Changes To State Estate Taxes

While major changes are likely on the Federal level following national elections last month (see our post here on tax changes post-elections) including the repeal of the federal estate tax, many states will still retain their own estate tax.  Readers should keep in mind that on the state level, the exclusions from state estate taxes can be much lower than on the federal level.  In New York, the current estate tax exemption is $4,187,500.00 and rises to $5,250,000 on April 1, 2017.  New York estates valued at 105% (or greater) of the exemption lose the exemption entirely.  In Connecticut, the exemption is now $2 million and the estate tax ranges from 7% to 12%, depending on the amount above the Connecticut estate tax exemption.  (Connecticut, along with Minnesota, are the only two states in America which also impose a gift tax.)

On September 30, 2016, New Jersey Governor Chris Christie and New Jersey legislators announced an agreement to repeal the New Jersey Estate Tax.  The exemption from New Jersey Estate Tax will be raised from $675,000 currently to $2,000,000 for 2017, and the estate tax is to be repealed in 2018.  This will likely make New Jersey an appealing jurisdiction (like Florida) for clients from an estate tax perspective.

Contact us to discuss estate tax minimization strategies.

The Coming Post-Election Tax Code Changes Mandate Timely Planning

Donald Trump has promised to rewrite the U.S. tax code, much like Ronald Reagan did in 1986.  With a Republican House and Senate, a tax code overhaul is likely.  Trump’s plan is likely to include:

  • Reduction in income tax rates for individuals and corporations. If enacted, the U.S. would shift from one of the highest corporate income tax rates in the world, to one of the lowest (from 35% to 15%).  For individuals, the highest tax bracket is now 39.6%, plus the 3.8% net investment tax, for a total of 43.4%.  Under the Trump plan, the highest rate would be 33%.
  • Elimination or significant reduction of estate and gift taxes.
  • Restructuring of tax on offshore income, including deemed repatriation and 10% tax on deferred offshore profits.
  • Elimination or partial repeal of the Affordable Care Act (Obamacare), including repeal of the 3.8% tax on net investment income.
  • Carried interest may be taxed as ordinary income.
  • Income earned through flow-through entities (LLCs and S-Corps) to be taxed at 15% rather than higher individual rates.

Apart from the Trump tax plan, Republican legislators have also offered their own plan which also calls for reduction of taxes.

The above are proposals, not yet law.  We can assist you in anticipating the coming tax changes, and planning ahead.  Some suggestions include:

  • Take charitable deductions now, rather than in 2017, when tax changes could likely make deductions less valuable. The current income tax rates are known and will probably be higher than in 2017.
  • If we can expect reductions in income tax and capital gains tax rates next year, consider whether to utilize tax deductions and losses in 2016 and postpone or defer gains and income until 2017.
  • Consider an enhanced role for life insurance and an Irrevocable Life Insurance Trust (ILIT). Insurance proceeds are not taxable as income to the beneficiary.  Growth within an insurance policy is not subject to income and capital gains tax.  If the estate tax will be repealed, insurance could be completely tax-free.  (State estate taxes may still apply.)  Insurance could thus play an enhanced roll in family planning, legacy planning, liquidity and tax-minimization.  An ILIT would add further benefits, including asset protection, creditor protection and extended wealth management for child beneficiaries.

Year-End 2016 Tax Planning, Year-End Gifting & 2017 Tax Changes

Year-end gifting may be changing soon. Each year, we begin our end-of-year suggestions with a reminder to clients who own FLPs, LLCs and family business ventures, that they should take advantage of year-end gifting to lower estate taxes.  This year the message is even more crucial, because discounted gifting of family enterprises is about to go away entirely.  The recent election results will not alter (at least for now) this change in tax law.

Take Advantage of Year-End Gifting to Lower Estate Tax – Before the Law Changes: New IRS Regulations Eliminate the Ability to Discount the Value of FLP and LLC Gifts to Family Members

In August 2016, the IRS finally issued proposed regulations that will eliminate (or severely limit) the ability to discount the value of transfers of interests in closely held entities (FLPs, LLCs, family corporations) to family members.  Such “leveraged gifting” has been an extremely important and common method used by estate planners to eliminate estate taxes.

The proposed regulations will undergo a ninety day comment period and a public hearing on December 1, 2016.  Shortly after that, the IRS will publish final regulations which will take effect within thirty days after publication[1].  These proposed regulations were expected and we have previously written about them here.

Readers are strongly urged to contact us to implement gifts of FLP and LLC interests to their heirs before the changes take effect.  Clients with FLPs should consider gifting limited partnership interests in order to decrease the value of their estate.  As long as clients retain their General Partner (GP) interests, clients will continue to control all assets within their partnership.  Yes, you can escape the estate tax and still control the assets.

