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2012 Estate Planning Notes
ESTATE PLANNING NOTES FOR 2012
Based on the Heckerling Institute on Estate Planning’s 2012 Current Events Session, the following is a short summary of the highlights of estate planning matters for the year.
The $5,000,000 Exemption. For 2012, the estate tax and gift tax exemption is $5,120,000, the highest exemption we have seen in our lifetimes. However, this is probably going away! We anticipate the 2013 exemption to drop to $3,500,000 or even $1,000,000 depending on Congress’ action (or inaction) this year. While the exemption is high – plan, plan, plan! Take advantage of gifting this calendar year to reduce your taxable estate. For a more in-depth discussion of the exemption, see our article entitled “Making the Most of Your Exemption and Other Estate Planning Musings”.
Gifting High Basis Assets. Always look at the tax basis for gifts, and gift high basis assets before gifting low basis assets because income taxation will become more of a planning issue in the future. Minimizing capital gains on carryover basis assets (gifted assets, versus assets that are inherited, with a stepped-up basis) is an important consideration that can be addressed now.
Portability. Portability allows a surviving spouse to use a predeceased spouse’s unused applicable estate tax exclusion amount, effectively doubling the amount that a married couple can pass to their beneficiaries free of tax. Portability is elected by filing a Form 706, and there is no shortened version. There are still unanswered questions as to the portability mechanism, i.e. whether only the executor can file Form 706; and, what if the kids elect out, so unused exemption will not carry over to the second spouse? Although portability is an extremely advantageous tax tool, it may not always be the law. We advise and emphasize not relying on portability and highlight the benefits of credit shelter trust planning to obtain the best result.
Valuation Discounts. Discounting is a valuable tool for reducing the size (or impeding the growth) of an estate. Discounting and freezing techniques can help business owners and land owners effectively plan for the future with their assets being ‘frozen’ at today’s value. However, there may be some modification to IRC Section 2704(b) restricting the use of valuation discounts. IRS regulations have been often promulgated but never published. Once published, the new restrictions on valuation discounts could be effective as of 1990! Congressional Democrats have proposed legislation in the past to curtail or eliminate the use of valuation discounts. The elimination of discounting techniques has been on the IRS “wish list” sine the Clinton Administration, and most recently President Obama proposed their curtailment in his recent Budget Proposal. We say “Use ‘em while you got ‘em!”. For a more in-depth discussion of discounts, see our article entitled “Valuation Discounts”.
Dynasty Trusts. Dynasty Trusts allow the creator to pass assets and wealth from generation to generation to reduce estate taxes and to preserve wealth within a family. Because of their potentially perpetual existence, it has been proposed to limit dynasty trusts to 90 years. This would require allocation of GST (generation skipping transfer tax) exemption every 90 years.
Georgia Estate Taxes. Currently, Georgia has no state estate or inheritance tax and neither does Florida. The prognosis for estate taxes to be assessed in Georgia is zero, and the probability of the return of the estate death tax credit is also near zero.
Grantor Trust Status. After some uncertainty about whether the power to substitute assets in a trust may cause taxable estate inclusion, Revenue Ruling 2011-28 confirms that the power to substitute assets in a trust does cause grantor trust status for estate tax purposes, as well as income tax purposes, even for life insurance trusts.
Claims Against an Estate. Section 2053 of the Code discusses claims against an estate. Claims over $500,000 require a qualified appraisal, as do certain charitable contributions. A Schedule PC (which is not out yet) will be required for protective claims. Until then, Form 843 must be filed to keep the statute of limitations open. One must have a detailed tickler system for IRS acknowledgment. This is one of those areas where the IRS must acknowledge that they received the protective claim, but if they do not acknowledge, the taxpayer must ask within a certain period of time. This is rather archaic and burdensome, so a thorough understanding of this shifting acknowledgment responsibility is important for establishing a proper tickler system and follow-up procedures.
Decanting. In Revenue Ruling 2011-101, the IRS said it was issuing no more rulings concerning decanting. For a more in-depth discussion of the decanting, see our article entitled “The Powers of Decanting and Appointment”.
Qualified Personal Residence Trusts (QPRT). A trust may be used to transfer a grantor’s residence out of the grantor’s estate at a low gift tax value. However, unless properly structured, Section 2036 and the Van case may require estate inclusion if the grantor retains enjoyment and lives in the property. On the other hand, in the Riese case, there was a taxpayer victory because at the end of the QPRT there was an intent to pay fair market rent.
