Category Archives: tax law

Charitable Remainder Trusts – Case Studies

steps lightIn my previous post, I discussed the structure and tax benefits of Charitable Remainder Trusts, and the ways in which CRTs can be used to meet various estate planning goals.  The following case studies from our practice illustrate how our clients have used CRTs to meet their goals.

 

Case Study #1

Client Goal – To sell highly appreciated stock without paying substantial capital gains taxes  

Howard owned stock in a highly appreciated life sciences corporation.  The stock was valued at over $1 million and had a very low tax basis.  Howard wished to sell the stock to take advantage of market growth, but the capital gains tax due following the sale would be substantial.  Instead of selling the stock himself, Howard established a Charitable Remainder Unitrust (CRUT).  He transferred the stock to the CRUT, and the CRUT sold the stock.  Howard received an income tax deduction when the CRUT was established and deferred capital gains taxes.  He and his wife will receive from the CRUT annual payments of 30% of the trust assets for their lifetimes.

Case Study #2

Client Goal – To generate income for retirement

Bob and Nancy owned a Massachusetts vacation home valued at over $5 million.  Bob had inherited the house many decades ago and it had a low tax basis.   The couple’s other assets – including retirement accounts, investment accounts, and a primary residence – were modest and therefore insufficient for retirement.  Bob and Nancy, now in their mid 60s, wished to sell the house so they would have sufficient income for their retirements.  Rather than sell the house and incur capital gains taxes, Bob and Nancy established a Flip CRUT to which they deeded the house.  They received an income tax deduction and deferred capital gains taxes.  Following the sale of the house, and for the remainder of their lifetimes, Bob and Nancy will receive quarterly payments of 6% of the trust assets.  These payments will allow them to retire comfortably.

Case Study #3

Client Goal – To be charitable

Samuel was unmarried and never had any children.  His total assets were valued at approximately $6 million.  Samuel was philanthropic by nature and specifically wished to benefit charities that provided educational opportunities for gifted children.  Therefore, Samuel established a CRUT to which he transferred ownership of approximately $1 million of appreciated real estate and investments.  He received an income tax deduction and, if the house were sold, would be able to defer capital gains taxes.  For the remainder of his lifetime, Samuel received annual payments of 5% of the total trust assets to supplement his retirement income.  On his death, the remaining trust assets passed to a charitable foundation whose purpose was to fund educational opportunities for gifted children.

Case Study #4

Client Goal – To provide future income to a child

Eleanor was in her late 80s with declining health.  Her husband had predeceased her by many years and she had one daughter, Janice.  Eleanor was seeking ways in which to pass a portion of her $8 million dollar estate to Janice prior to her death.  Eleanor made substantial taxable gifts,.  She also established a CRUT that would pay to Janice a unitrust percentage of 5% for a term of twenty (20) years.  The CRUT was funded with marketable securities with a low tax basis.  Eleanor received an immediate income tax deduction.  Janice will receive supplementary income for twenty (20) years.  At the end of the term, Janice will select public charities to which the trust remainder will pass.

Charitable Remainder Trusts – A Versatile Estate Planning Tool

SwissA Charitable Remainder Trust (CRT) is an irrevocable trust that provides for periodic payments to be paid to individual beneficiaries with a remainder paid to a charity.  CRTs are versatile estate planning tools that can be used to meet various goals – to reduce income taxes, to defer capital gains taxes, to generate lifetime income for the donor or others, and to benefit charities.

A CRT may be funded by a donor with cash, securities, real estate or tangible personal property (such as artwork).  The CRT terms must provide that the donor (and/or his or her spouse or other family member) receive periodic payments for life or a term of years.  The payments may be a percentage of the trust assets (a “unitrust” percentage between 5% and 50% of the total trust assets) or a fixed annuity amount.  The payments may be made annually or more frequently.  The CRT terms may vary in other ways.

At the end of the term or on the death of the surviving beneficiary, the remaining assets in the CRT are paid to a charity or charities selected by the donor.  The donor may select the charities when the CRT is established, but may change the charities at a later time.  To qualify under tax laws, the remainder passing to charity must be at least 10% of the total fair market value of the trust assets.