In summary:

– You can lower the value of your taxable estate, and pass up to $5,450,000 ($10,900,000[2] for a married couple) to your heirs, tax free.

– If you own an FLP, you can gift Limited Partnership (LP) interests to your heirs, and take advantage of discounting, to get even more out of your estate, tax-free (up to $21,800,000 in 2016).

– You can keep your General Partner (GP) interests and still control the FLP and its assets, even if you gift all of the Limited Partnership (LP) interests.

Also, don’t forget about the annual gift exclusion, which allows you to gift up to $14,000 ($28,000 for a married couple) in 2016 to as many people as you choose.

We realize that gifting and discounting are not simple concepts, and we welcome your questions.  We can advise you as to appropriate FLP discounts, prepare memoranda of gift for you[3], as well as the partnership valuation and gift valuation calculation letters (necessary for the IRS).  Please contact us with any questions regarding your year-end tax planning.

[1]This fall, two bills were introduced in the U.S. House of Representatives and Senate to derail the proposed IRS regulations, further illustrating the uncertain nature of our tax law.

[2] Under current law, in 2017, the exclusions go up: $5,490,000 for individuals and $10,980,000 for married couples.

[3]  A recent tax court case has made it imperative that the documents transferring the LP interests be worded very carefully.  These documents be prepared by qualified tax counsel.

New IRS Regulations Eliminate the Ability to Discount the Value of FLP and LLC Gifts to Family Members

This month, the IRS finally issued proposed regulations that will eliminate (or severely limit) the ability to discount the value of transfers of interests in closely held entities (FLPs, LLCs, family corporations) to family members.

Such “leveraged gifting” has been an extremely important and common method used by estate planners to eliminate estate taxes.

The proposed regulations will undergo a ninety day comment period and a public hearing on December 1, 2016. Shortly after that the IRS will publish final regulations which will take effect within thirty days after publication.

These proposed regulations were expected.  We have previously written about them here and here.

While we do not venture into political discussion, we point out that Hillary Clinton has stated that she will reduce the estate tax exclusion from $5,450,000 per person ($10,900,000 for a married couple) currently in effect, to $3,500,000 per person ($7,000,000 for a married couple) and reduce the gift tax exemption from $5,450,000 per person to $1,000,000 per person.  She will also increase the gift/estate tax to 45%.  (Donald Trump has proposed to eliminate the gift/estate tax entirely.)

Readers who have not yet completed their estate planning are strongly urged to contact us to implement gifts of FLP and LLC interests to their heirs before the changes take effect.

Please see our related articles:

Family Limited Partnerships & Discounting

Historic Opportunity to Avoid Tax on Over $10 Million+ of Assets

Year-End 2015 Tax Planning: Take Advantage of Gifting to Lower Estate Tax – Before the Law Changes

LLC/FLP Discounting and Leveraged Gifting to Lower Estate Tax May Soon Be Limited

Please contact us with any questions.

Why a Trust, and What about a Will?

Most people believe that, when they die, the way to pass their assets to their beneficiaries is via a will.  That is not wrong.  But there are downsides to a will.  And there is a better way: via a trust.

In order for assets to pass on to your heirs via a will, the will has to be filed in court in a process called “probate”.  This means that your will is submitted to a court of law.  That makes your will a public document.  Anyone can read your will, see what assets you owned, make a claim to your assets, and challenge the validity of your will in court.  Since the will names your heirs, and the assets to be dispersed to your heirs, this public information now also provides a roadmap to your heirs and their new wealth.  If you leave behind property in multiple states, there may be multiple probate court proceedings.

Moreover, in order to maneuver through this probate court process, and whether or not there is a will contest or outside claims to assets, your heirs will need to hire a lawyer.  The court will make sure that your assets are distributed the way you directed in your will.  And courts work very slowly, which means that those assets may not pass on to your heirs for another year or two, or much longer if there is a court issue, will contest or other probate problem.  In short, if you rely on a will to distribute your assets, you automatically involve the state, which has monetary costs, lack of privacy and delays.

A better mechanism for passing your assets to your heirs is via a trust.  A trust is an entity created to manage assets.  The trust is controlled by a trustee, who manages the property within the trust.  Subject to the terms of the trust, a trustee can invest, sell, buy, lease, mortgage, lend, collateralize, etc., whatever has been placed in the trust, e.g., cash, securities, shares of stock or LLC interests, art, real estate, patents, trademarks, anything of value.  If you establish a trust, and contribute assets to this trust, you may be the trustee over this trust and thus continue to control the assets in the trust while you are alive.  You would also chose a successor trustee.  Because the trust continues to exist after your death, the role of the successor trustee is to control the trust after you die.  The successor trustee, who could be your surviving spouse, relative or trusted friend, would be obligated to follow the instructions you set forth in the trust document, called a trust deed of settlement.  This document will also set forth who inherits your assets upon your death, much like a will directs where your assets are to be distributed at your death.  The people who inherit your assets are called “beneficiaries”.  The trustee has a fiduciary obligation to act in the best interests of the beneficiaries.