Health, Education, Maintenance and Support (the HEMS Standard). The HEMS Standard is a recognized and accepted standard for trust distributions to a beneficiary, yet keeping the trust property out of the beneficiary’s taxable estate. The trust should stick to the exact HEMS Standard; that is, using only the words health, maintenance, support and education. Using the words “comfort” and “welfare” continue to cause problems, regardless of what the regulations provide.
Defined Value Clauses. The Christiansen & Petter cases from last year distinguished Proctor and held that defined value clauses “based on values finally determined for estate tax purposes” were valid. The McCord & Hendrix case also distinguished Proctor where the taxpayer merely gifted all the property away and left it up to the parties to confirm their appropriate and respective interest in the property also worked. All of these cases involved charity and public policy of encouraging gifts to charities trumping the public policy of Proctor (creating a disincentive for the IRS to audit a transaction because of no possible additional tax revenue). However, these defined value clause cases probably have a “limited shelf life”, and extreme care should always be used when gifting hard-to-value assets.
Family Limited Partnerships (FLP). Tax cases regarding Family Limited Partnerships continue to be “hot buttons” with the IRS. The FLP cases continued with Linton being a step transaction analysis. The Holman case involved Dell stock, and in the Gross estate, 11 days was sufficient to allow enough time to have risk of valuation change between the time the FLP was funded and the limited partnership’s interest being gifted away. And in Jorgenson, there was no good reason for the FLP – a typical “bad facts make bad law” case.
Crummey Notices. Crummey notices are important, annual tasks for proper trust administration. In the Turner case, the husband paid the insurance payments directly and not through the trust, and the Trustee did not obtain Crummey notices – something we always advise our clients to obtain to ensure the gift is treated as complete and to document that the gifts are in fact present interest gifts qualifying for the annual gift tax exclusion. However, in this case, the Court held that lack of Crummey letters and the accompanying lack of formality of the gift being made to the trust, was not controlling. Although this is an important taxpayer victory, we will continue to discipline our clients to make their gifts to the trusts, and to obtain Crummey notices signed by the beneficiaries to ensure proper compliance with the Code and regulations.
Second Marriages. When there is a second marriage, it may be a good idea to combine the marital and charitable deductions. This concept was discussed in Private Letter Ruling 201117005 in which the taxpayer intended to create two trusts upon his death. The first was a Charitable Remainder Unitrust (CRUT), and the second was a Qualified Terminable Interest Property (QTIP) marital trust. If the spouse survived the taxpayer, the QTIP was to receive a fixed amount of assets to be divided between Fund A, which was to receive the residence, and Fund B, which was to receive all the interest in an LLC that held tangible assets such as automobiles, aircraft and cash. The spouse got all the income from Fund B and the exclusive right to use all the assets, as well as the use of the residence or any replacement residence in Fund A. Any part of Fund A that was not used to purchase a replacement residence was to be distributed to Fund B. The QTIP is a beneficial instrument because the surviving spouse receives the income from the trust’s assets during his/her life, but the trust principal is left to someone else, usually children.
The CRUT on the other hand, is funded and then distributes a fixed percentage of the value of its assets to a non-charitable beneficiary (this may be the grantor, surviving spouse or children), and, at a specified time, usually at the death of the grantor, the remainder of the trust is distributed to a charity. The CRUT may also be drafted to as to cease trust distributions to the surviving spouse if he/she remarries. The combination of the marital deductions and the charitable deductions and these trust tools allow a grantor great flexibility in providing for a second spouse during his or her lifetime, but also assuring that his children of a previous marriage receive a share of the assets as well.
*IRS regulations require that we inform you as follows: Any U.S. federal tax advice contained in this communication is not intended to be used and cannot be used for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or tax-related matters.
Georgia Education Expense Tax Credits: Do Not Wait!
June is the new November The Georgia Dept. of Revenue is approving education expense tax credits at 3½ times the rate for 2011. As of Mar. 16, the DOR had approved $8.6 million in tax credits. In 2011, the tax credit cap was met in November. This year, the cap is likely to be met in June—if not sooner. In 2011, 2,700 Georgia taxpayers were denied participation in the education expense tax credit program. Don’t let this happen to you in 2012! Apply today for your tax credit approval.
