King & Wood, P.A.

Can a Charity Be a Beneficiary of an Estate?

“Ever since a group of philanthropists created the Giving Pledge in 2010, taxpayers have expressed greater interest in potential estate planning strategies that would allow them to leave a significant portion of their assets to charity upon their death.”

The interest in charitable giving increased in 2020 for two reasons. One was a dramatic increase in need as a result of the COVID pandemic, reports The Tax Advisor’s article “Charitable income tax deductions for trusts and estates.” The other was more pragmatic from a tax planning perspective. The CARES Act increased the amounts of charitable contributions that may be deducted from taxes by individuals and corporations.

What if a person wishes to make a donation from the assets that are held in trust? Is that still an income tax deduction? It depends.

The rules for donations from trusts are substantially different than those for charitable contribution deductions for individuals and corporations. The IRS code allows an estate or nongrantor trust to make a deduction which, if pursuant to the terms of the governing instrument, is paid for a purpose specified in Section 170(c). For trusts created on or before October 9, 1969, the IRS code expands the scope of the deduction to allow for a deduction of the gross income set aside permanently for charitable purposes.

If the trust or estate allows for payments to be made for charity, then donations from a trust are allowed and may be tax deductions. Otherwise, they cannot be deducted.

If the trust or estate allows distributions for charity, the type of asset contributed and how it was acquired by the trust or estate determines whether a tax deduction for a charitable donation is permitted. Here are some basic rules, but every situation is different and requires the guidance of an experienced estate planning attorney.

Cash donations. A trust or estate making cash donations may deduct to the extent of the lesser of the taxable income for the year or the amount of the contribution.

Noncash assets purchased by the trust/estate: If the trust or estate purchased marketable securities with income, the cost basis of the asset is considered the amount contributed from gross income. The trust or estate cannot avoid recognizing capital gain on a noncash asset that is donated, while also deducting the full value of the asset contributed. The trust or estate’s deduction is limited to the asset’s cost basis.

Noncash assets contributed to the trust/estate: If the trust or estate acquired an asset it wants to donate to charity as part of the funding of the fiduciary arrangement, no charity deduction is permitted. The asset that is part of the trust or estate’s corpus, the principal of the estate, is not gross income.

The order of charitable deductions, compared to distribution deductions, can cause a great deal of complexity in tax planning and reporting. Required distributions to noncharitable beneficiaries must be accounted for first, and the charitable deduction is not taken into account in calculating distributable net income. The recipients of the distributions do not get the benefit of the deduction. The trust or the estate does.

Charitable distributions are considered next, which may offset any remaining taxable income. Last are discretionary distributions to noncharitable beneficiaries, so these beneficiaries may receive the largest benefit from any charitable deduction.

If the trust claims a charitable deduction, it must file form 1041A for the relevant tax year, unless it meets any of the exceptions noted in the instructions in the form.

These are complex estate and tax matters, requiring the guidance of an experienced estate planning attorney for optimal results.

Reference: The Tax Advisor (March 1, 2021) “Charitable income tax deductions for trusts and estates”

Should Inherited Money Be Equally Split Between Family Members

“When you’re planning to divide your estate unequally, explain the reasons to your heirs, and remember: They might be hurt anyway.”

Leaving an equal amount to adult children works for many families, but equal is not always equitable. In those cases, leaving different amounts to heirs can lead to irreparable breaks within the family. A recent article titled “The Unequal Inheritance: It Can Work, or It Can ‘Destroy Relationships’” from The New York Times examines the problem and some of the solutions. There are times, however, when even the fairest of decisions doesn’t heal the “Mom always liked you best” hurt, imagined or otherwise.

Unequal inheritances can trigger sibling fighting after a parent dies, some of which end up in court, especially if one child thinks that a parent was being overly influenced by the sibling who ended up with the bigger inheritance.

Parents need to explain their decision to each child, individually and as a group, or even seek mediation. Many estate planning attorneys encourage a family meeting, where everyone is in a neutral location, to discuss the parent’s wishes and estate plan. In some cases, the children understand when one of the siblings is disabled or has a lower earning potential.

Another reason for unequal inheritances is to balance things out when one child received significant support that others did not need. Equalization of gifts can be documented in an estate plan, as heirs may need to be reminded of the parent’s generosity at an earlier date. If this isn’t addressed, the siblings who received less help during the parent’s lifetime may resent their decision to give equally.

What about the caregiving child? Some parents decide to give extra to the adult child who became their primary caregiver. That usually takes the shape of the family home, a larger cash distribution or life insurance proceeds. However, siblings don’t always agree on how this is handled. Some will see the child’s decision to care for their parents as manipulative.

Blended families with stepchildren run into complications often. The growth in stepfamilies is a big part of why Americans 50 and older left their children unequal bequests, which more than doubled from 16 percent in 1995 to 35 percent in 2010, as reported in a study from the National Bureau of Economic Research.

At the same time, the study also found that the longer the relationship, the more likely the parent would leave stepchildren inheritances equal to that of a biological or adopted child.

Even when parents intend to split the estate equally, failing to plan for taxes can leave children with different inheritances. This happens when parents leave different types of assets to different heirs.

If a parent left a $500,000 IRA to one child and a $500,000 taxable brokerage account to another, the child who received the IRA will pay federal income taxes up to 37 percent on every withdrawal, which now must be done within ten years of the death of the parent. The child with the brokerage account would have to pay a long-term capital gains tax of up to 20 percent, when an appreciated asset was sold.

Generally speaking, IRA and other tax deferred accounts should have all children as equal beneficiaries. These accounts are usually outside of the probate estate. A house may be left in a trust or the will, with directions for the house to be sold and all assets divided equally.

