King & Wood, P.A.

Do You Need a Will or Trusts or Both?

“A traditional will could be the simplest but not necessarily the best way to pass on your legacy.”

A comprehensive estate plan is the best way to protect yourself during your lifetime and your family after you’ve passed. For many people, it’s tempting to think a simple will is all they need, as reported in a recent article, “Is a Will Really the Best Way to Pass an Inheritance to Your Family?” from The Motley Fool. This might be true if your estate is relatively small. However, there are good reasons to consider using a trust or other estate planning strategies.

A last will and testament is a binding document to allocate assets after death, assign guardianship for minor children, name an executor to manage your estate and convey other last wishes.

However, there are other considerations to an estate plan, including taxes, special needs of heirs and how quickly you want assets and property to be transferred. Your estate planning attorney can discuss how best to accomplish your goals once they are articulated.

One of the challenges of having only a will is probate. This court process authenticates a will and gives the named executor the power to manage the estate and eventually distribute assets. Probate can be a long, costly and public process when assets are unavailable to heirs.

In some jurisdictions, probate is a matter of months. In others, it can be years before probate is completed if the estate is complicated.

Most people don’t know this, but wills in probate become part of the public record. Anyone can see everything in your will, including who you leave property to and how much they receive.

An alternative is the living trust. This document establishes a legal entity to hold assets during your lifetime. The trustee can be yourself and a secondary trustee. The trustee administers the trust according to your wishes, which are established in the language of the trust.

Depending upon your state, your estate planning attorney can put a provision moving assets into the trust after your death, in case any asset is accidentally forgotten and not moved into the trust.

Living trusts are also revocable, meaning they can be amended or revoked at any point during your lifetime. This provides a great deal of flexibility.

Joint ownership is another option used mainly by married spouses. Joint Tenancy with Right of Survivorship (JTWRS) is a popular way to own property. Assets owned jointly transfer directly to the surviving spouse (or joint owner) without the need for probate.

Just as everyone’s life is different, everyone’s estate plan is different. State law varies, and the size and complexity of your estate will influence how your estate plan is structured. Your best bet might be a mixture of wills, trusts and joint ownership arrangements. An experienced estate planning attorney can create a comprehensive estate plan to suit your and your family’s needs.

Reference: The Motley Fool (September 4, 2023) “Is a Will Really the Best Way to Pass an Inheritance to Your Family?”

How Estate Planning Works with Exit Planning

“Estate planning alone isn’t enough protection for business owners, who need to also consider succession plans, as well as financial, legal and operational issues.”

A professionally created and well-executed estate plan is a must for protecting families and assets, minimizing tax liabilities and addressing personal and financial matters, says a recent article from Kiplinger, “For Business Owners, Estate and Exit Planning Join Forces.” Business owners also need to have an exit plan to be sure that their business and personal affairs will be managed according to their wishes.

Estate planning is critical because business owners are relied upon by their families and employees, customers, vendors, and the communities they serve.

Planning for the smooth transfer of ownership and management upon their retirement or death is vital for the owner, their family and all those impacted. This involves identifying and preparing successors, establishing a clear succession plan, and addressing leadership, ownership and management continuity.

Who will take over the business, how will it be valued and how can the transfer of ownership be handled to minimize tax implications and disputes among heirs? If heirs work in the business, will their roles be transitioned, and how will that happen?

Unlike personal estate planning, business owners must have their company valued by a professional, as this information will be needed to determine estate tax liabilities, equitable distribution and protect the financial well-being of surviving family members. Valuation methods include assessing the fair market value of the business, considering future earning positions, and factoring in relevant sector standards.

Estate planning for business owners also involves specific tax considerations, including minimizing estate taxes, gift taxes and capital gains taxes associated with transferring business assets. Some strategies include establishing trusts, gifting shares over time, or utilizing tax-efficient entities, such as Family Limited Partnerships (FLPs) or Grantor Retained Annuity Trusts (GRATs). An estate planning attorney will know the most appropriate strategy for each situation.

Business owners also have a vested interest in ensuring the continuity of their business. Estate planning may involve creating a continuity plan outlining how the business will be managed, who will have decision-making authority and how key roles and responsibilities will be fulfilled.