MEDICAID PLANNING USING IRREVOCABLE INCOME ONLY TRUSTS
For most clients, planning to obtain Medicaid is a last resort; however, with the catastrophic cost of long-term care exceeding $200,000 in many metropolitan areas, they are left with no choice. A careful review of a client’s assets, as well as their short-term goals and long-term objections, will determine whether transferring property to an Irrevocable Income Only Trust (“IIOT”) would be an appropriate part of an estate plan. Such planning, when used properly, can avoid the difficult decision to sell family legacy assets to pay for nursing care coverage.
Government rules and regulations attempt to ensure that Medicaid is in fact the payer of last resort. There are strict income and asset eligibility requirements, combined with a look-back penalty period, with rules and enforcement varying by state. The Deficient Reduction Act of 2005 extended the look-back period to five years on all transfers, including transfers to IIOTs. That means that clients must wait 5 years after transfer before applying for Medicaid. Since the IIOT must be in existence for five years, a critical question when funding the trust must be what assets the elder client can live without for a period of five years.
Moreover, since the Omnibus Reconciliation Act of 1993, unless certain exceptions apply (such as Special Needs Trusts), assets of a self-settled trust are considered available to the Settlor for Medicaid eligibility purposes regardless of whether trustee discretion is exercised or whether the trust was established for purposes of qualifying for Medicaid. Any trust principal which could be distributed under any circumstances, is considered an available resource for Medicaid purposes. Trust restrictions on when or whether a distribution may be made are disregarded. The intent of the 1993 Act was to minimize “Medicaid Planning”.
An IIOT is a trust set up to allow clients to meet the stringent Medicaid rules and requirements while preserving family legacy assets for future generations. The terms of the IIOT must be carefully drafted. Trust principal may not be distributed, under any circumstances, to the Settlor or the Settlor’s spouse. A “rainy day provision” can be added to allow the Trustee to distribute principal to family members, so long as the trustee does not have discretion to distribute to Settlor or Settlor’s spouse.
All income can be distributed to the Settlor. Trust assets are often invested in income producing securities while the Settlor is living autonomously. Once the Settlor goes into a nursing home, the Trustee may want to invest the trust assets in non-income producing securities. Note, the fact that the Settlor retains the right to IIOT income will cause inclusion of IIOT assets in the Settlor’s estate for estate tax purposes under IRC Section 2036. IIOT Trustees can not be given discretion or authority to allocate between principal and income.
Control over trust assets is retained by the Settlor through a testamentary limited power of appointment. This limited power of appointment can also be important to prevent IIOT transfers from being completed taxable gifts.
IIOT’s are generally grantor trusts for income tax purposes, thus allowing the client to retain the ability to exclude capital gains on the lifetime sale of their residence (which is generally the primary asset of the trust), and preserve homestead, senior citizen, and veteran’s property tax exemptions. Spendthrift provisions are included in the trust so that during the Settlor’s lifetime, trust assets are not subject to creditor claims of the Settlor, Settlor’s spouse or children.
The rules and regulations affecting IIOT’s have changed over the years and some IIOTs are grandfathered so as to be exempt from the new rules. To avoid any taint, no new property should be transferred to an old IIOT. If necessary, new IIOT’s should be created for additional property that clients wish to protect.
States are required by federal law to have an estate recovery program. Under Georgia’s estate recovery program, Georgia seeks recovery from the Medicaid recipient’s “Estate”. “Estate means all real and personal property under the Georgia probate code. Estate also includes real property passing by reason of joint tenancy, right of survivorship, life estate, survivorship, trust annuity, homestead, or any other arrangement. The estate also includes a life estate interest and excess funds from a burial trust or contract, promissory notes, cash, and personal property.
Assets in a IIOT should escape Georgia’s estate recovery program, as they are not included in the recipient’s probate estate, jointly owned. Nor does the IIOT confer a life estate on the recipient. As such, IIOT’s can be important tools to protect family legacy assets, while preserving the ability to access government funded health care.
If you would like to learn more about IIOT’s, please contact us (404) 255-7400.
H&A Successful in another Estate Tax Audit
H&A has again successfully settled an estate tax audit. In this case, the IRS confronted the Estate with an additional assessment of nearly $2.4 million dollars in estate taxes. The IRS assessment was based largely on three issues. First, the IRS argued that an LLC created prior to death should be included in the estate under IRC Section 2036. Second, the IRS argued that a vacation home previously owned by a QPRT and rented back to the decedent should be included in the decedent’s taxable estate under IRC Section 2036. Finally, the IRS disallowed an estate tax deduction for interest on a Graegin loan taken from the recently created LLC to pay estate taxes.
