Klitzman Law Group, PLLC

When Should I Start Doing Estate and Tax Planning?

Estate planning creates a legal framework to manage assets in the event of incapacity or upon death and should include tax planning to protect income and inheritances. A recent article from The Street, “Don’t Be a Grasshopper: The Importance of Proactive Tax and Estate Planning,” references Aesop’s fable of the Ant and the Grasshopper. The ants are always hard at work, preparing for winter, while the grasshoppers play all summer and starve when winter comes.

Fundamentals for estate plans include having an experienced attorney create a last will and testament to convey your wishes for asset distribution. This is also done through the creation (and funding) of trusts, which take assets out of your personal ownership and place them in a separate legal entity. One of the many benefits of trusts is that assets are distributed directly to beneficiaries, without needing to go through probate.

Other estate planning documents include a Power of Attorney, which designates another person of your choice to handle financial and legal decisions on your behalf if you are incapacitated. The Power of Attorney ends upon your death, so it is only used while you are living. Similarly, a Medical Power of Attorney, sometimes known as a Healthcare Proxy, is used to give another person, also of your choosing, the power to be involved with your medical care, speak with your health insurance provider and be part of your health care decision making.

Which estate and tax planning strategies you need will depend in large part upon the size of your estate. If you own a home, a car and investment accounts, a will is needed to distribute your assets and different types of trusts may be needed. If the family includes a disabled family member, you should speak with an estate planning attorney about Special Needs Trusts. If long term care is a concern, a Medicaid Asset Protection Trust may be helpful to protect the well spouse and family.

Proactive planning can be a little more complex for those with significant wealth. Strategies like a Dynasty Trust or Irrevocable Trust may be needed for those whose estates reach estate tax exemption thresholds, which are likely to shrink considerably in the future.

When possible, communicate your wishes with the family so there are no surprises after your passing. Decide how transparent you can be with your children and grandchildren. In some families, this is accomplished with a series of family meetings. For others, holding a meeting in the estate planning attorney’s office with the attorney present to answer questions can be more productive.

Regardless of your estate size and family dynamic, taking the time to create or update an estate plan is a kindness to your loved ones. They’ll know you made an effort to prepare so they can celebrate your life and hold their memories close without the distraction of family fights or protracted court proceedings.

Reference: The Street (September 3, 2024) “Don’t Be a Grasshopper: The Importance of Proactive Tax and Estate Planning”

Don’t Wait until the Last Minute to Address Estate Exemption Changes

As a result of the Tax Cuts and Jobs Act of 2017, individuals and married couples could transfer large amounts of their wealth without incurring federal estate or gift taxes for several years. The exemptions, still now in effect, are $13.61 million for individuals and $27.22 million for married couples.

A recent article from Reuters, “Avoiding the mad dash to 2026: the use of LLCs for vanishing gift exemptions,” advises high net worth individuals and families to consider using a Limited Liability Company to use the high exemption amounts before they decrease.

By forming and funding an LLC and then gifting the ownership interest in the LLC to subsequent generations, donors receive several benefits. They can centralize management of the underlying assets, use gifting to move assets out of their estate before 2026 and integrate the use of LLC gift interests into a long-term estate planning strategy. This strategy may apply to families who own businesses and real estate property.

The federal exemption amounts need to be used by December 31, 2025. If an individual only uses $5 million of their exemption before the deadline and then the exemption decreases to roughly $7 million, they’ll only have an exemption of $2 million for future lifetime gifts or upon their death. This is a “use it or lose it” opportunity.

The IRS has confirmed it won’t “claw-back” exemptions done before the law sunsets. If a person or a couple uses their exemption in a timely manner, the estate won’t be penalized. Donors who use the full exemption will be grandfathered into the higher exemptions, if the exemptions expire.

If a surviving spouse has remaining Deceased Spousal Unused Exemptions, or DSUE, they must first use all remaining DSUE before using their own exemptions. Let’s say a surviving spouse has $8 million of remaining DSUE and $13.61 of their own gift tax exemption. They would have to make gifts of at least $21.61 to use the entire remaining exemption.

If you are considering using the LLC gift strategy, you should start by forming an LLC and transferring assets into it. The assets may include cash, securities, private investments and real estate that you would otherwise have gifted to the next generation. Once the property has been contributed to the LLC, there will be time to decide how to make the gifts.

It is possible that the legislation could be negotiated towards the end of 2025. However, the LLC will already be in place, and the assets will still be under the donor's control and ownership.

