Articles About Estate Planning

The Tax Cuts and Jobs Act of 2017 made substantive changes to the Internal Revenue Code and in the process, created several new provisions, including “Qualified Opportunity Funds” (QOFs), which were designed to encourage taxpayers to invest in certain low-income (and also newly created) “Qualified Opportunity Zones” (QOZs) by offering some particularly unique (and potentially potent) tax benefits. Specifically, by investing into a QOF, a taxpayer gains the ability to defer taxes from the sale of any asset (including intangible assets like stocks), as long as the portion of the proceeds attributable to the capital gains on the asset that’s been sold are reinvested into a QOF within 180 days. Moreover, the portions of those deferred capital gains reinvested into the QOF are eligible for potentially two partial basis increases (once after five years and again after seven years), and if the investors hold the QOF for at least ten years, then all of the tax attributable to the gains of the QOF, itself, are completely eliminated if the QOF is sold.

Of course, such tremendous tax benefits don’t come without potentially prohibitive caveats, and there are many when it comes to QOFs. Specifically, capital gains on the sale of an asset that aren’t reinvested (on a timely basis) into a QOF by December 31, 2019 (a little over 4 months from the date this article was published) won’t be eligible for all of the available basis increases. Moreover, any still-deferred gain will become taxable either when the QOF is sold, or at the end of 2026 (whichever comes sooner).

Older potential QOF investors, or those with predictably shorter life expectancies, should also be aware of the disadvantages to beneficiaries who inherit a QOF. Typically, assets originally purchased with non-retirement funds receive a “step-up” in basis upon the death of the owner, giving the beneficiary the opportunity to sell the asset with little to no tax consequence. However, the gains that were originally reinvested into a QOF do not receive a step-up in basis, but instead, become income in respect to a decedent (IRD). Which means that QOFs tend to make poor estate planning vehicles, particularly when compared to other potential options. Plus, given the forced inclusion of any still-deferred gain at the end of 2026 and the extremely illiquid nature of QOFs, a beneficiary with limited other financial resources could find themselves between the proverbial “rock” and “hard place."

Ultimately, the key point is that for many older investors (or younger investors with shorter life expectancies), there may be better alternatives than a QOF, especially when considering the potential benefits, or lack thereof, for their heirs. Some of these include, not selling the asset in the first place (and waiting instead to simply bequest an appreciated asset, which will eventually receive a step-up in basis), maintaining the eligibility for a step-up in basis by using a 1031 exchange (but only in the case of real property), or making use of a charitable trust. Although QOFs do offer several unique and useful tax benefits that can’t be found in any other vehicle, older investors, in particular, should look carefully at more mainstream gain management strategies before going down the QOF road.

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Planning for incapacity is one of the most important aspects of a sound financial plan, and one that is taking on increased importance as the Baby Boomer generation continues to age in record numbers. But while medicine has not yet reached the point where it can prevent (or reverse) all cognitive and physical impairments, there are a number of tools that can be used to ensure one’s finances continue to be managed effectively in the event that diminished capacity becomes a reality.

One common approach used by individuals looking to allow a trusted family member to manage an account on their behalf is to simply add that person to the account as a joint owner. These so-called “convenience accounts” are generally easy to establish, but can lead to a number of unforeseen problems.

For instance, once an individual is added as an owner to an account, they have access to the funds within the account and may be able to use those funds for their own benefit, as opposed to their intended purpose. Similarly, adding an additional owner to an account can subject the account’s assets to the new owner’s creditors. Even in the best of scenarios, this “strategy” can prove problematic, as certain assets, such as IRAs and other retirement accounts, cannot be turned into joint convenience accounts in the first place.

A second way of allowing someone to assist in the management of an account is through the use of a Power Of Attorney. Powers of Attorney are tried and true legal documents that can be drafted in a number of ways to meet an individual’s desired outcome. A General Power Of Attorney, for instance, can be used by a Principal to grant an Attorney-In-Fact a broad array of powers over virtually all assets. A Limited Power Of Attorney, on the other hand, can be used to give an Attorney-In-Fact only specifically enumerated powers, and/or powers over only specifically enumerated assets.

