Estate Planning Bits

The disadvantages of IRD

Income in Respect of a Decedent, (IRD,) is income that a person has worked for (“earned”) during his or her lifetime, but did not realize for tax purposes due to his or her death. An example would be a 401(k) account with a beneficiary. The beneficiary will be very happy to learn that you left him or her money for future endeavors. However, that same beneficiary will learn that when the money is withdrawn, income taxes will be due at his or her ordinary income tax rate.

The issue with IRD is that the earned income needs to be taxed and does not receive a step-up-in-basis which would have allowed the beneficiary to avoid paying any taxes on the inheritance.

Under our current tax system, heirs receive a basis adjustment on property that they inherit. The basis in property inherited is the fair market value of the property at the time of your passing. Therefore, if you were to purchase stock at $10,000 in 2000, and at your death in 2005 the fair market value of the stock was $20,000, your heirs would have a $10,000 difference, a gain, to report. With the step-up-in-basis rule the heirs would receive that stock and its new value of $20,000, and if they then sold it for $20,000 they would receive that money without having to pay any income taxes. IRD income does not qualify for the step-up-in-basis rule because of its nature of not being realized.

Another bad point to IRD income is that the income taxes paid are in addition to the estate taxes that are also due. The beneficiary will be entitled to an income tax deduction for the estate taxes paid, but the total amount of both taxes is not comparable to the deduction.

Avoiding estate taxes

Once again politics have entered in to the decision-making process relative to taxes. The federal government has now postponed taking up the issue of Federal estate tax due upon death, and the decisions as to what one must do to attempt to eliminate or reduce estate taxes is again up in the air. The exemption for Federal estate taxes is currently $1.5 million for individuals dying in the year 2005. In the event that the individual is married, there is no tax between spouses, however, it is upon the second death that the government takes its significant share of the estate.

The lowest rate for estate taxes is currently 45%. This amount is calculated not merely based on the estate amount over $1.5 million, but rather by calculating the tax on the entire amount of the estate and then applying a credit directly against the tax. This has the effect of taxing every incremental dollar at the highest rate.

In 2006, the exemption rises to $2 million and this amount is increased to $3.5 million in 2009. 2010 is the year of no tax, regardless of the amount of money one has at death. In 2011 the sunset provisions of the law take effect and the exemption reverts back to the $1 million threshold. The House, Senate, and the President indicate that they want to increase the exemption to some greater sum, but it is unclear whether this will be effective in 2011, or whether the new schedule of exemptions will become effective immediately.

In any event, it is important to consider making use of these exemptions if one has significant assets. The tax could be eliminated if both spouses create separate trusts. This would leave the funds in trust for the benefit of the surviving spouse and children. The surviving spouse will not have an unfettered right to control the decedent spouse’s assets, but they will be available if necessary. With some planning, significant sums of money may be passed on to the next generation without estate tax.

By: Hyman G. Darling, Esquire

What are "Incidents of Ownership," and how do they impact your life insurance?

In regards to life insurance policies, if an insured has any control over a policy then that person is deemed to have incidents of ownership.

In general terms life insurance gets paid out to beneficiaries income tax free. However, if you owned the policy or had any control over the policy, then at your death the proceeds of the life insurance policy would be included in your estate and be subject to estate taxes. This effectively voids the income tax free planning you were looking to achieve.

Basically, if an insured has any rights or privileges in a life insurance policy or even has access to the policy’s cash value, then he or she is considered to have incidents of ownership on that policy. The Internal Revenue Service says that if a person has ANY rights (incidents of ownership) in a life insurance policy, the proceeds of that policy will be included in his or her estate for estate tax purposes.

The lesson here is that, as an insured, you should never retain ANY rights in the policy, not even the right to change the named beneficiaries of the policy, because that is enough to qualify you as having incidents of ownership.