CRTs offer significant tax benefits.  When the CRT is established, the donor receives an income tax deduction for the value of the remainder that passes to charities.  In addition, capital gains taxes are deferred until distributions are made.

CRTs are a versatile estate planning tool.  We have used them in our practice to meet a variety of client goals.  Stay tuned for an upcoming post on case studies from our practice.

Image from flickr/Jinho Jung

Will your Executor have access to your emails?

cellphoneAre you wondering what will happen to your Facebook account, emails, online photos and other digital assets after your death?  If so, you may soon have a clearer answer under Massachusetts law.  Norfolk Probate Court will soon decide whether a Personal Representative appointed in Massachusetts may access the emails of a deceased person in the case of Ajemian v. Yahoo!.  The case has worked its way through the Massachusetts courts for the last several years.

Ajemian is an interesting case with potentially significant implications.  John Ajemian died in August 2006.  He died intestate (without a Will) and at the time of his death owned a Yahoo email account.  His siblings were appointed as Personal Representatives (PRs) of his estate by Norfolk Probate Court.  After their appointment they asked Yahoo for access to John’s email account.  Yahoo denied their request.  So the PRs brought an action in Norfolk Probate Court to obtain access, but the court denied their petition.  The court held that Yahoo was prohibited from disclosing the emails under the Stored Communications Act (SCA), a federal law designed to maintain the privacy of electronic communications held by internet service providers.

On appeal, the Massachusetts Supreme Judicial Court held in October 2017 that Yahoo was not prohibited from releasing the emails to the PRs under the SCA.  The reason was two fold.   First, the emails were property of John’s estate over which the PRs could exercise control and ownership.  Second, the PRs could “lawfully consent” to the release of the emails, an exception to the disclosure prohibition of the SCA.

While the SJC decision was a victory for the PRs, the court declined to determine whether Yahoo was required to disclose the emails under Yahoo’s terms of service agreement (TOS) with John.  Yahoo argued that the TOS gives it the authority to terminate the account at any time which allows it to deny the PR’s access.  The SJC remanded to the Probate Court to determine whether Yahoo could withhold the emails under the TOS.

Yahoo petitioned to the Supreme Court, but the Supreme Court declined to hear the case in late March 2018.   This means the case is now in the hands of Norfolk Probate Court again to determine whether Yahoo can deny the PRs access to the emails based on the provisions of the TOS.

I am eagerly awaiting the decision of Norfolk Probate.  It will have widespread implications in determining whether and how PRs may access the digital assets of a decedent in Massachusetts.  Even after Norfolk Probate decides, questions will likely remain.  Will a PR be able to access a digital asset if the TOS explicitly prohibits access by a PR or states that the account terminates at death?  Will the PR’s authority over the decedent’s assets trump the provisions of the TOS?  What if access to the digital assets is not addressed in the decedent’s estate plan?

Stay tuned for additional updates about the Ajemian case and estate planning for digital assets.  This is an interesting and developing area of the law.

IRS offering same sex couples restored exclusion amount

HumptyIt’s tax season again, which means that it’s time to file your gift tax return if you made taxable gifts in 2017.   This year’s gift tax return instructions contain an interesting change for taxpayers who made taxable gifts to a same sex spouse prior to the Supreme Court’s decision in United States v. Windsor.  (If you, like me, have been thinking that our federal government did nothing kind in 2017, you’ll like this one.)

First, some background.  The Defense of Marriage Act (DOMA) was the federal law that prohibited same sex marriage.  Under DOMA, a taxpayer who made gifts to his same sex spouse in excess of the annual exclusion was required to use some of his applicable exclusion amount because the gifts were not eligible for the marital deduction.   In addition, a taxpayer who established a trust for the benefit of a much younger same sex spouse (who qualified as a “skip” person under generation skipping transfer (GST) tax law) was required to allocate a portion of his GST tax exemption to the trust if he wanted the trust to be GST exempt.

