Uncategorized

Healthy Outlook Estate Planning After the New Tax Law — It’s Still Relevant

The need for estate-tax planning is still alive and well despite the feeling by many that, given the tax-law changes, it is irrelevant to them.
 
This article will highlight the changes but also explain why estate-tax planning should be an important consideration for many if not most individuals.
 
The Tax Cuts and Jobs Act of 2017 (TCJA) temporarily doubled the amount that an individual can transfer free of federal estate or gift taxes. Federal gift and estate taxes are ‘unified’ — tax isn’t imposed until the cumulative gifts and taxable estate exceed the exclusion.  Before TCJA, each individual could transfer $5 million free from estate and gift tax. Under the new law, for decedents dying and gifts made from 2018 through 2025, the estate and gift tax exemption doubles to $10 million.
 
The exemptions are indexed for inflation after 2011, so the exemption for 2018 would have been roughly $5.6 million. It is now about $11.2 million ($11,180,000). It is estimated that, under prior law, only about .02{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of taxpayers were liable to pay federal estate tax. If you’re one of the .02{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5}, you should be in touch with your estate-planning professionals to consider taking advantage of this temporary increase.  This article will provide food for thought for the other 99.98{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5}.
 
The step-up in basis was not changed. The basis of property received from a decedent remains the fair market value as of the decedent’s date of death. If assets such as securities or real estate are received by your heirs after your death and sold, there will be very little income tax due. If the property was gifted prior to your death, the property has a carryover basis — your heirs will pay tax on the difference between the sales price and the amount you invested in the asset. 
 
By not gifting appreciated assets, your heirs may save 15{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} federal tax on the gain (potentially 20{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} federal tax plus a possible 3.8{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} tax on net investment income for higher-income taxpayers) plus the state tax.  If the asset in question is a collectible, the federal tax rate is 28{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5}, and the Massachusetts tax rate is 12{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5}.  
 
Planning gets complicated for taxpayers in states, like Massachusetts, with a lower estate-tax exemption. The question hinges upon analyzing what is the tax impact of the state estate tax compared to the possible capital-gains tax savings that high tax basis result to a decedent’s heirs?  
 
Should you gift? That’s a personal decision. No one understands your situation and your family as well as you. Do you have more than enough financial resources? Are your heirs able to handle money responsibly, or should trusts be considered? While the federal transfer taxes are unified, many states do not count gifts toward exemption, providing an opportunity to save state estate taxes.  
 
Certain gifts are not taxable gifts. Present interest gifts, or outright gifts, up to $15,000 in 2018 per recipient are not considered taxable gifts. A married couple can gift up to $30,000 per recipient. Also, direct payment of tuition to an educational institution is not considered a taxable gift. If you won’t need the money and if appropriate, that’s a common and effective method of reducing state estate taxes.
 
Massachusetts has ‘decoupled’ from the federal estate-tax exemption. In Massachusetts, the estate-tax exemption is $1 million. In general, lifetime taxable gifts will not increase the state estate tax. There are nuances too involved for this article. But to illustrate potential savings, Massachusetts estate tax on a $1.6 million gross estate (no deductions for simplicity) is $70,800. That will get your attention.
 
But Massachusetts estate tax on a $1 million estate with $600,000 in lifetime taxable gifts is $33,200. Yes, you read correctly — the tax could be higher on a lower estate, so planning is critical.
 
In 2017, legislation was introduced in Massachusetts that would increase the estate-tax exemption as well as exempt the decedent’s primary residence. I think most would agree that an increase in the Massachusetts estate-tax exemption is needed. Massachusetts is commonly included in the list of states ‘where not to die.’
 
The Massachusetts estate tax applies to the taxable estate of every individual domiciled in Massachusetts and to the real and tangible personal property of non-residents located in Massachusetts.
 
Some taxpayers believe it’s necessary only to spend fewer than 183 days in Massachusetts to avoid Massachusetts taxes. There are two tests to determine whether an individual is taxed as a resident. For income-tax purposes, a taxpayer who is domiciled elsewhere is taxed as a Massachusetts resident if he or she maintains a permanent place of abode in Massachusetts and spends more than 183 days in the state. There is an ‘or.’ A taxpayer is also taxed as a resident if he or she is domiciled in Massachusetts, even if he or she spends fewer than 183 days in the state. Most states have similar concepts.
 
‘Domicile’ is subjective, and it is the focus of many court cases. It’s important to be careful here. ‘Domicile’ is deemed to be the individual’s ‘true’ home, considering facts and circumstances. It takes into consideration an individual’s social, economic, and political life. There are checklists designed to help individuals determine if they can prove that they changed domicile. If your estate plan includes moving, you should consult with your attorney or accountant.
 
What about retirement-plan benefits? For many people, these represent the largest asset in his or her taxable estate. Distributions from retirement plans after death are ‘income in respect of a decedent.’ There is no step-up in basis at death, and beneficiaries will pay tax on inherited retirement benefits.  
 
If age 70½ or older, consider taking advantage of transfer of IRA funds directly to a charity. Such a distribution counts toward your required minimum distribution and is not included in your adjusted gross income. Making charitable gifts from your IRA instead of using after-tax assets saves you and your beneficiaries income taxes.  
 
Your beneficiary designations will affect how the account is paid out.  For blended families, it is possible to designate a trust to benefit your spouse during his or her lifetime, with the remainder passing to your children. Depending on your beneficiary designations, it is possible to stretch out the payout period. Note, however, that proposals have been introduced over the last few years to require that distributions to non-spouse beneficiaries be made over no more than five years.
 
Distributions from a Roth IRA are not taxable, provided they are ‘qualified’ distributions — made after the taxpayer reaches 59½ and five years after the Roth was established. Converting an IRA to a Roth IRA triggers a current income tax, and payment of that income tax — or prepaying your beneficiaries’ income tax — reduces your taxable estate.
 
Of course, payment of the income tax also removes funds from investments, so it’s important to review illustrations that take into consideration when you will need to take withdrawals from the IRA, tax rates, and projected rates of return.  
 
Estate-planning needs are unique and require careful consideration.  Documents and beneficiary designations should be reviewed periodically. The importance of non-tax issues such as creditor protection, blended family concerns, etc., have not been minimized by tax reform.