Klitzman Law Group, PLLC

Prepare Now for Coming Changes to Estate Taxes

Anyone who wants to leave their estate to heirs needs to plan now so their wishes will be followed and, equally importantly, to minimize their estate’s tax liability. A recent article from The San Diego Union-Tribune asks, “Are you prepared for changes to estate tax laws? Here’s what you need to know.”

Because of the Tax Cuts and Job Acts of 2017, taxpayers who die in 2024 can pass up to $13.61 million federal tax-free to their heirs. In 2025, this amount will be adjusted for inflation. On January 1, 2026, the federal basic exclusion amount reverts to $5 million indexed for inflation. Many experts expect this to adjust to $6.5 to $7 million.

When calculating the total value of one’s estate, the IRS looks at all taxable gifts made while you are living, and all assets transferred upon your death. This includes the value of your home and its contents, retirement and investment accounts, life insurance not owned by an irrevocable trust, cash, annuities, boats, vehicles and bank accounts.

Estate planning must include tax planning. With the right planning, preserving the 2024 and 2025 higher exclusions may be possible through a lifetime gifting program. Let’s say the exclusion amount in 2026 is $7 million. You’d have to gift more than $7 million before January 1, 2026, to preserve the current exclusion amount.

Two years ago, in April 2022, the Treasury and IRS published Proposed Regulation Section 20.2010-1(c)(3) to limit certain types of gifts from qualifying for the current exclusion and restrict benefits of certain types of gifts if they were made within 18 months of the date of death. This regulation is still proposed and not final. However, you and your estate planning attorney must remember it during the estate planning process.

If making large, multi-million-dollar gifts is not possible without constraining the taxpayer’s lifestyle, there are other gifting strategies to use to take appreciating assets out of the estate over time. One way to do this is to make annual exclusion gifts every year. These are gifts that pass entirely tax-free. In 2024, a taxpayer could gift up to $18,000 per person to an unlimited number of people without paying any gift taxes.

Gifts to 501(c)(3) charities of any amount can be made tax-free with no gift or estate tax. This includes gifts made while you are living or after you have passed.

It is also permissible to pay an unlimited amount for tuition for an unlimited number of people, if the payment is made directly to the educational institution. These gifts may not include room, board, or fees. Similarly, one person can pay for another person’s medical expenses if the payment is made directly to the healthcare provider.

There are many ways to prepare for the coming changes to tax laws. What is right for one person may not be right for another, as everyone’s circumstances are unique. Discussing how to prepare for these changes with your estate planning attorney should take place soon, as it takes time to work out the details of a new estate plan and you can be sure estate planning attorneys will be very busy in 2025.

Reference: The San Diego Union-Tribune (April 30, 2024) “Are you prepared for changes to estate tax laws? Here’s what you need to know”

Will I Need to Pay Taxes on Inheritance?

It happens all too often: a couple has an estate plan created, including a last will, upon the birth of their first child. However, it’s never updated when a second child is born. Or a man neglects to update his named beneficiary on a retirement account after he and his first spouse divorce. Failing to update wills or beneficiary assignments results in problematic situations for heirs, according to the article “Inheritance Tax: What Happens When You Split What You Inherit With Someone Outside of the Will?” from Go Banking Rates.

When someone inherits money or other assets, they sometimes must pay taxes on it—if they live in one of only six states still having an inheritance tax. Those states are Iowa, Kentucky, Nebraska, New Jersey, Pennsylvania, and Maryland.

The taxes range from 0% to 16% on assets with a value greater than the state threshold. The rates also vary depending on the relationship between the decedent and their heir.

If you live in Nebraska, as of 2023, any immediate family members must pay a 1% tax on inherited assets if the estate is valued at more than $100,000. Heirs not immediate family members must pay 11% for assets valued over $40,000 and 15% for assets worth more than $25,000.

If you live in Pennsylvania and are a minor child under age 21 or a spouse, you don’t need to pay an inheritance tax. However, children of the decedent do have to pay one.