For business owners with partners or co-owners, implementing buy-sell agreements is crucial. These agreements establish the terms and conditions under which ownership interests can be transferred or sold in the event of a triggering event, such as disability, retirement, or death. A buy-sell agreement ensures a smooth ownership transition and prevents disputes among remaining owners. This should be in place long before it’s needed.

Business owners must work with trusted professionals, including estate planning attorneys, tax advisors and business valuation experts, to effectively navigate the complexities of estate and exit planning.

Reference: Kiplinger (June 7, 2023) “For Business Owners, Estate and Exit Planning Join Forces”

Should You Give Your Children an Inheritance Now?

“Retirees should secure themselves first, and if you’re all set there, then consider a few other things, such as the impact on the children and tax issues.”

The first question to ask before considering making gifts to heirs is similar to the advice heard on airplanes—“Make sure to secure your own oxygen mask before helping your kids.” But, first, make sure you secure yourself, advises a recent article titled “Leaving an Inheritance? Is It Better to Give to Kids Now or Later?” from Kiplinger.

The biggest unknown is long-term care expenses. Assuming you’ve done the correct planning for this, possibly with a Medicare Asset Protection Trust or another trust, and there are enough assets for your retirement, consider the impact of an early inheritance on your children.

Money can be a lifesaver or a murky bog, depending on the amount and the recipient. Consider what your children have done in the past with finances. If they received a gift in the past, did they use it to cover expenses, invest it, or show up at the next family gathering in a flashy luxury car? Reconsider an early inheritance, if a generous gift went to a $15,000 handbag.

The beneficiary of the funds often matters more than the amount or the type of gift. This is one reason trusts are popular estate planning tools. Trusts allow you to exercise a great deal of control over how and when the beneficiary spends their new money.

You should also consider the age and stage of the child you’re considering making a gift to. Let’s say you’re 65, and your children were born when you were 30. Your life expectancy is 85. The decision is about whether or not to give the children money in the next 20 years or at the end of 20 years. In 20 years, your children will be 55 and likely in their peak earning years. Your grandchildren will be graduating from college. Your children will be in a period where the gap between their earnings and expenses is the largest—in other words; it’s not a time when they’ll necessarily need the money.

The time they may need the money more is when their children are young. Childcare costs, or having only one spouse earning income, could be when your gift is most beneficial.

Taxes need to be considered as well. Because of the current large gift tax exemption, most of us don’t have to worry about gifting unless our estate is more than $12 million. However, capital gains, and income taxes need to be considered.

Some families prefer to leave stock to their children. You’ll likely pay 15% in capital gains taxes, if you sell stock. There's no tax if someone in the lowest two income brackets sells the stock. If you leave a stock at death in a non-retirement account, there is a step-up in basis—your child won’t pay taxes on the gains accumulated in your lifetime.

There are many different ways to approach this. However, the first step should be a talk with your estate planning attorney, who can help you determine when and how to distribute your wealth.

Reference: Kiplinger (March 7, 2023) “Leaving an Inheritance? Is It Better to Give to Kids Now or Later?”

What Is a Qualified Disability Trust?

“A qualified disability trust (QDisT) is a special needs trust that qualifies for a federal tax exemption.”

A qualified disability trust, or QDisT, qualifies for tax exemptions and applies to most trusts created for an individual with special needs. In most cases, explains a recent article from Investopedia, “Qualified Disability Trust: Meaning and Tax Requirements,” the person receiving income from the trust must pay income tax. However, in 2003, the IRS added a section allowing some disability trusts to reduce this tax liability. This is another example of why reviewing estate plans every few years is important.

Trusts need to meet several requirements to be considered qualified disability trusts for tax purposes. However, if a special needs trust meets these criteria, it could save a lot in taxes.

Most special needs trusts already meet the requirement to be treated as qualified disability trusts and can be reported as such at tax time. For 2022 tax year, the tax exemption for a QDisT is $4,400. For tax year 2023, the amount will increase to $4,700. Income from a QDisT is reported on IRS Form 1041, using an EIN, while distributions to the beneficiary will be taxed on their own 1040 form.