Health Care Proxies in the aftermath of Terri Schiavo

In the aftermath of the Terri Schiavo case, let's not forget the hard lessons. While the case was being decided, and in the midst of the entire flurry of litigation, many individuals were anxious to create their own health proxies in order to attend to their personal medical decisions in the unfortunate event of incapacity. Although the case has been decided, and Terri is now gone, there is no time like the present to continue the planning process.

Everyone should make his or her own desires about health care known to loved ones and physicians. If one does not wish to be, “hooked-up to a machine,” then now is time to make the decision. Thinking that “I will take care of it later” may turn tragic. It may be the entrance to a nursing home or medical facility that requires a health proxy to be signed. In the event that the person entering the facility is no longer competent to make his or her own decisions, then an alternative procedure will be necessary, which is a guardianship proceeding.

A guardianship requires time, effort, emotion and cost. A physician will have to verify that the person is incapacitated, and then a hearing must be held in order to determine that the individual is in fact legally incompetent to make his or her own decisions. One must also keep in mind that the proposed ward will have to be given notice of the proceeding, and in the event that the person is not 100% incapacitated, he or she may be very upset to be served with a notice stating that another family member has petitioned the court indicating that he or she can no longer make decisions.

Even assuming that the family is in agreement as to who will make the decisions as the guardian, it should be the decision of the ward prior to incapacity to choose who he or she wishes to make all of the medical decisions. In addition, had a copy of the document been prepared, signed, and presented to the physician, the individual would have been able to express his or her own desires to the doctor, who could have also made further documentation as to the wishes of the patient.

In addition, the person could have also expressed any particular religious beliefs regarding his or her own decisions relative to end of life, as well as the role of the advisor or agent in clarifying and carrying out his or her wishes.

It is also important to note that the individuals whose cases relative to these decisions have become so public, Karen Quinlan, Nancy Cruzan, and Terri Schiavo, were all young. Therefore, it is important to make decisions and start the process early so that the plan will be initiated. It may always be changed, but once the initial plan is created, it is relatively simple to make changes and amend it in the future.

By: Hyman G. Darling , Esquire

If I give my grandchild money for his college education, is it taxable?

You would like to give your grandchild a large amount of money to be invested and one day used to fund his college education, but would your grandchild have to pay taxes on this gift? Would you have to pay taxes on making this gift? This scenario brings forth just one facet of a number of situations in which one may be required to pay a gift tax.

Let’s start with the positive, your grandchild is not required to pay a tax on the gift or report it as taxable income, but the government has limited self control in keeping its hand out of the cookie jar, so you may be required to pay a gift tax.

A transfer of property from one person to another is considered a gift if the person transferring the property either receives nothing in exchange for it or receives something in return which is not worth as much as the property given. You are considered to have made a gift to your grandchild because you received nothing in return for the money except your grandchild’s love and affection.

You must pay a gift tax if you give more than $11,000 worth of gifts annually or $22,000 annually if you are married and file joint tax returns. If you desire to give your grandchild an amount that exceeds your annual exclusion then you may either spread the gift over a period of years or wait until they are in college. Once they are in college you may directly pay their college expenses without having to pay a gift tax. Generally five types of gifts are not taxable. These exempt gifts are:

1. Gifts below your annual $11,000 exclusion

2. The payment of medical or educational expenses on another’s behalf

3. Gifts to your spouse

4. Gifts to a political organization

5. Gifts to charities

By: Brett A. Kaufman, Esquire

The right life insurance policy is a great tool to reduce the tax burden on your heirs upon your death.

Recently in a seminar I was asked: “Can a beneficiary of my estate pay for the taxes by using my IRA account”? 

Those of you who have IRA accounts should know that upon death your estate may be subject to federal estate taxes, and these taxes need to be paid within nine (9) months of your passing. This becomes important because if heirs withdraw money from your IRA to pay estate taxes, then they are subjecting themselves to “income tax” on the withdrawal from the IRA account.

This is definitely not what you want your heirs to do. By taking money from an IRA to pay estate taxes, they cause two problems:

1)       Creating another tax on their inheritance

2)       Reducing the amount of tax deferred money that you were trying to leave your heirs in the first place.