Inheritance tax is different than estate tax. The federal government doesn’t levy an inheritance tax but has an estate tax. Heirs pay the inheritance tax, while the deceased person's estate pays estate taxes.

To get a rough idea of the estate’s value, the executor adds up the fair market value of all assets the decedent owns, including property, cash, investments, cash and insurance. The executor must next add all liabilities: credit cards, mortgages, car loans, etc. Subtracting the total liabilities from the assets results in the value of the net estate. An estate planning attorney will be able to help determine an accurate value.

In 2024, the threshold for estate tax is $13,610,000, paid only by a few Americans.

Some states also have an estate tax. This includes Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. State estate taxes vary considerably, from as low as 0.8% to 20%. A local estate planning attorney will know your state’s estate tax and how to structure your estate plan to limit tax liabilities.

Inherited property is taxable if you sell it for more than it was worth when it was first inherited. Let’s say someone leaves you a valuable sailboat with a fair market value of $100,000 when you inherit it. If you don’t want it and sell it for $200,000, you have a capital gain of $100,000. You’ll likely owe capital gains tax on the difference.

If someone neglected to update their estate plan and a sibling was left out of the will, you can make them whole by sharing the estate. However, you’ll have to inherit the asset first and then determine how to distribute it. An estate planning attorney is the best resource to solve this problem.

Reference: Go Banking Rates (April 8, 2024) “Inheritance Tax: What Happens When You Split What You Inherit With Someone Outside of the Will?”

Supreme Court Considers Case on Estate Insurance Tax Treatment

The U.S. Supreme Court could soon rule on a case that would significantly impact succession plans for closely held businesses and put those plans at risk for higher taxes, as reported in a recent article from Bloomberg Tax, “High Court Signals Doubt Over Estate Insurance Tax Treatment.”

Thomas Connelly and his brother created a buy-sell agreement for their family business, Crown C Supply Co. In the agreement, whichever brother survived the other had the option to buy the other’s stock or required Crown to redeem the stock, using proceeds from the company's life insurance policies for both brothers. Michael passed away, and his brother followed the terms of the agreement.

The IRS’s position is that Michael’s redeemed stock is worth more than reported, since the company’s value increased when it received the insurance proceeds. According to the IRS, Michael’s redeemed 77% equity interest was valued at $5.3 million. The estate had reported a value of $2.3 million less, since it did not include the value of the insurance proceeds.

Thomas claims the company’s net worth did not increase because the insurance proceeds were offset by the agreement to redeem his brother’s shares.

An assistant to the Solicitor General asked the Court to distinguish between an obligation to outside creditors and the value to an equity interest holder. Redemption gives one shareholder cash in exchange for their assets, while the other is to maintain control of the company.

To date, at least three Circuit Courts have addressed the issue of whether life insurance proceeds used for a stock exemption increase the company’s value. Unfortunately, they don’t all agree. In legal circles, the expression is “Courts are split.”

For business owners with buy-sell agreements incorporating insurance policies, this decision could have significant ramifications for their estate plan. What had been a relatively straightforward estate planning tool may not be allowed after the Supreme Court releases its decision.

Should the Court rule against the estate, there are several alternative planning options. An experienced estate planning attorney can guide privately held businesses in structuring and funding their buy-sell agreements.

Reference: Bloomberg Tax (March 27, 2024) “High Court Signals Doubt Over Estate Insurance Tax Treatment”

Estate Planning for a Taxing Inheritance

Estate planning should address tax planning to accomplish several goals. In addition to minimizing tax liability, tax-sensitive estate planning can ensure family members inheriting wealth are given a helpful asset, not a costly one. A recent article, “Inheriting Tax Liabilities” from Financial Advisor, explains how this can be done.

A beneficiary inheriting a pre-tax traditional IRA has to pay full state and federal income tax on any withdrawals, which must occur within ten years. Demographics show this inheritance most often occurs when the heirs are in their careers' highest tax income bracket, making it a double tax whammy.

There’s no step-up in basis for a traditional IRA. A $3 million IRA isn’t a $3 million IRA when it’s inherited. If the person inheriting the IRA is in a high-tax state and is also a high-income earner, they could lose nearly 45% every year when taking their required distributions.