Heterosexual married couples were required to do neither.  A heterosexual married taxpayer could make unlimited gifts to a spouse without allocating application exclusion.  In addition, a heterosexual spouse would never be considered a “skip” person for GST purposes, no matter the age difference.

In 2013, in Windsor, the Supreme Court held that DOMA was unconstitutional. Shortly after Windsor, the IRS issued new rules that stated that same sex marriages would be treated the same as heterosexual marriages under federal tax law.  Gifts between same sex couples would be treated the same as gifts between heterosexual couples.  The gifts would be eligible for the unlimited marital deduction, no applicable exclusion would have to be used, and the spouse would not be considered a “skip” person for GST purposes.

But the injustice imposed by DOMA prior to 2013 was not remedied until 2017 when the IRS released Notice 2017-15.   In 2017, the IRS now offers the following two (2) remedies for same sex taxpayers:

  • Restoration of Applicable Exclusion Amount. A taxpayer who used his applicable exclusion when reporting gifts to a same sex spouse can now file a gift tax return and request that his exclusion be “restored”.  The taxpayer can get back his previously used exclusion by filing a gift tax return with a calculation of what he used in prior tax years.  This can be done even if the limitations period has run, which means the exclusion can be restored back to the beginning of the marriage, as long as the marriage was recognized under state law.  If the taxpayer would have to make a QTIP or QDOT election to qualify the gift for the unlimited marital deduction, he will also have to file a request for 9100 relief.
  • Recalculation of the Available GST Exemption. The IRS will treat as void certain allocations of GST exemption to transfers to a same sex spouse and/or his or her descendants.  This allows the taxpayer to recalculate his remaining GST exemption and get back GST exemption allocated on prior returns.  As above, to obtain relief, the taxpayer must file a gift tax return and explain the recalculation of his or her GST exemption.

In both cases, the IRS states its preference that the restoration and recalculation be done on the first gift tax return required to be filed after issuance.  This means the requests for recalculation should be made on the 2017 return, if 2017 gifts were made.

Image of Denslow’s Humpty Dumpty 1904 from Wikipedia.

Your Living Will and Dementia

elderlyA Living Will is a legal document that is typically part of an Estate Plan.  In a Living Will, you express your wishes about the medical care you would like to receive at the end of your life.  It includes instructions about when and under what circumstances you want medical care to be withheld or withdrawn resulting in your death.  The instructions in your Living Will guide the person named as your health care agent in your Health Care Proxy in making end of life health care decisions for you when you are unable to do so.   To put it bluntly, you are instructing the health care agent when it is okay to “pull the plug”.

If you do not have a Living Will, Massachusetts law presumes that you wish your life to be extended as long as possible with all available medical treatments and interventions, even if you have a poor quality of life with little chance of recovery.  If that is not your wish, you should put your wishes in writing by signing a Living Will that expresses your wishes.  Verbal instructions to family members are not legally binding.

A recent and interesting NPR program focused on a team of doctors at the University of Washington who are advising patients, while still healthy, to sign a dementia-specific Living Will.  Their sample dementia directive form includes specific instructions about end of life care for those suffering from Alzheimer’s or other forms of dementia.  It allows the patient to express different wishes about desired care at different stages of illness – mild, moderate and severe

These doctors believe specific language for dementia should be included in a Living Will because dementia is unique and as dementia progresses patients become increasingly unable to express wishes about medical care and the side effects of that care become increasingly intolerable.   The University of Washington doctors also cite the increasing number of people who will be suffering from dementia in the future as another reason to specifically address this issue.

I advise all my clients to sign a Living Will and offer my clients recommended language.  The Living Wills I recommend do not yet include specific instructions for dementia.   Although I do not specifically endorse the University of Washington sample dementia directive form, I believe this is an important issue and intend to pay more attention to it in the future.   If you wish to explore this issue further, consult an estate planning attorney or check out the resources available at The Conversation Project.