The best way to fully understand a QDisT is through an example. Let’s say a child is diagnosed with a disability, and their grandparents contribute $500,000 to an irrevocable special needs trust the child’s parents have established for the child's benefit. The trust generates $25,000 in annual income, and $10,000 is used annually for expenses from the child’s care and other needs.

Who pays the income tax bill on the trust’s gains? There are a few options.

The parents could include income from the trust as part of their taxes. This would be “on top” of their earned income, so they will pay their marginal tax on the $25,000 generated from the trust—paying $8,000 or more.

Alternatively, trust income spent for the child’s benefit can be taxed to the child—$10,000, as listed above. This would leave $15,000. However, this must be taxed to the trust. Trust income tax brackets are high and increase steeply. Paying this way could lead to higher taxes than if the parents paid the tax.

The QDisT was designed to alleviate this problem. QDisTs are entitled to the same exemption allowed to all individual taxpayers when filing a tax return. In 2012, for instance, the personal tax exemption was $3,800, so the first $3,800 of income from QDisTs wasn’t taxed.

The deduction for personal exemptions is suspended for tax years 2018 to 2025 by the Tax Cuts and Jobs Act, except the same law said that in any year there isn’t a personal exemption, the exemption will be allowed for a QDisT.

For tax year 2022, $4,400 is the indexed tax exemption amount for these trusts, including most special needs trusts. For tax year 2023, the amount will increase to $4,700.

To be reported as a qualified disability trust, specific requirements must be met:

• The trust must be irrevocable.
• The trust must be established for the sole benefit of the disabled beneficiary.
• The disabled beneficiary must be under age 65 when the trust is established.
• The beneficiary must have a disability included in the definition of disabled under the Social Security Act.
• The trust must be a third-party trust, meaning all funding must come from someone other than the disabled beneficiary.

An experienced estate planning attorney can help set up a special needs trust to meet the criteria for a QDisT and enjoy the tax benefits the statute grants.

Reference: Investopedia (March 4, 2023) “Qualified Disability Trust: Meaning and Tax Requirements”

When Is a Family Limited Partnership Needed?

“You don’t have to be ultra-wealthy for a family limited partnership to make sense.”

Being able to transfer wealth from one generation to the next is a good thing, especially now, when a big change is coming to the federal estate tax exemption amount, says a recent article titled “The Pros and Cons of Family Limited Partnerships” from The Wall Street Journal.

In 2022, estates valued at up to $12.06 million are exempt from federal taxes. However, on January 1, 2026, the exemption sinks to around $6 million, with adjustments for inflation. As a result, wealthy Americans are now re-evaluating their estate plans and many are turning to the Family Limited Partnership, or FLP, as a tax saving strategy.

An FLP can be tailored to suit every family’s needs. You don’t have to be ultra-wealthy for an FLP to make sense. An upper-middle class family owning a small business or real estate properties they’re not ready to sell could make good use of an FLP, as well as a real estate mogul owning properties in multiple states.

There are some caveats. The cost of setting up an FLP ranges from $8,000 to $15,000. However, it can go higher depending on the state of residence and the complexity of the partnership. There are annual operating costs, tax filings and appraisal fees. The IRS isn’t always fond of FLPs, because there is an institutional belief that FLPs are subject to abuse.

The FLP needs to be drafted with an experienced estate planning attorney, working in consultation with a CPA and financial advisor. This is definitely not a Do-It-Yourself project.

What makes these partnerships different from traditional limited partnerships is that all partners are family members. There are two kinds of partners: general and limited. The parents or grandparents are usually the general partners. They contribute the bulk of the assets, typically a small business, stock portfolio or real estate. Children are limited partners, with interests in the partnership.

The general partners control all of the investment and management decisions and bear the partnership liability, even though their ownership of assets can be as little as 1% or 2%. They make the day-to-day business decisions, including funds allocation and income distribution. The ability of the general partner to maintain control of the transferred assets is one of the FLP’s biggest advantage. The FLP reduces the taxable estate, while maintaining control of the assets.

Once the entity is created, assets can be transferred to the FLP immediately or over time, depending on the family’s plan. The overall goal is to get as much of the property out of the general partners’ taxable estate as possible. Assets in the FLP are divided and gifted to limited partners, although this is often a gift to a trust for the limited partners, who are the general partners’ descendants. Placing the assets in a trust adds another layer of protection, since the gift remains outside of the limited partner’s taxable estate as well.