H&A was able to successfully defend the Estate on each and every issue on which the IRS based its assessment. Through proper planning, creative thinking, and hard work by H&A, the Estate recently received from the IRS a no-change closing letter. This was a collaborative effort across all firm departments, and is a testament to the wide ranging skills and knowledge offered to our clients. I’d like to thank everyone involved for their efforts in bringing this matter to a successful conclusion.
We cannot guaranty similar results, as success or failure of any audit defense depends on the facts and circumstances of the individual case. If you need help dealing with the IRS, please do not hesitate to contact us at (404) 255-7400.
2011 Year End Tax Letter
December 7, 2011
Dear Tax Clients:
As the 2011 tax year comes to a close, now is the time to review your financial situation and determine what tax planning opportunities exist to decrease your 2011 taxes. We are ready to help you plan efficiently and effectively for 2011 and future years.
Individual Income Tax
While the lower Bush era tax cuts are currently not scheduled to expire until the end of 2012, there are still year-end tax savings opportunities available. The additional twist for year-end 2011 tax planning is the uncertain future for tax rates after 2012. Many political observers forecast that higher income taxpayers will only be asked to pay more.
Year End 2011 Action Items:
Make your 2011 State Income Tax payments in December 2011, instead of waiting until January 2012, unless you are in an AMT situation.
Sell any stock “losers” this month to offset your 2011 capital gains, plus $3,000. Avoid “wash sale” rules by not buying the same stock within 30 days before or after the sale of the stock. Otherwise, the losses will not count.
Has your 2011 Federal Income Tax been under-withheld? Or have you had other income and not made estimated tax payments? Have more tax withheld from your December paychecks. This will avoid underpayment penalties.
If you are 70 ½ and older, you can make charitable contributions directly from your IRA to a bona fide charity. No charitable deduction is available for the donation, but income tax will not be due on what would otherwise be a taxable distribution form the IRA. This tax break is especially advantageous for retired taxpayers who are no longer able to itemize their deductions. The limit is $100,000 and it is scheduled to expire at the end of this year.
Consider converting your traditional IRA to a Roth IRA. You would owe tax on the IRA amount currently, to the extent it exceeds basis, but retirement distributions from the Roth IRA would potentially be tax free – especially advantageous since it is expected that tax rates will increase after 2012.
Provisions currently scheduled to expire 12/31/2011:
Payroll Tax – For the 2011 tax year, the employee share of Social Security Tax withholding was reduced from 6.2% to 4.2% of the taxable wage base of $106,800. This reduction is scheduled to expire at the end of the year. President Obama has proposed a measure that would continue the payroll tax deduction for 2012 at an even lower rate of 3.1% of the scheduled 2012 taxable wage base of $110,100. This new measure has not yet become law and is currently under debate in Congress.
Alternative Minimum Tax Exemption – In order to prevent many moderate income tax payers from being subject to the AMT, the exemption amounts for 2011 were increased to $48,450 for single taxpayers and $74,450 for married taxpayers filing jointly and surviving spouses. Unless Congress acts to extend the higher exemption amounts, the exemption for 2012 and beyond will decrease to $33,750 for single taxpayers and $45,000 for jointly filing married taxpayers and surviving spouses.
Provisions currently scheduled to expire 12/31/2012:
Federal Income Tax Rate Brackets – The current tax rates of 10, 15, 25, 28, 33 and 35% are scheduled to expire 12/31/2012. If they were allowed to expire, the rates for 2013 and future years would revert to the “pre- Bush tax cut” rates of 15, 28, 31, 36 and 39.6%.
All indications at this time are that President Obama supports extending the tax rate cuts, except to the highest tax brackets starting at $250,000 for married filling jointly taxpayers and $200,000 for all other taxpayers. The Republicans continue to only support an extension of the lower Bush-era rates across-the-board to all taxpayers. This will continue to be a hotly debated issue in Washington. We will keep you informed as new developments continue to unfold.
Capital Gains/Dividends – In 2011 and 2012, qualified capital gains and dividends are taxed at a maximum rate of 15%. Unless this provision is extended, the maximum rate on net capital gains would increase to 20% in 2013. All dividends would be taxed as regular income, and therefore, could be subject to the maximum rate of 39.6%.