However, whereas a will has to go through the probate court process, a trust does not.  At your death, the successor trustee (who you’ve appointed when you created the trust), follows the directives of the trust (which you’ve set forth when you created the trust), including distribution of trust assets to the beneficiaries who you’ve named when you created the trust.  The beneficiaries can be your children, other family members, your alma mater, charities, etc.  Distributing your assets under the terms you’ve set forth could be accomplished by a will through the public probate process, or instead, the very same terms could be satisfied by a trust, privately, without involving the state, without a probate court, without lawyers, and with less of an opportunity for others to challenge the validity of the inheritance terms that you’ve set.

Moreover, because a trust avoids probate and the delays of probate, the successor trustee can step in immediately and administer the trust assets.  The successor trustee can communicate with banks and brokerage firms without a need for court appointment, and can begin to settle the estate and make distributions much faster than if a probate court were involved.  In addition, because banks, brokerage firms and other custodians will freeze an individual account at death, thus complicating the account and delaying distributions and payments, a trust account may continue seamlessly with the successor trustee.  Finally, illiquid assets (e.g., real estate, private investments, private equity, limited partnership interests) that may be complicated by the probate process and require re-titling of the assets after death, can instead continue smoothly in the name of the trust.

The trust is a “revocable” trust, meaning that you have the ability to revoke, or cancel it.  You also have the ability to modify it.  For instance, you can change your beneficiaries or change the trustee.  Because the trust is revocable, the IRS doesn’t consider it to be an independent taxpayer and the trust will not get its own taxpayer ID number.  However, when you die, the trust becomes irrevocable.  At that point, the successor trustee (who you’ve already chosen), steps in and is obligated to follow the terms of the trust that you’ve set forth.

It is more difficult to contest the terms of a trust than the terms of a will.  This is because whereas the will is admitted to a probate court for all to see, nowhere is the trust publicly recorded.  A probate court automatically provides a venue and a mechanism for challenging a will.  Yet, trusts are not public documents and trusts avoid the probate process.

This allows you a greater opportunity to control the terms of distribution, knowing that it will be more difficult for others to challenge those terms.  For instance, you might direct the successor trustee to pursue a certain investment at the exclusion of another.  You might also, for example, set forth pre-conditions for inheritance, such as completing college or graduate school.  If you leave behind a child who is a minor, you can create a sub-trust for that minor, funded with life insurance, IRA proceeds or other accounts payable on your death, and set the terms of that sub-trust, such as delayed distributions at certain ages or periodic support payments over the life of a beneficiary.

An additional important benefit to a trust is that the assets held in trust may be protected from lawsuits, including divorces, and the claims of creditors.  On the other hand, after distribution from a will to a beneficiary, the inheritance is vulnerable to creditors of the beneficiary, including a spouse.

Your will still does have a role in estate planning, even though distribution of your assets is controlled by a trust.  In your will, you set forth your personal representative, who is the person you empower to take care of your funeral arrangements, final personal debts and your last tax return.  This person can be the same as your successor trustee.  If you have children who are minors, the will is also the document to name their guardians in the event both parents pass away before the children reach adulthood.  Finally, the will also should include a provision that any property that you did not address in your trust should now “pour over” into the trust and be subject to the terms of your trust.

Another benefit to a trust is that, if you are married, it preserves both spouses’ exemptions from the estate tax.  Each person currently is allowed an exemption from federal estate tax for the first $5.45 million worth of assets.  In other words, if one’s estate is valued at less than $5.45 million, there is no federal estate tax.  (State estate tax may apply, however, and there is great disparity among exemptions and estate tax rates across all the states.)  That exemption of $5.45 million is now “portable”, meaning that if one spouse did not use up the exemption at death, the unused amount can be transferred to the second spouse and added on to the exemption of that second spouse.  The net effect is a combined federal exemption of $10.9 million for the couple.  On the state level, however, there may not be portability and the exemptions may be much smaller in your state.  Through the use of a revocable family trust, both spouse’s exemptions on the state level could be preserved.  Notably, portability cannot be accomplished via a will.

Thus, while a will has traditionally been thought of as the way to pass on one’s assets at death, wills have significant drawbacks including the probate court process, delays and lack of privacy.  A trust is a better way to accomplish the same inheritance planning, privately, more efficiently, without involving courts or lawyers, with greater control over inheritance terms, and with lower estate taxes.

For information about your estate planning needs, contact Rubinstein & Rubinstein today.

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