To avoid a challenge by the IRS, the partnership must be conducted as a business entity. Meetings need to be scheduled regularly, with formal meeting minutes recorded properly. General partners are to be compensated for their services, and limited partners must pay taxes on their share of income from the partnership. The involvement of professionals in the FLP is needed to be sure the FLP remains compliant with IRS rules.

An alternative is to create a Family Limited Liability Company instead of a Family Limited Partnership. These can be created to operate much like an FLP, while also protecting partners from liability.

Partnerships are not for everyone. Your estate planning attorney will advise regarding whether an FLP or an FLLC makes more sense for your family.

Reference: The Wall Street Journal (Dec. 3, 2022) “The Pros and Cons of Family Limited Partnerships”

Don’t Miss Out on Estate Planning Opportunities

“People often overlook critical steps when they are doing their estate planning.”

The recent article, “Rooting Out Estate Planning Opportunities,” from Financial Advisor offers a number of frequently missed opportunities in estate planning. Chief among them are failing to update estate plans, as changes to tax laws could mean that strategies used when your estate plan was initially created may no longer be relevant.

Before these opportunities can be discovered, it’s important to have a clear accounting of all of your assets, including a balance sheet of each “bucket” of resources: personal assets, trust assets, qualified plan assets, etc. The secret to success: meeting with your estate planning attorney every few years to review this entire picture to identify potential opportunities.

Once you have a sense of the whole picture, it’s easier to spot opportunities. For instance:

A Spousal Lifetime Access Trust, or SLAT, is an irrevocable trust used when a grantor wants to transfer part of their spousal exclusion into a SLAT to provide for their spouse and descendants. The SLAT keeps assets out of the donor’s estate and authorizes the trustee to make distributions to the grantor’s spouse, while at the same time it allows children or other heirs to be named as beneficiaries. Many couples use these trusts to protect assets from lawsuits.

There are some drawbacks to keep in mind. If one spouse is the beneficiary of the other spouse, all is well while both are living. However, if one spouse dies or becomes incapacitated and all assets are in the trust, the other may lose access to the trust created for the now deceased spouse.

The loss of access and the restrictions on SLAT distribution could be addressed by having both spouses purchase life insurance policies to fill the gap. At the same time, the couple would be well advised to look into disability and long-term care insurance.

Another situation is the use of a credit shelter trust, often called a bypass trust because it bypasses the surviving spouse’s estate. They are not as advantageous as they used to be because of today’s high estate tax exemption. They were also popular when the surviving spouse wasn’t able to use their deceased spouse’s estate tax exemption.

With the federal estate tax exemption up to more than $12 million, many who still have credit shelter trusts may find they don’t make sense in the short term. However, for now the federal estate exemption is set to drop down to $6 million when the Jobs and Tax Act sunsets. Depending upon your circumstances, it may be worthwhile to maintain this trust. Your estate planning attorney will be able to guide you.

Merging old trusts into new ones, or “decanting” them, makes sense in some situations. A new trust can be better crafted to align with the latest in tax laws and serve the same beneficiaries for as long as your state’s laws permit.

The two important takeaways here:

• Estate planning requires a complete look at all of your assets and liabilities to make the best decisions on how to structure any estate and tax strategies; and
• Estate plans need to be reviewed on a regular basis—every three to five years at a minimum—to ensure the strategies still work, despite any changes in tax laws and your situation.

Reference: Financial Advisor (Nov. 1, 2022) “Rooting Out Estate Planning Opportunities”

Why Is Beneficiary Designation Important?

“When you set up your estate plan it is important to coordinate the legal planning documents that you or you and your attorney create with the document provided by your retirement account custodian and/or your life insurance carrier called a ‘Designation of Beneficiary.’”

The beneficiary designation will always supersede language of your will. Neglecting to know which assets have beneficiary designations and failing to update the designations can undo even the best estate plan.