The timeframe for IRA inheritances is tricky. Let’s say a couple works hard and saves in their tax-deferred 401(k) for three decades. When they retire, they roll those savings into traditional IRAs. When the second spouse dies, her children will probably be 55 to 60 years old, when people are usually in their highest earning and taxable years.

Another hitch: inherited IRA distributions can’t be donated to charity or kept in the IRA to be passed along to the heir’s children.

How to address this? It depends.

If there are two adult children and one has more modest wages and resides in a low-tax state, giving the lower-income heir a larger percentage of the IRA will result in a larger after-tax amount. If the other child is a high-income earner, bequeathing after-tax assets may make more sense. The two heirs may end up with the same amount when adjustments are made to their circumstances.

In some instances, it makes sense for the parents to convert traditional IRAs to Roth IRAs and pay the taxes to give heirs the advantages of the Roth IRA. Another strategy is to bequest pre-tax IRA assets to a charity and give heirs tax-free assets.

Think less about equal inheritances and more about adjusting assets to end up with the same spendable savings.

The same adjustments will be helpful when planning for illiquid assets like the family home. Preparing assets like real estate or art collections requires time, and the cost of commissions and marketing can reduce the inheritable value of the assets.

An inheritance is a gift to loved ones, improved by clear-sighted estate planning that considers the individual family’s circumstances in more depth. Review your family’s entire picture with your estate planning attorney so the end results will truly be what you wish.

Reference: Financial Advisor (March 15, 2024) “Inheriting Tax Liabilities”

Do I Pay Taxes on Wedding Gifts?

A generous gift for a child’s wedding doesn’t necessarily cause a tax problem unless your lifetime gifts are over the lifetime exclusion limit, which is extremely high right now. A recent article from Yahoo! Finance, “Do I Need to Worry About the Gift Tax If I Pay $60,000 Toward My Daughter’s Wedding?” says most Americans won’t have to worry about the gift tax.

In 2024, the lifetime exclusion is $13.61 million per person and $27.22 million for a married couple. Unless you’ve gone above and beyond these limits, you can make as many gifts as you like to anyone you choose without worrying or paying the 18% to 40% federal gift tax.

But there’s one thing to remember: if you make a gift over the annual gift limit, which is $18,000 per person in 2024 or $36,000 for a married couple, you need to send the IRS Form 709. The form should be submitted even if no gift taxes are due. It’s a simple and smart move.

How do gift taxes work? The federal gift tax doesn’t come into play often. Most gifts are tax-free simply because of the size of both the annual and lifetime gift exclusions. You can gift freely if you keep the limit in mind.

The lifetime exclusion for gift and estate taxes is so high right now that few Americans need to worry about it. If you are generously minded, you may gift $13.61 million (individual) and $27.22 million (married couple). The lifetime exclusion is just as it sounds: the number of gifts you may give during your life or as part of your federal estate.

If you are charitable-minded, you may make many contributions. There are no gift taxes levied on charitable donations, gifts to spouses or dependents, or gifts to political parties. As long as you pay directly to the institutions, there are no taxes on college tuition or healthcare expenses.

If you have a wedding coming up and are concerned about gift taxes, you can pay the vendors directly rather than giving money directly to the happy couple.

There are some strategies to manage the gift tax. One would be to split your $60,000 gift between your daughter and her fiancé. Both gifts would be under the 2024 $36,000 per person exclusion, assuming you are married, so there would not be a gift tax.

Another tactic is to spread the gift out over a few years. Let’s say you’re a single parent. You could gift your daughter and her fiancé $15,000 each this year and next, keeping you below the $18,000 annual gift tax exclusion.

If you’ve already given a gift of $60,000 to your daughter and made gifts over and above the $13.61 million lifetime exclusion, speak with your estate planning attorney to determine where you fall in the gift tax brackets and how much you’ll need to pay.

The easiest way to avoid gift taxes is to pay the vendors directly, but this depends on your overall situation. For instance, where is the money coming from—tax-deferred accounts or investment accounts? It would be wise to talk with your estate planning attorney before making a large gift.