When using a Power Of Attorney to provide for account administration in the event of incapacity, it is critically important to make sure that the Power Of Attorney actually remains in force at that time! Thus, instead of a Nondurable Power Of Attorney, which is no longer effective once the Principal is incapacitated, planning should incorporate either a Springing Power Of Attorney, which typically only becomes effective at the time of incapacity, or a Durable Power Of Attorney, which is effective upon execution of the Power Of Attorney document and remains in effect even after incapacity.

Finally, some individuals may wish to use a Revocable Living Trust to allow for continued management of accounts and financial matters in the event of their incapacity. Revocable Living Trusts are often more expensive to create, but because the Revocable Living Trust actually takes title to accounts and assets, they also offer benefits not available when a Power Of Attorney is used.

Revocable Living Trusts, for example, are less likely to be rejected or held up in lengthy legal department reviews by financial institutions. Also, unlike the rights conveyed to an Attorney-In-Fact via a Power Of Attorney, which end no later than the Principal’s death, the rights granted to a Trustee via a Revocable Living Trust can continue after the Trust creator’s death, allowing for effective post-death management of assets as well.

Notably, though, whichever approach(es) is(are) used, it is critical to act before an individual becomes incapacitated and can no longer legally act on behalf of themselves. Powers Of Attorney should be submitted to financial institutions before they are actually needed, and Revocable Living Trusts should be properly established and funded in advance. Absent such actions, one’s financial affairs may be left up to the mercy of the courts... when time is of the utmost importance.

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The Irrevocable Life Insurance Trust (ILIT) has long been a staple of estate planning – a means of avoiding the death benefit of a life insurance policy from being subject to estate taxes by having it owned not by the insured or family themselves, but an independent third-party trust holding the life insurance for the family’s (beneficiary’s) benefit instead. Which was necessary in a world where, as recently as 10-20 years ago, even basic term insurance for a 30-something-year-old breadwinner to protect the children in the event of an untimely death could cause an estate tax liability.

But the drastic increase in the estate tax exemption, especially with last year’s doubling to $11.2M (or $22.4M for a married couple with portability) under the Tax Cuts and Jobs Act of 2017, has not only removed more than 99% of households from Federal estate tax exposure, but has rendered a large number of existing ILITs unnecessary for families who once had an “estate tax problem” in the past (when exemptions were lower) but won’t be in any foreseeable future.

And the good news is that despite the “irrevocable” label in its name, in many cases it is possible to either “rescue” life insurance out of an ILIT that’s no longer needed, or to unwind the ILIT altogether. In some cases, it may be as straightforward as the grantor simply substituting the life insurance policy out of the ILIT in exchange for cash of equivalent value (or alternatively buying the policy back). In other scenarios, if the life insurance itself is no longer needed, it may be easiest to simply let it lapse, rendering the ILIT irrelevant because it would no longer have any assets left to oversee. And if the life insurance policy has cash value, it can simply be surrendered or sold in a life settlement transaction, with the cash potentially distributed to beneficiaries (at least if the trustee has discretion to do so). Alternatively, if the beneficiaries themselves want to keep the policy, it may be feasible to distribute the policy in-kind under the trustee’s discretion, or to terminate the trust outright (either under the terms of the trust, as a consent termination of the grantor and beneficiaries, or court-directed termination at the direction of the beneficiaries).

Of course, the caveat is that the trustee must still honor the terms of the trust, and if the trust is more restrictive in preventing various “unwinding” or policy rescue options, the parties are still bound by the terms of the trust (unless, perhaps, the ILIT can be decanted to a new trust under state law). Nonetheless, the fact remains that while the “irrevocable” nature of an ILIT means the terms of the trust itself cannot be changed, that doesn’t mean the grantor, beneficiaries, and trustee can’t work within the terms of the trust and state law to eliminate an ILIT that is no longer necessary in today’s estate tax environment!

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Over the past several years, the rise of the Federal estate tax exemption has dramatically reduced the scope of “traditional” estate planning, which is less about estate tax planning now and more about simply ensuring that the right legal documents are in place to specify how various assets should be disposed of, and who is responsible for doing so.