The beneficiary designation for your life insurance or retirement account custodian provides an opportunity to tell the company who is to receive life insurance proceeds or retirement savings upon your death, explains a recent article titled “This Important Estate Planning Step is Often Missed” from Coeur d’Alene/Post Falls Press. If these are not coordinated with a last will and testament, the results are problematic at best, and worse, financially, and emotionally devastating.

This epic fail comes in many different forms, but the most common is when a life insurance policy has never been updated and an ex-spouse receives the policy proceeds. The rules differ between retirement accounts and life insurance and can be impacted by various state and federal laws (and the divorce decree, if the life insurance policy was included). However, for the most part, the ex will receive the proceeds and litigation will not succeed.

Another common beneficiary designation mistake is when a person has created a living trust or revocable trust to prevent assets from going through probate when they die. Probate can take many months to complete and there are several strategies used to take assets out of the probate estate.

When the living trust is established and assets are transferred into the trust, those assets do not pass through probate.

However, if a person (or married couple) established a living trust and fails to list both primary and secondary beneficiaries for life insurance and/or retirement accounts, it is entirely possible that the assets will go through probate.

Take the time to make an inventory of all assets and accounts. Determine which ones have a beneficiary designation and find out who is named as the beneficiary. If your retirement accounts and life insurance policies were established decades ago, this is especially important.

Failing to coordinate beneficiary designations with your estate plan could undermine your wishes. Review these items with your estate planning attorney to avoid these and many other potential pitfalls.

Reference: Coeur d’Alene/Post Falls Press (May 23, 2022) “This Important Estate Planning Step is Often Missed”

Does Power of Attorney Perform the Same Way in Every State?

“The law sometimes appears to contradict itself. Specifically, the words ‘anything and everything’ do not always legally mean ‘anything and everything’.”

A power of attorney is an estate planning legal document signed by a person, referred to as the “principal,” who grants all or part of their decision-making power to another person, who is known as the “agent.” Power of attorney laws vary by state, making it crucial to work with an estate planning attorney who is experienced in the law of the principal’s state of residence. The recent article from limaohio.com, titled “When ‘anything and everything’ does not mean anything and everything,” explains what this means for agents attempting to act on behalf of principals.

When a global or comprehensive power of attorney grants an agent the ability to do everything and anything, it may seem to the layperson they may do whatever they need to do. However, each state has laws defining an agent’s role and responsibilities.

As a matter of state law, a power of attorney does not include everything.

In some states, unless certain powers are explicitly stated, the POA does not include the right to do the following:

• Create, amend, revoke, or terminate a trust
• Make a gift
• Change a beneficiary designation on an account
• Change a beneficiary designation on a life insurance policy.

If you want your agent to be able to do any of these things, consult with an experienced estate planning attorney, who will know what your state’s law allows.

You’ll also want to keep in mind any gifting empowered by the POA. If you want your agent to gift your property to other people or to the agent, the power to gift is limited to $16,000 of value to any person in one year, unless the POA explicitly states the power to gift may exceed $16,000. An estate planning attorney will know what your state’s limits are and the tax implications of any gifts in excess of $16,000.

These types of limitations are intended to give some common-sense parameters to the POA.

Most people don’t know this, but the power of attorney can be as narrow or as broad as the principal wishes. You may want your brother-in-law to manage the sale of your home but aren’t sure he’ll do a good job with your fine art collection. Your estate planning attorney can create a power of attorney excluding him from taking any role with the art collection and empowering him to handle everything else.

Reference: limaohio.com (April 30, 2022) “When ‘anything and everything’ does not mean anything and everything”

When are You Required to File a Gift Tax Return?

“Filing a gift tax return is something that might feel a little bit gratuitous—after all, you were gifting something, not accumulating income, so why would the IRS possibly need to be in the loop?”

The IRS wants to know how much you’re gifting over the course of your lifetime. This is because while gifts may be based on generosity, they are also a strategy for avoiding taxes, including estate taxes, reports The Street in a recent article “Do I Need to File a Gift Tax Return?”

Knowing whether you need to file a gift tax return is relatively straightforward. The IRS has guidelines about who needs to file a gift tax return and who does not. Your estate planning attorney will also be able to guide you, since gifting is part of your estate and tax planning.