Given the uncertainty over the future of these federal exemptions, meet with your estate planning attorney now to develop a strategy to maximize wealth transfer. Other tools must also be explored, all of which take time to consider and execute.

Reference: Reuters (Aug. 26, 2024) “Avoiding the mad dash to 2026: the use of LLCs for vanishing gift exemptions”

How Does Probate Work?

Very few Americans know how long it takes to settle an estate or how probate works and are surprised when their inheritance takes months, if not years, to arrive. This, according to an article from USA Today, “Inheritance on hold? Most Americans don’t understand the time and expense of probate,” may become a problem over the next twenty years. During that time, boomers, who control about half the wealth in America, will be passing, and as much as $84 trillion is expected to move from one generation to the next.

Most inheritances are expected to go to millennials, who don’t know if their parents have an estate plan. Only half have spoken with their parents about estate plans, and more than half of all millennials don’t have a will or trust in place.

The tendency to avoid what we don’t understand, plus our discomfort with talking about money and death, is something to overcome, say estate planning attorneys.

The first parent to die isn’t where most people encounter probate. If the parent had an estate plan created, their will usually passes most assets to the surviving spouse or to a trust set up for beneficiaries. However, when the second parent dies, the adult children are the ones to deal with serving as executors, selling the family home, paying estate taxes, and waiting for probate to be finished before receiving their inheritance.

Some accounts pass by beneficiary designations, where the account owner names the people, they want to receive the asset upon their death. These assets don’t go through probate and are more straightforward for heirs.

State laws differ, so if your parents live in another state, the will is probated where they live. If there is no will, the court will apply state laws to distribute property, and the family won’t have any say in what happens to a person’s property, which could include items with great sentimental value, investments, and real estate.

Step one is working with an experienced estate planning attorney to create an estate plan to avoid or minimize probate. The estate plan also includes documents to control who will manage assets if a person becomes incapacitated, as well as who will manage their medical care. These documents are Power of Attorney and Health Care Power of Attorney.

Talking with parents, or parents talking with their children, about estate plans, is very important for all concerned, even if it is difficult. If children live in different stages, an online gathering is better than waiting until everyone is together for a holiday.

Reference: USA Today (July 30, 2024) “Inheritance on hold? Most Americans don’t understand the time and expense of probate”

How Does Probate Work?

Very few Americans know how long it takes to settle an estate or how probate works and are surprised when their inheritance takes months, if not years, to arrive. This, according to an article from USA Today, “Inheritance on hold? Most Americans don’t understand the time and expense of probate,” may become a problem over the next twenty years. During that time, boomers, who control about half the wealth in America, will be passing, and as much as $84 trillion is expected to move from one generation to the next.

Most inheritances are expected to go to millennials, who don’t know if their parents have an estate plan. Only half have spoken with their parents about estate plans, and more than half of all millennials don’t have a will or trust in place.

The tendency to avoid what we don’t understand, plus our discomfort with talking about money and death, is something to overcome, say estate planning attorneys.

The first parent to die isn’t where most people encounter probate. If the parent had an estate plan created, their will usually passes most assets to the surviving spouse or to a trust set up for beneficiaries. However, when the second parent dies, the adult children are the ones to deal with serving as executors, selling the family home, paying estate taxes, and waiting for probate to be finished before receiving their inheritance.

Some accounts pass by beneficiary designations, where the account owner names the people, they want to receive the asset upon their death. These assets don’t go through probate and are more straightforward for heirs.

State laws differ, so if your parents live in another state, the will is probated where they live. If there is no will, the court will apply state laws to distribute property, and the family won’t have any say in what happens to a person’s property, which could include items with great sentimental value, investments, and real estate.

Step one is working with an experienced estate planning attorney to create an estate plan to avoid or minimize probate. The estate plan also includes documents to control who will manage assets if a person becomes incapacitated, as well as who will manage their medical care. These documents are Power of Attorney and Health Care Power of Attorney.

Talking with parents, or parents talking with their children, about estate plans, is very important for all concerned, even if it is difficult. If children live in different stages, an online gathering is better than waiting until everyone is together for a holiday.

Reference: USA Today (July 30, 2024) “Inheritance on hold? Most Americans don’t understand the time and expense of probate”

What Happens to Federal Estate Tax in 2025?

Unless new legislation occurs, the Tax Cuts and Jobs Act of 2017 will expire, and the lifetime estate and gift tax exemption for individuals and married couples will drop significantly. With the IRS making clear it’s a “use it or lose it” proposition, a recent article titled “A Crucial Window For Estate Planning” from Financial Advisor provides some options to consider.

