because the IRS needs to track the basis of the asset to determine any net capital gains or other calculations for tax liability purposes.  Price minus basis equals profit is the rough calculation to determine how much a person realized in a sale, which in turn determines the capital gain on the sale of the asset.  

There is a tension built into the system whereby the executor wants to assign the lowest possible value to the asset, so as to keep the value of the estate low, while the beneficiary wants to have the highest possible value assigned so when they dispose of the asset in the future it will incur less tax liability.  The IRS sought to address this tension when they lobbied Congress create 26 U.S.C. § 6035, which in turn enabled them to create the new IRS form 8971.  Form 8971 requires an executor to notify the IRS which beneficiary receives what and the value of the asset.  Part of the same legislation also created 26 U.S.C. § 1014 which requires beneficiaries to use the value of the asset at the date of death for purposes of reporting basis.  This value cannot be greater than the amount that the executor reported on the estate tax return.

SEEMINGLY COMPLICATED

The Generation skipping transfer tax seems complicated to understand and it absolutely should only be dealt with by a seasoned professional, but there are some hallmarks that are present in each such transaction so that individual taxpayers know when the tax will apply and can follow a general conversation about the topic. To begin with, the name may seem a bit confusing at first. The skipping that the name refers to is the tax that would (should according to some lawmakers and IRS officials no doubt) be incurred when a second generation passes on the inherited asset.

The generation skipping transfer tax was first introduced in 1976 to avoid what Congress saw as an avoidance of the estate tax by wealthy families that could afford to hire attorneys to create complicated, long term trusts that avoided the estate tax. The net result was that less wealthy, middle class families were paying a disproportionate share of the estate taxes; in other words, those who could least afford it were paying more of the tax. The generation skipping transfer tax in its current incarnation creates tax liability anytime a transfer of an asset or money is transferred more than one generation from the grantor or to someone who is at least 37.5 years younger.

The State of New York’s estate tax does not mirror the federal estate tax regime in many ways. A lack of careful planning may result in a New York estate tax liability even where the estate is not taxed at the federal level.

New York’s Estate Tax

New York’s estate tax, like its federal counterpart, is a tax levied on the value of the decedent’s estate upon death, and before distribution. New York’s estate tax parallels the federal estate tax with some exceptions.

Julius Schaller was a Hungarian-American immigrant was a wealthy grocery store owner who had acquired substantial assets that exceeded the threshold for paying estate taxes. In order to avoid the tax burden, he established a special scholarship foundation for Hungarian immigrants who pursue performing arts. He named it the Educational Assistance Foundation for Descendants of Hungarian Immigrants in the Performing Arts. Estate planning attorneys often create such organizations for wealthy individuals. However, it must be a legitimate nonprofit organization.

The foundation was established as a nonprofit organization and granted tax-exempt status under Section 501(c)(3) of the Internal Revenue Code. But there was a catch. The foundation was a rouse. It hardly advertised the scholarship, and during the first two years of operation, the scholarships were only awarded to his heirs – specifically a nephew, niece, and another member of the family. This is a problem.

The IRS does not take kindly to those who set up fake organizations under the guise of providing a legitimate scholarship or philanthropic service to the public. As such, the IRS revoked the foundation’s nonprofit status, and litigation ensued.

The House of Representatives recently passed a bill that would eliminate the federal estate tax. The bill is expected to pass in the Senate but be vetoed by the President, thus most likely preventing it from becoming law. However, the bill does bring up an interesting aspect of the federal estate tax, namely, how small businesses and family farms need to estate plan in order to protect their assets.

Federal and State Estate Taxes

Currently, the federal estate tax applies to any estate that is over $5.43 million, and any assets over that amount in the estate can be taxed up to forty percent. State estate and inheritance taxes vary and must be checked on a state by state basis; however, some states can take a significant portion of the estate’s worth if the assets are not properly shielded by an estate plan. For example, Ohio repealed its estate tax in 2013, but Maryland has both estate and inheritance taxes up to sixteen percent on estates worth more than $1 million.

It’s not uncommon to turn on the television and see an advertisement for a state that is enticing visitors to vacation or move there permanently. However, more and more states across the nation are also trying to advertise that they are a great place to die. In 2015, four states are increasing their state-level estate tax exemption, reducing or eliminating altogether the amount of state estate tax that heirs will have to pay.

States Lowering Estate Taxes

As of January 1 next year, Tennessee’s estate tax exemption will jump to $5 million from $2 million this year. In addition, Maryland’s raised its estate tax exemption level from $1 million this year to $1.5 million next year. Minnesota is increasing to $1.5 million from $1.2 million, and in April 2015, New York’s exemption level will rise from $2.062 million to $3.125 million.

We often discuss the importance for local families to account for the New York estate tax. Far more media coverage is given to the federal tax, and some local residents are under the mistaken assumption that the state law mirrors the federal. It currently does not. Even families who do not have asset to trigger the federal tax may still need to plan appropriately for the New York tax on estates.

However, if current plans are carried out, in a few years .there may be much more congruence between the state and federal rules. That is because earlier this month New York changed exemption levels for the estate tax. Previously, assets over $1 million were exposed to the tax at a 16% top rate. Now, however, the exemption level is raised to slightly more than $2 million ($2,062,500). Not only that, but that level is set to steadily increase or five years until, in 2019, the exemption level matches the federal exemption amount at that time (projected to be $5.9 million).

Important Provisions in the Estate Tax Law

The idea of “portability” is an important part of many estate plans. Portability is technically an informal word referring to a federal tax-saving option using the deceased spouse’s unused exemption (DSUE). Essentially, portability is a tool for married couples that, when used prudently, can shave millions of dollars off an estate tax bill.

Under the current law, assets under $5.34 million are exempt from the federal estate tax (though the New York tax kicks in far lower at $1 million). Importantly, there are unlimited tax-free transfers allowed between spouses. That means that if one spouse dies and leaves everything to the other, then there will not be a federal estate tax burden, regardless of how many assets are passed on.

However, when the surviving spouse passes away and transfers those assets to others–perhaps adult children–then the tax would apply to assets over the individual exemption level of $5.34 million. But portability changes that. Instead of using only an individual exemption, a surviving couple may be able to use any unused exemption from their former spouse in addition to their own. This means that up to $10.68 million may be exempt from the tax. In short, portability can save an estate millions of dollars in taxes.

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