If you give a gift worth more than $16,000, it is likely you need to file a gift tax return. Let’s say you gave your son your old car. The value of used cars today is higher than ever because of limited supply. Therefore, you probably need to file a gift tax return. If the car title is held by you and your spouse, then the car is considered a gift from both of you. The threshold for a gift from a married couple is $32,000. Make sure that you have the right information on how the car is titled.

What if you added a significant amount of cash to an adult child’s down payment on a new home? If you as a member of a married couple gave more than $32,000, then you will need to file a gift tax return. If you are single, anything over $16,000 requires a gift tax return.

529 contributions also fall into the gift tax return category. Gifts to 529 plans are treated like any other kind of gift and follow the same rules: $16,000 for individuals, $32,000 for married couples.

What about college costs? It depends. If you made payments directly to the educational institution, no gift tax return is required. The same goes for paying medical costs directly to a hospital or other healthcare provider. However, any kind of educational expense not paid directly to the provider is treated like any other gift.

Do trusts count as gifts? Good question. This depends upon the type of trust. A conversation with your estate planning attorney is definitely recommended in this situation. If the trust is a “Crummey" trust, which gives the beneficiary a right to immediately withdraw the gift put into the trust, then you may not need to file a gift tax return.

A Crummey trust is not intended to give the beneficiary the ability to make an immediate withdrawal. However, the withdrawal right makes the gift in the trust a “current gift” and it qualifies for the annual exclusion limit. Recategorizing the gift can potentially exempt the person giving the gift from certain tax obligations. Check with your estate planning attorney.

Even when filing a gift tax return, the amount of tax being paid is usually zero. This is because the gifts are offset by each person’s lifetime exemption. The IRS wants these returns filed to keep track of how much each individual has gifted over time. Unless you are very wealthy and making gift transfers from a family trust or to family members, it is not likely you will ever end up paying a tax. You are, however, required to keep the IRS informed.

Reference: The Street (March 31, 2022) “Do I Need to File a Gift Tax Return?”

 

Is Succession Planning Necessary for Family Business Entities?

“While 88% of business owners believe their family will control their business in five years, statistics from Family Business Institute show that only 33% of businesses survive to transfer to the next generation, and only 10-15% continue to the third generation.”

Failing to have a succession plan is often the reason family businesses do not survive across the generations. Creating, designing and implementing a succession plan can protect the family’s legacy, according to the article “Planning for Success: How to Create a Suggestion Plan” from Westchester & Fairfield County Business Journals.

Start by establishing a vision for the future of the business and the family. What are the goals for the founder’s retirement? Will the business need to be sold to fund their retirement? One of the big questions concerns cash flow—do the founders need the business to operate to provide ongoing financial support?

Next, lay the groundwork regarding next generation management and the personal and professional goals of the various family members.

Several options for a successful exit plan include:

• Family succession—Transferring the business to family members
• Internal succession—Selling or transferring the business to one or more key employees or co-workers or selling the company to employees using an Employee Stock Ownership Plan (ESOP)
• External succession—Selling the business to an outside third party, engaging in an Initial Public Offering (IPO), a strategic merger or investment by an outside party.

Once a succession exit path is selected, the family needs to identify successors and identify active and non-active roles and responsibilities for family members. Decisions need to be made about how to manage the company going forward.

Tax planning should be a part of the succession plan, which needs to be aligned with the founding member’s estate plan. How the business is structured and how it is to be transferred could either save the family from an onerous tax burden or generate a tax liability so large, as to shut the company down.

Many owners are busy with the day-to-day operations of the business and neglect to do any succession planning. Alternatively, a hastily created plan skipping goal setting or ignoring professional advice occurs. The results are bad either way: losing control over a business, having to sell the business for less than its true value or being subject to excessive taxes.

Every privately held, family-owned business should have a plan in place to establish what will happen if the owners die or become incapacitated.

An estate planning attorney who has experience working with business owners will be able to guide the creation of a succession plan and ensure that it works to complement the owner’s estate plan. With the right guidance, the business owner can work with their team of professional advisors to ensure that the business continues over the generations.

Reference: Westchester & Fairfield County Business Journals (March 31, 2022) “Planning for Success: How to Create a Suggestion Plan”