Lifetime and Annual Giving. These are basic strategies used to transfer wealth and minimize tax exposure. Removing assets from the estate, especially if they would have been gifted after passing, shields them from any possible future appreciation. The exclusion right now is $18,000 per individual and $36,000 for married couples. These numbers are not likely to be seen again.

Another way to reduce the estate is to pay for a family member or loved one’s medical or academic costs. Be certain to write checks directly to the school or the health care provider. If money is gifted to the person themselves, there may be gift tax consequences.

Trusts are used to minimize taxes and distribute assets with great precision. One trust used for appreciating assets, like a family business or real estate property, is the Intentionally Defective Grantor Trust (IDGT). When a trust is designated “intentionally defective,” the grantor can divide the income tax responsibility from the estate and gift tax liabilities. The assets in the trust may grow tax-free because the grantor is paying the income taxes, which reduces the estate size.

This is typically used when business or real estate assets are transferred in exchange for a promissory note, allowing the asset to grow outside the estate. The Trust repays the note with income from the business.

The IDGT has what is known as “swap power.” The person who created the trust can swap assets of equivalent value between their personal estate and the trust. These are complex estate planning instruments, and an experienced estate planning attorney must handle these strategies to achieve the desired goals.

Many other changes will occur when the TCJA expires. Speak with your estate planning attorney to prepare for them.

Reference: Financial Advisor (July 12, 2024) “A Crucial Window For Estate Planning”

Is It a Good Idea to Convert IRA to a Roth?

Converting a traditional IRA (Individual Retirement Account) to a Roth IRA is a great move if you can swing it, says an article from U.S. News & World Report, “How to Convert to a Roth IRA.” The advantages to the account owner and heirs are considerable.

The Roth IRA grows tax-free, which is good for trimming taxes during retirement when income is usually limited. It’s only available to single tax filers earning less than $146,000 or $230,000 for people filing jointly. However, higher earners can use the Roth conversion to fund a Roth from a traditional IRA.

Financial advisors say people still working should make the conversion if they are in lower tax brackets than they will be during retirement.

A good time for the conversion is after you’ve retired and before you’re required to take RMDs (Required Minimum Distributions) from the traditional IRA. The goal is to save lifetime taxes. How does it work?

When transferring funds from a traditional IRA to a Roth, the account owner must pay taxes on the amount being transferred at their current income tax rate. However, once the conversion is made, those funds grow tax-free. Even better, when you take out qualified withdrawals in retirement, the withdrawals are tax-free.

Roth conversions are a good idea for people in lower income brackets with retirement savings in IRAs. People who might be taking unpaid leave or are unemployed may also benefit from lowered income levels.

The key benefit of a Roth conversion is reducing taxes. Contributions are made with after-tax dollars, which means account owners don’t receive any income tax deduction upfront, which is what happens with a traditional IRA. However, once you start taking withdrawals from a Roth, as long as you’re 59 ½ or older and the account has been open for at least five years, you’ll enjoy not paying taxes on those withdrawals.

There is more to appreciate about a Roth IRA. There are no Required Minimum Distributions, so you can take or not take withdrawals whenever it suits your budget. As your estate planning attorney will tell you, your heirs will not pay income taxes on withdrawals or distributions either.

Then there’s the “Backdoor Roth,” where high-income taxpayers may contribute to Roth IRAs even though their income is higher than the allowable amount. This is a little intricate, and you may want to speak with your estate planning attorney about it. You make a nondeductible contribution to a traditional IRA, then convert it to a Roth IRA. This must work with any other retirement and estate planning strategies.

There are some pitfalls. You’ll need cash to pay taxes on the conversion. If you’ve done the conversion when your income tax rates are high, it may not make sense. Do this when you’re in a lower-income tax bracket.

Last thought – if you plan to pay the taxes out of the account you’re converting, the conversion will be less valuable, as the funds to pay the taxes won’t be converted and enjoy years of tax-free growth.

Reference: U.S. News & World Report (July 19, 2024) “How to Convert to a Roth IRA”

Who Should Pay Taxes on Trust Income?

Irrevocable trusts include language directing how taxes on income should be paid. This falls into two general kinds of taxes, according to a recent article from Kiplinger, “Should You or the Trust Pay a Trust’s Income Taxes?” The first category includes transfer taxes, typically in the form of gift and estate taxes and generation-skipping transfer taxes, which are less common. The second category includes income taxes, such as earned income taxes and income taxes on investments, as well as capital gains taxes, best described as income taxes on property appreciation following the sale or exchange of property.