Yet at the same time, the rise of the digital world has created a new wrinkle for estate planning: how to transition “digital” assets. Which is important not only for those digital assets that can carry a monetary value (such as cryptocurrencies, domains, websites, etc.), or login credentials to such sites (e.g., usernames and passwords to bank and investment accounts), but also social media profiles and actual media files (e.g., digital photos). As once the account owner passes away (or is merely incapacitated), the heirs may have difficulty finding and accessing those digital assets after the fact.

While it might seem simple enough to solve the problem by just keeping a list of account credentials “in a safe place” for someone to use “just in case”, the fact that they might have the information to access to the accounts doesn’t necessarily mean that they have the legal authority to do so, especially when a website’s Terms of Service do not permit a transfer of ownership. In fact, heirs could potentially be found guilty of “hacking” by trying to access a loved one’s online accounts after he/she is gone… even if it was the individual’s dying (but not legally binding) wish!

To address the situation, various legal measures have been proposed in recent years, including the Uniform Fiduciary Access to Digital Assets Act (UFADAA), and the Privacy Expectation Afterlife and Choices (PEAC) Act. But after various implementation struggles, the Uniform Law Commission ultimately created the Revised Uniform Fiduciary Access to Digital Assets Act (RUFADAA) in 2015, which received widespread support and in just a few years has been adopted by more than 40 states.

RUFADAA gives a clear hierarchy of instructions for how a person’s digital assets are to be treated should a fiduciary seek access, which may include not only executors after death, but trustees, court-appointed guardians, and attorneys-in-fact. The starting point is that online service providers can create an “online tool” that functions as a form of “digital power of attorney” to specify who has control and access for that specific site. In addition, RUFADAA provides a clear legal framework for digital asset rights to be specified in traditional legal documents (e.g., Wills and powers of attorney). And clarifies that it’s only in the absence of an online tool, or any legal documents, that finally the service provider’s own Terms of Service will control.

Ultimately, the importance of estate planning has always been about ensuring that assets are distributed in the desired manner after death, and identifying the individual(s) responsible for doing so. But the complications of digital estate planning are unique, not only because of the complexities of bequeathing “digital” assets, but also because most individuals accumulate so many online accounts it may be difficult to even know where all the digital assets are! Fortunately, though, that means there’s a valuable role for the financial advisor to play in helping clients to ensure their digital estate plan is in order. Starting with helping clients at the next meeting understand the value of using a secure password manager, not only for the benefits of cybersecurity, but because it can form the core of the digital asset inventory they’ll want to begin the digital estate planning process!

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Since 2011, when one member of a married couple passes away, the surviving spouse is eligible to carry over any unused portion of the deceased spouse’s estate tax exemption amount. This rule, allowing “portability” of the deceased spouse’s unused exemption (DSUE) amount, provides a substantial reduction in estate tax exposure for couples whose combined net worth is more than $5 million (or is expected to grow above that amount in the future), and reduces or eliminates the need for many couples to utilize a bypass trust in their estate plan.

However, the caveat to portability of the estate tax exemption at the death of the first spouse is that it only applies if a Form 706 estate tax return is filed in a timely manner to claim portability – even, or especially, if the estate under the filing threshold and otherwise wouldn’t even need to file an estate tax return.

Unfortunately, though, many executors don’t even realize that there is a requirement to file an estate tax return for those who are not subject to an estate tax, and the oversight often isn’t discovered until the surviving spouse subsequently passes way. And by that time, it’s too late to go back and file for portability. At least, not without submitting a potentially costly request to the IRS for a private letter ruling to be granted an extension.

To help ameliorate this common oversight of executors – and the high volume of PLRs the IRS was receiving – in 2014 the IRS granted executors the opportunity to retroactively claim portability by filing an estate tax return for anyone who had passed away since 2011, under Rev. Proc. 2014-18. Yet since those rules lapsed (at the end of 2014), it has once again become increasingly common for executors to submit PLR requests to the IRS to receive an extension for an accidentally missed Federal estate tax return deadline.

Thus, the IRS has now issued Rev. Proc. 2017-34, which grants a permanent automatic extension for the time to file an estate tax return just to claim portability, beyond the original 9 months requirement. In order to utilize the extension, the executor merely needs to file a not-otherwise-required-to-be-filed Form 706 estate tax return within 2 years of the decedent’s date of death, and note on the return that it is being filed as a permissible extension under Rev. Proc. 2017-34.