Themes and Highlights from the 2018 Heckerling Institute on Estate Planning

Letter HDale and I recently attended the 52nd annual Heckerling Institute on Estate Planning in Orlando, Florida.  The passage of the Tax Cuts and Jobs Act in 2017 meant that there was even more to learn and discuss this year.  The following are some of the themes and highlights that we found most interesting.

The federal estate tax exemption has substantially increased.  The new tax law raised the federal estate tax exemption substantially, but did not repeal the federal estate tax.  The new higher exemption (with the chained CPI adjustment) is expected to be $11.18 million per person in 2018.

Gifting may still make sense.  For those with federally taxable estates, gifting up to the increased federal exemption amount may make sense.  The experts predict that the IRS is unlikely to impose “clawback” if the exemption returns to its 2017 level after 2025 when the increased exemption is scheduled to sunset.  Upcoming regulations will likely formally address “clawback”.

Keep your eyes on the sunset.  Some portions of the new tax law sunset in 2025.  Some do not.  The increased federal exemption sunsets at the end of 2025.  This illustration from the Tax Policy Center explains the sunset provisions.

Family entities may be targeted by the IRS.  In Estate of Powell v. Commissioner, the Tax Court agreed with the IRS and held that all assets in a family limited partnership (FLP) were includible in a decedent’s estate under Section 2036(a)(2) of the Internal Revenue Code even though the decedent owned only a limited partnership interest because the decedent retained the right to dissolve the FLP in conjunction with other family members.  The court also addressed the possibility of “double inclusion” of the assets under Section 2043.  Because the IRS may use Powell to attack other family entities in the future, it may be wise to rethink the structure and terms of those entities.

Managing tax basis and federal income tax planning are essential.  The increased federal exemption means federal income tax planning is even more important.  Clients and advisors must focus on estate planning strategies to maximize tax basis and reduce capital gains taxes by passing high basis assets to future generations.

Attitudes about charitable giving are changing.  The new tax law, as well as new attitudes about charitable giving and philanthropy, are changing the landscape of charitable planning.  Many younger clients are focused more on charitable impact and less on tax savings.   Crowdfunding websites like Kickstarter and Go Fund Me offer new giving opportunities that may appeal to young philanthropic clients more than traditional strategies.

Look at Roth conversions in a new light.  Natalie Choate discussed some interesting opportunities for planning with retirement accounts, including an in depth discussion of the rules regarding Roth conversions and opportunities for income and estate tax planning with Roth conversions.  Importantly, the new tax law eliminated the opportunity to “recharacterize” (or undo) a Roth conversion.

 

Think you no longer need a good Estate Plan? You’re probably wrong.

Long roadThink you no longer need a high quality Estate Plan now that the Tax Cuts and Jobs Act has taken effect?  Think again!  You do, and here’s why.

The Tax Cuts and Jobs Act of 2017 increased the Federal estate and gift tax exemption to $11.2 million.  This means that individuals with $11.2 million and married couples with $22.4 million will not be subject to Federal estate taxes at their death.   Nonetheless, even for those of us who will likely never have such substantial wealth, it is still essential to have in place a high quality Estate Plan.  The following are three important reasons.

  • State estate tax laws remain in place. Massachusetts (and thirteen other states plus the District of Columbia) still impose a state estate tax.  In 2018, the Massachusetts estate tax exemption is $1 million and the top estate tax rate is 16%.   The Massachusetts estate tax is unlikely to change substantially in the near future.  Massachusetts estate taxes can be substantial and failing to plan for them is a mistake.
  • The Federal tax laws may change. A future Democratic Congress may amend the new tax law and reduce the Federal exemption back to the 2017 level ($5.49 million per individual) or even lower.   For this reason, it is important to have in place a flexible estate plan with estate tax planning provisions that are designed to minimize or eliminate both state and Federal estate taxes, regardless of the specifics of the existing law.
  • Estate taxes are not the only reason to have a good Estate Plan. There are lots of reasons – other than estate tax planning – to have in place a high quality estate plan.   Estate planning is essential to ensure that all family members are provided for properly.  This includes minor children, disabled adults, second spouses, adult children likely to divorce, adult children with unique needs or lifestyles, spendthrifts, and more.  More complex planning is also required for those who own family businesses or unique assets.  In addition, a good estate plan simplifies the process of estate administration and may avoid unnecessary delays, costs, and family conflict.  Finally, an estate plan can ensure that your assets can be managed properly for your benefit during you lifetime if you become incapacitated.