Who is responsible for paying these taxes? Rental income from real estate, profits from trust investments, appreciation income from selling property and distributions of assets from the trust are all taxable. Trust income is reported on either the trust’s income tax returns or on the tax return of either the trust maker or the beneficiary. The trust income tax return pays taxes at trust tax rates, while the beneficiary will pay taxes at individual tax rates.

While it seems intuitive to opt for the trust to pay the taxes, trust tax rates are often far higher than individual tax rates.

Trust tax rates are higher because an irrevocable trust has only hundreds of dollars of standard deductions. Irrevocable trusts pay the highest federal taxes after a few thousand dollars of income. Unless the trust maker is already paying taxes in the highest tax brackets, it’s almost always less costly for the taxes to be paid by the trust maker.

When speaking with your estate planning attorney about how to structure an irrevocable trust, the conversation will include how the irrevocable trust’s tax responsibilities will be managed. When the trust is being created, examine your budget to ensure the taxes will be manageable.

The language in the trust is known as “grantor trust status,” permitting the trust maker or another person to pay trust income taxes.

When an irrevocable trust is treated as a grantor trust, the trust maker is treated as the owner of the trust’s income or principal and must include any items about trust income, deductions and credits on their personal tax filing. This is required even though income remains in the trust.

Making matters more complicated, in some cases, having trust income tax grantor powers may mean the trust is included in the trust maker's taxable estate. Estate taxes are different from trust taxes. If the grantor has the power to revoke or amend the trust, it may also be considered part of the grantor’s taxable estate, as opposed to a true irrevocable trust outside of their estate.

Creating and planning trusts should only be done with the help of an experienced estate planning attorney, as there are many nuances to be considered.

Reference: Kiplinger (July 1, 2024) “Should You or the Trust Pay a Trust’s Income Taxes?”

Can Estate Planning Reduce Inheritance Taxes?

If not renewed, the expiration of changes in estate and gift taxes from the Tax Cuts and Jobs Act of 2017 (TCJA) on Dec. 31, 2025, will reduce federal estate tax exemptions to $7 million for individuals and $14 million for married couples. A recent article from CPA Practice Advisor, “A Crucial Window for Estate Planning: Preparing for 2026 Changes,” reminds us the IRS has said any benefits used under the current exemption are not subject to any “claw-backs.” In other words, use this tax advantage while you can.

It’s important to note the many benefits of estate planning are not just for wealthy people. The cohort referred to as “mid-affluent”—individuals and couples with or who will have significant assets and growth—should carefully plan for future tax exposure. Someone with $5 million in assets today could see their wealth grow to exceed the future exemption thresholds, making estate planning a vital means of protecting their wealth.

There are several techniques to minimize estate tax consequences, and your estate planning attorney will be able to identify the most appropriate for your unique situation.

Lifetime and Annual Gifting. Making gifts while living transfers wealth to the next generation while minimizing your estate’s tax exposure. Right now, you may gift $18,000 per person, or $36,000 per married couple, to as many people as you wish. Making these gifts annually allows you to reduce your taxable estate and enjoy seeing the recipients benefit from your gifts.

If you’d like to help someone with tuition or medical costs, you may pay any amount you wish without generating gift taxes as long as the payments are made directly to the educational institution or healthcare provider.

Spousal Lifetime Access Trust (SLAT). A SLAT is an irrevocable trust designed to benefit the spouse. Other family members can also be named as beneficiaries. The spouse has access to the income from the trust during their lifetime, and upon the spouse's death, the remainder can be distributed as per the grantor’s wishes.

Grantor Retained Annuity Trusts (GRATs). These trusts are best in a low-interest rate environment. Assets are transferred to the trust, with the right to receive annuity payments for a set period, usually two to ten years. When the grantor dies, assets pass to designated beneficiaries.

Intentionally Defective Grantor Trusts (IDGTs). No, they’re not broken. By creating an “intentionally defective” trust, the grantor splits the income tax responsibility from the estate and gift tax implications. The grantor pays the income taxes, allowing assets in the trust to grow tax-free.

There are more, including Qualified Personal Residence Trusts, Charitable Remainder Trusts, Charitable Lead Trusts, Dynasty Trusts and Irrevocable Life Insurance Trusts.

If you expect the value of your taxable estate to come close to or exceed the future estate tax threshold, now is the time to discuss the various options with your estate planning attorney.