In addition, the IRS has granted prior estates yet another opportunity for retroactive portability as well. For any member of a married couple who died after 2010, there is once again an opportunity to file a (now very late) Form 706 estate tax return to claim portability, with a deadline of January 2^nd of 2018. Which allows surviving spouses (including same-sex married couples) to claim a carryover of the DSUE amount for any spouse who passed away in 2011 or later. And in situations where the then-surviving spouse also passed away and owed an estate tax, there’s even an opportunity to retroactively claim portability, and then file an amended estate tax return, and receive an estate tax refund of up to $2 million!

For most, though, the new rules simply provide an extended time window for executors to realize the need to file a Form 706 estate tax return to claim portability in the first place. Nonetheless, in situations where at least one member of a married couple passed away in 2011 or later, there is a limited time window to claim retroactive portability through the end of the year as well!

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In recent years, both President-Elect Trump and the Republicans have called for a repeal of Federal estate taxes, and with the Republican clean sweep in Washington, all eyes are on potential legislation to eliminate the estate and gift tax in 2017.

In today's guest post, from estate planning gurus Jonathan Blattmachr and Marty Shenkman, we look at the prospects for estate tax repeal, and what it could actually mean for both the future of estate planning, and the near-term strategies that clients might want to engage in... or not...

Because the reality is that total repeal is not entirely certain - at least, not permanent repeal. The lack of 60 Republican votes in the Senate means legislation to totally repeal the estate tax could be filibustered, and while estate tax repeal could be passed as budget reconciliation legislation with a simple majority, that's only possible if it includes another infamous 10-year sunset provision thanks to the so-called Byrd rule. In addition, even if the estate tax is repealed, it's not clear whether the gift tax would also be repealed, nor whether the systems might at least be partially replaced with other tax exposure at death - for instance, either a requirement to report all capital gains at death, or a renewal of the "carryover cost basis" rules that were temporarily applicable in 2010. And all of these changes could also end out on the cutting room floor, a bargaining chip the Republicans concede in exchange for getting some other legislation done.

Given these dynamics, the world of estate planning has a dark cloud of uncertainty hovering over it. Actual repeal could dramatically reform the focus of estate planning, eliminating the focus on estate tax planning and shifting it instead towards asset protection planning (and to a lesser extent, income tax planning). However, the potential for repeal with a sunset provision limits the ability to fully count on estate tax repeal from a planning perspective, which means it may still be desirable to shift assets out of the estate, "just in case". On the other hand, if there is no carryover cost basis (and step-up in basis remains), then it may be especially damaging to shift assets out of the estate, rather than retaining control to enjoy a step-up at basis in death.

Which ultimately means that many popular estate planning strategies will remain in place, at least for now, and especially for those just trying to manage estate tax exposure given the recently proposed Section 2704 Treasury Regulations that would drastically curtail family limited partnership discounts. But realistically, perhaps the most likely outcome will simply be that a lot of substantial estate planning grinds to a halt for the next 3-6 months, until it becomes clearer whether or how much of a focus the new Republican administration will really take regarding estate tax repeal, or not.

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For high-net-worth individuals who built their wealth through entrepreneurship and creating a business with substantial value, a significant challenge is not only that the business will someday be subject to estate taxes, but that the continued growth and success of the business just compounds the problem further.

Accordingly, an increasingly popular strategy in recent years to manage this issue is the Intentionally Defective Grantor Trust (IDGT), a unique type of trust structure where the income of the trust is still the grantor’s for income tax purposes, but the assets of the trust are excluded from his/her estate for estate tax purposes. In other words, the trust is “effective” for estate taxes, but “defective” for income taxes.

The benefit of this arrangement is that the value of the trust, and any growth thereon, are excluded from the grantor’s estate. But the fact that the trust is “defective” for income tax purposes is also a good thing, as it means the grantor can pay all of the IDGT’s income tax bills (without being deemed a gift), and can sell the family business to the IDGT in exchange for an interest-only installment note, without triggering capital gains taxes (since the grantor is effectively just selling the business to themselves).

Which means in essence, establishing an IDGT and then selling the grantor’s business to it, in exchange for a promissory note, means the grantor has transmuted his/her assets from a potentially high-return high-growth family business into a low-yield bond (given today’s low Applicable Federal Rates that are used to determine the interest rate for the installment note sale).