Reference: Yahoo! Finance (March 14, 2024) “Do I Need to Worry About the Gift Tax If I Pay $60,000 Toward My Daughter’s Wedding?”

Acting Now Before Historically High Estate Tax Exemption Sunsets

It’s unclear what the federal estate tax will look like after 2025, with the future of the exemption and many other provisions from the 2017 law provisions hinging on the outcome of the 2024 election. Given the uncertainty, a recent article from Bloomberg Tax Daily says succinctly, “Rich People Rush to Offload Wealth Before Estate Tax Break Drops.”

Estate planning attorneys advise clients impacted by the possible dramatic drop in the federal exemption to act now. Waiting until 2025 may lead to attorneys fully engaging with clients who began the process early and may not have time for latecomers.

Wealthy taxpayers have slowly started making gifts since 2018 to take advantage of the increased exemption, but estate planning attorneys have noted a significant uptick in activity. Planning for these gifts years before the sunset helps prevent “donor’s remorse” and ensures clients that their estate lawyers will have time for new returns, appraisals of assets and other associated tasks needed.

Last-minute plans could result in transferring too much or not the right assets, or they could leave parents without adequate assets to maintain their lifestyle.

The IRS published guidance in 2019 affirming that taxpayers can use the higher exemption amount and will not be penalized later if it changes. In other words, use or lose it.

To take advantage of the current exemption amount, several types of trusts should be considered. One of the most widely used is to create a Spousal Lifetime Access Trust (SLAT). This allows the donor spouse to still receive benefits from the assets, since their partner now controls them. However, if there is a divorce or the beneficiary dies, the donor loses access.

Another option is a Dynasty Trust, which benefits future generations. A taxpayer could also put a business asset with continued appreciation in the trust and still pay the income tax, further lowering the value of their estate. As dynasty trusts are intended to be in place for numerous generations, they need to be designed by an experienced estate planning attorney to conform to the law and have some flexibility as well.

A common strategy is adding a trust protector who can modify the agreement. The donor chooses how the protector can alter the trust, which may be adding or removing beneficiaries or tweaking the trust based on future changes to the law.

Caution must be used while planning to use the elevated exemption before 2026. For instance, if gifting a property like a home they live in, people should think carefully before taking action. Planning must consider whether the assets gifted or placed in trusts will be needed in the coming years, especially if the family’s assets are just at or less than the elevated amount.

Reference: Bloomberg Tax Daily (Feb. 28, 2024) “Rich People Rush to Offload Wealth Before Estate Tax Break Drops”

What Women Preparing for Retirement Need to Know

One woman’s story is a warning to everyone. Four months after Caroline S. married for the second time, she received a notice from the IRS about back taxes her new husband owed—$1,600 would be taken from her tax refund to make up the difference. Her new husband blamed his ex-wife, saying she hadn’t prepared their returns correctly. A few months later, the IRS put a levy on the couple’s new joint bank account and froze the funds because he was not paying withholding taxes.

As described in the article from Kiplinger, “What Every Woman Needs to Know Before Retiring,” it took two years and $50,000 of Caroline’s money to clear her debt to the IRS. There had been no sign of her second husband’s having financial problems and no reason for her to be concerned about the IRS until there was. Her advice: Keep your eyes wide open and your accounts separate.

Not knowing their household’s financial situation is among the biggest missteps women make. If they find themselves single, through divorce or death, the challenges can be daunting. Women tend to live more years in retirement and earn roughly 84 cents for every dollar men earn. Women represent 55% of all Social Security beneficiaries aged 60 and older, and their percentages rise as the population ages. The highest rate of divorces now involves couples between ages 55 and 64.

However, youth is no guarantee of financial security. One couple was in their mid-forties when the husband died. The wife, a self-proclaimed planner, had wisely addressed estate planning and legal issues when they were relatively young. There were living wills and trusts established, and life insurance policies purchased. The husband had gone to medical school after a successful career in engineering and had $100,000 in outstanding student loans, which were canceled because only his name was on the loans.