An irrevocable life insurance trust is a simple strategy you can use to avoid this problem. You can take distributions from your IRA starting at the age of 59 ½. With these distributions, you can then reinvest the “distribution money” into the purchase of a life insurance policy that is held by an irrevocable trust. Basically, you establish an irrevocable trust into which you will make gifts, (by using your gift tax exclusion.) The trust will then buy the life insurance policy on your life. Upon your passing, the proceeds from the life insurance policy will be used to pay your estate taxes, as well as any income taxes on your account.

By using this strategy you establish proper planning for a life insurance policy to pay all future taxes that might be due upon your death. Your heirs can avoid having to come up with the sufficient funds to pay estate taxes due and avoid having to pay any income taxes on the IRA account simply by purchasing the right policy.

What are Trustees and what do they do?

A trustee is a person, persons or even a licensed corporation that is appointed by a trust-maker (also known as “the grantor”) to oversee the operations of a trust established by the trust-maker. Each trustee, whether a sole trustee or co-trustees, owes a special duty of care in maintaining the trust and its assets. Therefore, the primary duty of a trustee/trustees is to follow the trust-makers instructions which are set forth in the trust document. In general, a trustee is merely an agent that the trust-maker can rely on to care out his or her wishes and instructions.

All states differ as to what powers and duties are owed by a trustee in carrying out the management of the assets in the trust estate. However, some of the primary responsibilities of a trustee are as follows:

a.                   Account for and pay all taxes, medical expenses and other applicable expenses listed in the trust

b.                   Distribute assets to beneficiaries in accordance with the Trust

c.                   Gather information on asset values in order to complete an inventory for the Trust

d.                   Prepare accounts as may be required by law

e.                   Obtain a federal tax identification number from the Internal Revenue Service in order to prepare Trust tax forms

Therefore, prior to appointing a person as trustee a trust-maker should look for a person who is trustworthy, able to mange the trust affairs wisely, be financially and fiscally responsible, able to handle investments, be in good health and have the ability to outlive the trust-maker, and have a good relationship with the trust-maker.

What is a Power of Attorney and why should I have one?

A Power of Attorney (POA) is one of the most important and powerful legal documents that everyone should have in their estate plan. It allows you to appoint someone to take control of your financial affairs that you usually take care of yourself.

A POA alleviates the necessity of a guardianship or conservatorship in the event of your mental incapacity or physical disability. This document allows your attorney in fact to handle your affairs without the necessity of formal probate proceedings, thereby saving expense, emotion and privacy. You retain the right to modify or revoke the power at any time, and it terminates automatically on your death. The appointed individual is referred to as your “attorney-in-fact”. Your attorney-in-fact typically has the power to buy or sell real estate, manage your property, conduct your banking transactions, invest your money, make legal claims and conduct litigation, attend to tax and retirement matters and make gifts on your behalf.

The POA can either be a “durable” or “springing” power. A Durable Power of Attorney is the most common form and is effective immediately. This may cause some concern because your attorney-in-fact can act on your behalf without you knowledge; therefore, you should make certain that you name someone you can trust. The Durable POA is usually held in your attorney’s office and a request of the document by your attorney-in-fact to access the document will be coupled with the attorney following up with you to ensure that you are incompetent and unable to make your own financial decisions.

With a Springing Power of Attorney, a formal determination by a physician must be obtained before the document is effective. This could lead to additional delay and expenses. It could also result in banks and other institutions not accepting the authority under the document. In the event this occurs the POA could be subject to court interpretation. Therefore, most attorneys draft a Durable POA.

A Power of Attorney is an extremely beneficial document to have as part of your estate plan. It allows you to establish the authority you wish convey to your attorney-in-fact, avoid guardianship or conservatorship savings and provide you with privacy. Therefore, if you do not currently have a POA you should consult with an estate planning attorney to discuss creating one.

By: Brett A. Kaufman, Esquire