The change in the Federal tax laws may change the nature of estate planning and may even create new opportunities for planning.   But it does not eliminate the need for planning.  We intend to offer more advice on this in future months.  Stay tuned!

Hugh Hefner and Inter Vivos QTIP Trusts

HefnerThe iconic Hugh Hefner, founder of Playboy magazine, died last week.  Hefner was married three times and had four children, two from each of his first two marriages.  He was also survived by his current wife, 31 year old Crystal Harris, whom he married in 2012, at the age of 86.

There is no doubt that Hefner’s estate is large, and likely includes interests in Playboy Enterprises, Inc., the privately held company he founded.  How will his estate be divided?  That depends on his Estate Plan.

If Hefner planned properly, we’ll never know the details of his Estate Plan.  Rumor has it Crystal Harris will not receive any assets from the Estate, but that Hefner nonetheless provided for her.  But how?  My theory is that before his death Hefner established and funded a Trust for Crystal’s benefit that would provide for her after his death.  This kind of trust is known as an irrevocable inter vivos QTIP Trust.  (My husband tells me in this context it sounds like something dirty.  It’s not.)  QTIP stands for Qualified Terminable Interest Property.   Inter vivos means it was established during the donor’s lifetime.  Irrevocable means it cannot be revoked or amended.

There are several features of the inter vivos QTIP Trust that make it a good estate planning strategy for Hefner (and perhaps others like him).

First, a QTIP Trust is eligible for the unlimited marital deduction, and thus is not subject to estate taxes at Hefner’s death.  In addition, Hefner’s gifts to the trust during his lifetime were not taxable gifts and thus did not deplete his gift/estate tax exemption.   What is left in the trust at Crystal’s death will be included in her estate, but may be fully protected by her own estate tax exemption so that no estate taxes will be due.

Second, for the trust to qualify for the marital deduction, Crystal must be the sole beneficiary.  In addition, she must receive all the net income from the trust, and may receive principal.  These Internal Revenue Code requirements are likely consistent with Hefner’s goals in providing for Crystal.

Third, when the trust was established, Hefner set its terms.  This means Crystal does not control the assets.  In addition, Hefner directed how the assets remaining in the trust at Crystal’s death will pass.  Thus, he could ensure that they pass to his children or grandchildren.  If he had left assets outright to her, they could pass to her future husband or children.  For this reason, QTIP Trusts are a great planning strategy for couples in second or third marriages.

Fourth, the QTIP Trust may be a grantor trust, so that Hefner – the donor – paid the income taxes on the trust income during his lifetime.   This ensures that the income taxes do not deplete what is available for Crystal after his death.

Fifth, the QTIP Trust is separate from Hefner’s other estate plan documents.  This creates less risk of a Will contest or other conflict during estate administration.

Inter vivos QTIP Trusts are not for everyone, but they can offer some clients significant benefits and estate tax savings.

Image from flickr, Alan Light. https://www.flickr.com/photos/alan-light/255835461.

Don’t Take Your Testamentary Freedom for Granted

river-frontage-233041_960_720Despite recent events, the United States is still the land of the free.  And one of the (less discussed) freedoms we enjoy in the U.S. is the freedom of testation – the freedom to dispose of our assets at our death however we wish.  With few exceptions, we in the U.S. are free to disinherit children, leave insufficient assets to a spouse, and benefit pets rather than family members, to list a few examples.  The one notable exception is that most states (including Massachusetts) have an elective share statute which ensures that a spouse cannot be totally disinherited.