Even with all of their planning, this widow had a lot to deal with, managing trusts, bank and investment accounts, credit card transfers and the avalanche of paperwork and digital assets following the death of a spouse.

How to prepare? Have a complete team of advisors, including an experienced estate planning attorney, a financial advisor and an accountant. An estate plan should be integrated with tax planning and household budgets. This checklist can help:

• Have the money conversation before moving any relationship into serious waters. Make sure that you’re on the same page as your partner and get full disclosure of their financial status.
• Don’t leave financial matters for your spouse or partner to handle without being involved at all.
• Familiarize yourself with everything – all property, all accounts, all debts—and be a part of all decisions.
• Fully fund your own 401(k), IRA or other retirement account.
• Consider adding life insurance and long-term health insurance to cover future hardships.
• Make sure wills and other estate planning documents are current and update them periodically.
• Ask your estate planning attorney whether each person in the couple needs to have their own trust.
• Keep individual loans in separate accounts, so the surviving spouse will not be liable for the debt.
• Don’t mingle accounts and funds any more than absolutely necessary to run the household.
• Keep at least one credit card in your name only. An individual credit history can go a long way if you are divorced or widowed.

Reference: Kiplinger (Feb. 24, 2024) “What Every Woman Needs to Know Before Retiring”

New Required Minimum Distribution Rules for 2024

In 2023, the SECURE 2.0 Act changed the age for starting RMDs (Required Minimum Distributions) to 73, and in 2033, the age will change to 75. Depending upon your income from RMDs and other sources, premium costs for Medicare could increase once withdrawals begin, and taxes may also be higher, reports the article “Don’t Overlook These New RMD Rules for 2024” from U.S. News & World Report.

RMDs are required distributions taken from traditional IRAs and 401(k)s after a certain age. There are expensive consequences for missing withdrawals, and some guidelines relating to charitable giving and Roth 401(k) RMDs.

Before the SECURE 2.0 Act, the age to start RMDs was 72. In 2024, if you were born between 1951 and 1959, you must start your RMDs after age 73. Were you born in 1960 or later? You can delay RMDs until you reach age 75.

Deadlines are important to know. You may get a little more time to take your first RMD. However, subsequent RMDs must be taken each calendar year. If you’re celebrating your 73^rd birthday in 2024, you have two choices: you can take your first RMD by December 31, 2024, or you can choose to wait until April 1, 2025. However, if you decide to wait until April, you’ll have to take a second RMD by December 31, 2025.

RMDs are calculated on the prior year’s account balance on December 31, so delaying an RMD isn’t always the best strategy. Having to take two RMDs in the same year will mean, in most cases, the RMD will be slightly higher for year two.

What you pay for Medicare Part B and D premiums is related to income. If you delay taking withdrawals until age 73, your income could be lower, and your premiums could be less. Once you start taking RMDs, your income may go up, and Part B and D premiums may be more expensive.

You'll face penalties if you fail to take an RMD at the right time. Before the SECURE Act 2.0, the tax penalty was 50% on the required amount not withdrawn. If you failed to take an RMD of $2,000, you’d need to pay $1,000 in penalties. The penalty is now 25%. This is better, but still costly. If you miss a $2,000 RMD, the penalty will be $500. However, if the error is corrected within two years, the penalty drops to 10%, so it pays to address the issue. In some cases, if you can prove the RMD was due to a mistake and demonstrate that reasonable steps were taken to address the issue, you might get lucky, and the IRS could waive the penalty altogether.

Talk with your estate planning attorney about tax planning for RMDs. There are several strategies, including making charitable donations directly from IRAs and 401(k)s, which may be appropriate for your situation.

Reference: U.S. News & World Report (Jan. 26, 2024) “Don’t Overlook These New RMD Rules for 2024”

Plan for 2024 Income Taxes as the New Year Gets Underway

You may have many questions about the IRS’ adjustments. Now is the time to consider what moves to make in 2024 for the tax year ahead, according to a recent article from l Advisor, “Best Practices: 2024 Income Tax Planning.” Deferring income could provide tax savings, or bunching itemized deductions in 2024 to take a standard deduction the next year could help save money over the long run.