Reference: CPA Practice Advisor (June 13, 2024) “A Crucial Window for Estate Planning: Preparing for 2026 Changes”

What Is IRS Rule 706 and Why Should Someone to File It?

IRS Form 706 Estate and Generation-Skipping Transfer Tax Return has become a hot-button issue in the estate planning and tax worlds. A recent article appearing in Forbes addressing this issue, “How To Avoid Faulty Advice On IRS Form 706 And The Portability Election,” makes it very clear this is one to get right from the start.

The IRS was so overwhelmed by the number of private letter ruling requests it issued a rule of its own to extend the ability to make the portability election to on or before the fifth anniversary of the decedent’s date of death.

What’s the issue? Portability allows a surviving spouse to claim their late spouse’s unused tax exclusion amount. It’s known as the Deceased Spouse Unused Exclusion Amount or DSUEA. The important thing to know is the DSUEA isn’t an automatic process. The spouse must complete Part 6 of IRS Form 706, and the portability election becomes effective as of the DOD of the deceased spouse.

This allows the surviving spouse to shelter more assets upon the other spouse’s death. It effectively locks in the deceased spouse’s exemption amount and gives the surviving spouse a greater chance of not needing to pay estate taxes upon the second spouse's death.

This option will become even more critical in 2026 if the Tax Cuts and Jobs Act expires and the federal gift and estate tax exemption amounts will return to 2018 levels. With inflation, estate planning attorneys expect the revised exemption amount to be roughly $6 million.

Determining the form is unnecessary because the estate is not large enough to reach the exemption level, or it’s a waste of time to prepare the form, which could be an expensive mistake. The number of requests for private letter rulings clearly proves the value of ensuring this form is completed when administering an estate for a deceased spouse.

Speak with your estate planning attorney to learn if your estate will be impacted if the federal estate tax exemption returns to prior values. Planning ahead for the loss of a spouse and potential changes in estate tax liabilities will require time and resources to be well spent. The cost of a private letter ruling or paying federal estate taxes is far more costly.

Reference: Forbes (May 21, 2024) “How To Avoid Faulty Advice On IRS Form 706 And The Portability Election”

Does Your Retirement Plan Include Moving to a Lower Tax State?

People have long moved from high-tax to low-tax states. However, this movement increased during the pandemic and continues today. The response from high-tax states has become aggressive, especially in cases where people maintain a home in two states and try to pay taxes only in the less costly state. A recent Forbes article issues a clear warning: “Beware The Tax Traps Spring On Those Who Move In Retirement.”

These states levy a tax on income, estate and sales taxes based on where people make their legal domicile. However, determining where you live isn’t quite as cut-and-dried as people think. Tax departments in high-tax states have amped up their residency audits. When the system sees someone who once filed an income tax return as a full-time resident begins filing as a part-time resident or doesn’t file, the state wants to ensure that it’s not missing out on any revenue.

A residency audit is conducted. It may consist of a questionnaire asking about where the person lives, asking them to provide information about their lifestyle and providing details about the property they own in both states.

An aggressive state will search property records and other public records for evidence of ongoing connections to the state. Social media has become part of this information gathering, no matter how private people may set their profiles.

If you’ve moved for retirement or enjoy the benefits of living in two or more states, you’ll need to choose a state and prove your legally established residence in that state. Ideally, you’ll do this long before the residency audit arrives.

Did you already receive a letter from a state tax authority asking questions? Chances are the state has already begun investigating your status. The letter might include a questionnaire, an interview request, or both.

If you haven’t yet moved, consider how you’ll respond to these questions:

• Where do you vote?
• Where are your cars, boats, or other vehicles registered?
• Do you belong to a house of worship, and if so, where is it located?
• Do you have an estate plan, and what address does it show?
• Where do you own property, and how much time do you spend at each location?
• Do you belong to any social clubs – country clubs, bowling leagues, gyms, or community groups?
• If you own a business or are an employee, where is your business or employer located?

You’ll need to demonstrate where you live and whether you’ve truly cut ties with your prior state of residence. A final word of advice: don’t go into a residency audit unprepared or unrepresented. The possibility of paying taxes in two states should motivate you to make any necessary changes.

Another detail to consider when moving to retirement is that an estate plan made in one state may not be valid in another state. A local estate planning attorney in your new domicile should be consulted to review your will, power of attorney, healthcare directives and other state-specific documents to ensure they will be effective in your retirement home.

Reference: Forbes (April 23, 2024) “Beware The Tax Traps Spring On Those Who Move In Retirement”