And in the long run, this can produce a substantial estate tax savings, to the extent that the business inside the IDGT outgrows the relatively low hurdle rate associated with the installment note. In fact, the strategy can be further leveraged by obtaining valuation discounts on the sale of the family business as well, though notably a recent proposed Treasury Regulation would crack down on such discounts, potentially as early as 2017. Nonetheless, even without a potential valuation discount, the opportunity for estate tax savings in using an IDGT is significant in the long run, simply for the ability of a successful family business to outearn and outgrow today’s ultra-low interest rate environment!

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Using a Family Limited Partnership (FLP) or Family LLC to obtain favorable valuation discounts on gifts or bequests has been a staple of high-net-worth estate planning for the past 15 years. While IRC Section 2704, passed in 1990, was intended to limit the aggressive use of valuation discounts, over the decades since a number of Tax Court cases, along with evolving state laws, have undermined the IRS’ ability to enforce those rules.

Accordingly, after years of failed attempts to get Congress to update the rules, the Treasury department has decided to pursue its own crackdown, in the form of newly proposed 25.2704 Treasury Regulations. In fact, the proposed Regulations under Section 2704 are so expansive, that they would severely limit the use of valuation discounts for any type of family limited partnership or other family business transfer, where the family will retain control before and after the gift or bequest occurs.

The new rules would include the imposition of a new 3-year lookback to determine whether a minority valuation discount should apply (limiting deathbed transfers used to create a minority interest), the introduction of new “disregarded restrictions” that go beyond the already-ignored “applicable restrictions” in situations where the family will retain control after the transfer (and effectively create an implied put right for any recipients of a transfer, which significantly curtails most valuation discounts), and a shift away from only looking at restrictions that are “more restrictive” than available state law (given that many states have already shifted their laws to become more restrictive in recent decades).

Fortunately, the proposed Treasury Regulations must go through a 90-day public comment period through November, following by a public hearing in December, and must then be re-evaluated before final issuance (which in turn wouldn’t take effect until 30 days thereafter). And of course, the more restrictive rules are a moot point for the overwhelming majority of families – including family businesses – that still don’t have a value high enough to trigger estate taxes given an exemption of $5.45M for individuals and $10.9M for most couples.

Nonetheless, for those high-net-worth families who are over the estate tax thresholds, just a few months remain to engage in transfer planning to maximize current valuation discounts before the new rules take effect!

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The bypass trust is a popular estate planning strategy used to reduce a couple’s exposure to estate taxes, by leaving the assets of the first spouse to die not to the surviving spouse, but to a trust for his/her beneficiary instead. If the surviving spouse doesn’t inherit the assets directly, they’re not subject to future estate taxes when the second spouse ultimately passes away.

However, while the bypass trust is effective for saving on estate taxes, it’s not very favorable for income tax planning, given that trusts reach a top 39.6% tax bracket (plus the 3.8% Medicare surtax on net investment income) at “just” $12,400 of taxable income. And at that threshold, long-term capital gains (and qualified dividends) are subject to a whopping 20% + 3.8% = 23.8% tax rate as well. Plus state income taxes to boot (if applicable).

Fortunately, though, the tax rules for bypass trusts (and other “non-grantor” trusts) allow trusts that distribute their income to beneficiaries to distribute the tax consequences to the beneficiaries as well – allowing those beneficiaries to claim the income on their own personal tax returns (and be subject to their far more favorable individual tax brackets) while the trust claims a “Distributable Net Income” (DNI) deduction to avoid any double taxation.

Of course, the caveat to passing through income from a trust to the beneficiary is that while distributing the income to the beneficiary may minimize income taxes, it just compounds the estate tax problem the bypass trust was designed to avoid (by pushing the income back into the spouse’s taxable estate). However, given the significant rise in the Federal estate tax exemption over the past 15 years – from “just” $1M in 2001 to $5.45M today – many bypass trusts are actually no longer necessary. Which means it has suddenly become a far more effective strategy to start deliberately making income distributions from a(n existing) bypass trust to the beneficiary, who may no longer face any estate taxes, but can materially reduce the family’s income tax exposure in the process!

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