The current inflation-adjusted lifetime exemption—the amount the IRS permits an individual to give away throughout their lifetime without needing to pay federal gift tax—is, for now, still very high, at $13.61 million. Now is the time to speak with your estate planning attorney about options for philanthropy and grants, whether gifting to a charity, making direct contributions to an IRA, or supporting a 529 college savings plan.

A discussion should also take place with your CPA to discuss tax loss harvesting and liquidating assets depending on personal needs and market performance. Positioning your portfolio to maximize the benefit of a lower tax rate on long-term capital gains investments and qualified dividends should also be considered.

As we move through a presidential election year, tax chatter is likely to pick up. The sun-setting of federal estate tax exemption laws and the IRS’ increased scrutiny on high-net-worth individuals may impact estate planning and exemptions.

The IRS is funding thousands of new agents and adopting new technology, including AI and analytics, to improve oversight with a focus on pass-through entities including LLCs, GPs, LPs and S-Corporations, among others.

With the federal estate tax exemption anticipated to end at the close of 2025, now is the time to prepare. Maintaining the current exemptions for another ten years would cost the government $3.3 trillion, so it is likely sunset at the scheduled time. The rules cover higher standardized deductions, reduced estate tax, lower tax rates at all levels, qualified business income and a $10,000 limit on state and local tax deductions.

Reference: Financial Advisor (Jan. 25, 2024) “Best Practices: 2024 Income Tax Planning”

How Do I Use Donor-Advised Funds?

Under current tax laws, if you own an IRA and are 70½ and older, you may directly donate $100,000 to a charity without needing to report the contribution as income. According to the article “Donor-Advised Funds And Tax-Wise Charitable Giving” from Financial Advisor, this is referred to as a QCD or Qualified Charitable Distribution.

A QCD is a great way for people over 70 to support a charity, while saving on taxes. The donor gives pre-tax money to a cause they care about, creating a dollar-for-dollar income tax deduction. It’s beneficial for filing 2024 taxes when the federal standard deduction for those over 70, married, and filing jointly stands at more than $30,000 (including the additional amount for seniors). Also, there are limits on state and local income tax deductions. Because of the high standard deduction and state and local limits, and most seniors are unlikely to have much in the way of deductible interest charges, all or most of a person’s annual donations to charity are not tax deductible. Using the QCD, taxpayers can get deductions in a different way.

People looking for innovative tax strategies face another problem created by the 2019 SECURE Act. If taxpayers inherit money from IRAs or 401(k)s of deceased parents or other relatives, they must add those proceeds to taxable income within ten years. Chances are their inheritance will come during their peak earning years, meaning their taxes will rise much more than if they were retired when income would be lower.

The combination of higher income taxes and less time to grow inherited retirement accounts could easily mean a loss of nearly twice as much as what heirs would have lost before the SECURE Act.

The SECURE Act tax hurdles don’t stop there, making estate planning with taxes in mind an even more critical part of financial plans. Most IRA and 401(k) heirs, especially those with small mortgages, won’t receive a full federal income tax deduction for what they give each year. Some of these deduction issues could be resolved if deduction limits are restored starting January 1, 2026, when the Tax Cuts and Jobs Act might end. However, the SECURE issues remain.

One solution might be for the IRA or 401(k) account owners to create a pool of money, effective upon their deaths, which the children can use later for their annual charitable donations. The pool of money could be created by designating a donor-advised fund (DAF) as a beneficiary of all or a portion of their retirement accounts when they die. Here’s the general concept: if the children are going to be making annual charitable donations during their lifetimes, the owners arrange it so the children don’t use mainly after-tax funds to make their donations. Instead, they can use pre-tax money from the charitable vehicle.

Talk with your estate planning attorney about how making donor-advised funds part of your estate plan could alleviate tax burdens for you, your estate and your heirs.

Reference: Financial Advisor (Dec. 6, 2023) “Donor-Advised Funds And Tax-Wise Charitable Giving”