Limit on Itemized Deductions – Unless the Bush tax cuts are extended, higher-income taxpayers will revert to a limitation on itemized deductions in excess of a statutory threshold of adjusted gross income. There would also be a similar limitation on personal exemptions for high-income taxpayers.
Marriage Penalty Relief – The provisions currently in place to mitigate the “marriage penalty” for two income couples will expire at the end of 2012.
Small Business Tax
Bonus Depreciation – The bonus depreciation percentage for the cost of new equipment, including computers and software, purchased and placed in service in 2011 will be 100%. The bonus depreciation rate is scheduled to drop to 50% in 2012.
Action Item: Accelerate planned equipment purchases to December and you will be able to deduct the entire cost of the equipment on your 2011 tax return.
Hiring Incentives for Veterans – The Returning Heroes Tax Credit and the Wounded Warriors Tax Credit were recently enacted on November 21, 2011. Under this new law, employers are eligible for a tax credit when hiring certain qualified military veterans. This provision is currently scheduled to expire on 12/31/2012.
Action Item: A certification form must be filed with the state workforce agency within 28 days of the employment date to certify that the individual is eligible for the Work Opportunity Tax Credit.
From 1099 Reporting – There are new questions on this year’s Schedule C (Profit or Loss from Business) and Schedule E (Supplemental Income and Loss) regarding the 1099 reporting of certain payments made to individuals in the course of your trade or business. IRS is asking taxpayers if they had any payments that would require 1099 reporting and if yes, were all required forms filed.
Action Item: Confirm that you are in compliance – Penalties can add up quickly.
Federal Estate and Gift Tax
The current estate tax for 2011 is set at a maximum 35% rate and a $5 million exclusion. For 2012, the maximum rate remains the same at 35% and the inflation-adjusted exclusion is $5.120 million. Absent future legislation, after 2012, the exclusion amount will be $1 million with a maximum 55% rate. However, many experts are predicting that Congress will lower the exclusion to $3.5 million and raise the maximum rate to 45% after 2012.
Action Item: Lifetime gift giving should continue to be part of your master estate plan. Individuals can currently gift up to $13,000 per year and married couples can gift up to $26,000 per year, to each individual gift recipient free of any gift tax.
Other Items
IRS “Phishing” Scams – The IRS continues to be diligent in their efforts to protect taxpayer information and “shut down” scams as quickly as possible. They stress that the IRS does not solicit taxpayer information via e-mail. Any emails received from the “IRS” requesting personal information should be deleted.
Audits of Tax Returns – There has been an increase in audit and notice activity related to clients’ Individual Income Tax Returns (Form 1040) over the past couple of years. As the federal government continues to struggle financially, the audit/notice activity for Estate and Trust Tax Returns (Form 1041) is also starting to increase. This includes the assessment of severe non-filing penalties in cases where tax returns have not been properly filed. It should be noted that tax returns are required to be filed even if no tax is due. We are ready to help if you have any issues in this area.
Health Care Directives – Once a child turns 18, a parent/guardian’s access to medical records is terminated. Therefore, if you have young adult children, it is advisable for them to execute and Advanced Health Care Directive naming you (or someone they trust) as their personal representative so that these records do not become blocked from access.
Health Care Act
Small Business Tax Credit – Currently a tax credit is available to qualified small employers to help offset the cost of employer provided health insurance coverage.
Medicare Payroll Surtax – Effective 2013 the law currently contains provisions for imposing an additional Hospital Insurance tax of .9% on earned income in excess of $200,000 for individuals and $250,000 for married couples filing jointly. An additional 3.8% Medicare contribution tax is imposed on unearned income for higher-income taxpayers.
Estates and Trusts – The 3.8% tax is also imposed on certain estates and trusts.
Medical Expense Deduction – The threshold for the itemized medical deduction will increase after 12/31/2012. However, individuals who are 65 and older will be exempt from this increase through 2016.
State of Georgia Changes
Individual Income Tax Retirement Exclusion – The income tax exclusion on retirement income, for taxpayers who are 65 or older, increases from the current $35,000 of retirement income to the following:
2012 $ 65,000
2013 $100,000
2014 $150,000
2015 $200,000
2016 Unlimited
No need to move to Florida – Georgia is increasingly becoming a retiree friendly State.
Individuals who are ages 62 through 64 are still entitled to the $35,000 individual tax exclusion on retirement income.
Happy Holidays!