There is no way around it—inheritances are seen as a proxy for love, and any unequal distribution will be felt as such, even by the most rational of people. Speak with your estate planning attorney to learn how to avoid these scenarios and consider holding a family meeting to make sure your intentions and the reasons behind your intentions are made clear to all concerned.

Reference: The New York Times (Feb. 19, 2021) “The Unequal Inheritance: It Can Work, or It Can ‘Destroy Relationships’”

 

Searching for Lower Taxes? Check State Laws

“Some states are great to live in, but not so great to die in.”

If you are among the many Americans making a move because of economics, a recent article from MarketWatch titled “Thinking about moving to a state with lower taxes? These are the mistake to avoid” has the information you need about the tax impact of your prospective new home state.

Moving to a state with no personal income tax is not the quick and easy answer it seems. You’ve got to look at ALL the taxes that apply to residents, from property taxes to estate and inheritance taxes.

Here’s a good example: Texas has no personal state income tax. Colorado has a flat 4.63% personal state income tax. Therefore, if you are working and have a good income, it makes sense that Texas would be your best option, right? Wrong.

The property tax rate on a home in some Colorado Springs neighborhoods is about 0.49% of the property’s actual value. Let’s say you move to one of these areas and buy a home for $500,000. Your annual property tax bill: $2,450. Let’s say your taxable income is $200,000. Your Colorado state income tax bill would be $9,260, and with the property tax, your tax bill would be $11,710. For that same $500,000 home in Dallas—your property tax would be $21,200 or about $17,800 if you are over age 65 or a surviving spouse. The higher property tax means that your annual tax bill is lower in Colorado.

What about after you die? Seventeen states and the District of Columbia impose their own estate tax or inheritance tax, and Maryland imposes both. Exemptions from the state estate tax are way below the current federal estate tax exemption. However, if you move to the wrong state, your estate could shrink dramatically from the state’s death taxes.

To clarify, an estate tax is charged against the entire taxable estate, regardless of who inherits from the estate. An inheritance tax is charged against people who receive inheritance. The rate usually depends upon their relationship to you.

Here are a few state estate taxes to consider:

• Connecticut’s top estate tax rate is 12%, with a $5.1 million exemption allowed for 2020. The exemption increases to $7.1 million in 2021, and $9.1 million in 2022. Above $15 million of the estate tax value, the tax rate drops to 0%.
• Hawaii’s top estate tax rate is 20%, and in 2020, there is a $5.49 million exemption.
• In Illinois, the top tax rate is 16%, with a $4 million exemption in 2020.

Review the entire tax picture, before making this important decision. You should also confer with your estate planning attorney to learn how your estate’s structure—trusts and other estate planning tools—would work in a different state. Keep in mind that all of these tax exemptions, including the federal one, are likely to change as local, state and federal governments respond to the increased costs and lowered revenues brought about by the COVID-19 pandemic.

Reference: MarketWatch (Aug. 30, 2020) “Thinking about moving to a state with lower taxes? These are the mistake to avoid”

 

Understanding GRATs in Estate Planning

“Simultaneously, T&E practitioners are well aware of the primary risk posed by a GRAT; namely, the mortality of a grantor during the GRAT’s term.”

The 9^th U.S. Circuit Court of Appeals addressed whether a Grantor Retained Annuity Trust, or GRAT, should be included as a taxable asset in an estate, where the decedent died during the annuity period. The case, Badgley v. United States, was discussed in an article from Wealth Management titled “A String of Bad Luck: GRAT Assets Included in Taxable Estate.”

In 1988, Patricia Yoder created a GRAT, retaining the right to receive an annual annuity for a 15-year term. On the earlier of the term’s expiration and her death, the remainder interest would transfer to Patricia’s daughters under the terms of the GRAT. She funded the GRAT with a partnership interest valued at approximately $2.4 million. A gift tax return reporting the gift of the GRAT’s remainder interest was filed. She died in November 2012, just before the end of the GRAT term.

The family filed an estate tax return, and the entire date-of-death value of the GRAT was included in the gross estate. The executor of the estate then filed an action for a tax refund, claiming that only the present value of the unpaid annuity payments should have been included. A district court rejected that argument, stating that Patricia’s annuity interest was both a retained right to income and the continued enjoyment of the property, as defined in IRC Section 2036 and, therefore, was wholly includable.

The executor argued that it was not includible, as there is no explicit mention of annuities in Section 2036. The court disagreed, stating that “if the taxpayer does not let the property go, neither will the taxman.”

The court held that Section 2036 includes purportedly transferred property that the taxpayer continues to retain possession and enjoyment of, or a right to income. If there is enough of a connection from the owner to the transferred property, the property is included in the taxable estate.

In this case, the owner of the annuity received a substantial economic benefit from the GRAT, in the form of a 15-year annuity, so it was properly included in her estate.

When planning to minimize taxes during life and death, GRATs are frequently used to transfer appreciation from a person’s taxable estate with minimal or no gift tax, by reducing or zeroing out the value of the remainder interest, through fine-tuning the trust term and annuity amount.

However, there is a risk: there’s no way to know when a person will die. The successful use of the GRAT is predicated on avoiding the estate tax, in addition to the gift tax, and the GRAT success requires the person to survive the GRAT’s term.

An estate planning attorney working closely with the family and their financial professionals will need to explain how the GRAT works to ensure that it works to their estate’s benefit.

Reference: Wealth Management (May 13, 2020) “A String of Bad Luck: GRAT Assets Included in Taxable Estate”