While this “testamentary freedom” may seem like common sense to us, it is unusual and does not exist in most countries around the world.  In much of Latin America, contintental Europe, the Middle East, and Asia, “mandatory inheritance” or “forced heirship” laws require that spouses and descendants (and sometimes even parents or siblings) inherit, regardless of what a decedent’s Will states.  These laws are especially common in civil law jurisdictions.  The rationale of these laws is the legal theory that family members have an automatic right to inherit property and that decedents have an obligation to adequately provide for them.  In most countries, the forced heirship law applies to a portion of the estate (e.g., 1/3), although it may be a large portion.  The decedent may dispose of the rest as he or she wishes.

In the United States, Louisiana is the only state with a forced heirship law.  But even Louisiana’s law is limited in that it only prohibits the disinheritance of children who are under age 24 or who are disabled or incapacitated.  Puerto Rico also gives a decedent’s children the right to inherit a portion of the Puerto Rico estate, provided that a surviving spouse retains a usufruct (or a life estate) in the property.

For U.S. clients who own real property abroad, it is important to consider forced heirship laws of the country where the property is located as part of your estate planning.  Otherwise that property may pass under that country’s forced heirship law, and not as designated in your estate plan.

Here is an example that came up recently in my practice:

Sarah died as a Massachusetts resident owning a valuable vacation home in Puerto Rico.  She was survived by her husband, Jack, and three grown children.  Her Massachusetts estate plan left all of her assets to Jack.  Nonetheless, Puerto Rico’s forced heirship laws required that a portion of the Puerto Rico home pass to the three children.  Jack retained only a usufruct, or life estate.  The property was sold, but only a part of the proceeds passed to Jack.  The rest passed to the children.  It was not the result Jack wanted, or Sarah would have wanted.

If you own real property in a forced heirship jurisdiction, you should discuss with your estate planning attorney how that property will pass after your death under that jurisdiction’s laws.  In some cases, there may be an opportunity, with advance planning, to circumvent the laws and obtain the result you want.  For example, you may want to form an entity to own the property.

Gifts to 529 Plans – Have Your Cake and Eat it Too

food-1281766_960_720Lifetime gifting to children and grandchildren is an important estate planning tool that can result in substantial estate tax savings.  For that reason, we often recommend it to wealthy clients.  Typically, for gifted assets to be excluded from a donor’s estate at death and not subject to estate taxes, the gift must be complete and irrevocable.  That means that once a gift is made the donor cannot access or control the gifted assets.  Even clients with substantial assets may be reluctant to make gifts because of this loss of access and control.

But there is one type of gift that allows donors to make lifetime gifts that will be excluded from their estates without losing access or control – gifts to Section 529 plans.  529 plans are tax-advantaged investment accounts in which a donor sets aside money to fund a child or grandchild’s college education.  Contributions to a 529 plan of which the donor is the owner (sometimes called the “participant”) are not included in the donor’s estate and will not be subject to estate taxes.  Yet, importantly, the donor, as the account owner, retains control over the assets.  In addition, the donor can reacquire the assets in the future (provided he pay income taxes and a penalty).  Because the donor retains access and control, gifts to 529s allow the donor to “have his cake and eat it too.”

There are some disadvantages to consider.  Distributions from 529 plans must be used on qualified higher education expenses and if not, are subject to penalty.  Assets in a 529 account may impact the student’s eligibility for financial aid.  For more on that, see my prior post.  Also, there is one exception to the estate exclusionary rule.  A donor may frontload a 529 account with five times the annual gift tax exclusion amount (currently $14,000), for total gifts of $70,000 per donor, but if he dies within five years following the contribution, a portion of the gift will be included in his estate and subject to estate tax.

For clients interested in reducing estate taxes but reluctant to lose access to and control of assets, lifetime gifts to 529 plans may be an appealing way of making lifetime gifts.  In addition, for emotional reasons, the opportunity to fund a grandchild’s college education may be especially meaningful.   529 accounts are also easy and inexpensive to set up and administer, and for those reasons can be a great way to make gifts.

Image from pixabay.